Blog: Form 1040 Schedule 1, line 8t – A Deferred Comp Dilemma

Executive Summary

Nonqualified plan sponsors required to use “box 11” of Form W-2 in 2023 to report payments of nonqualified deferred compensation and/or FICA taxation of unpaid deferred compensation may soon receive negative feedback from nonqualified plan participants who are upset about potential double taxation of nonqualified deferred compensation. The issue of double taxation arises because the Form 1040 filing instructions for 2023 require nonqualified deferred compensation payments reported in box 11 of Form W-2 to be reported on an employee’s Form 1040 as “wage” income subject to income tax and again as “additional income” on line 8t of Schedule 1, also subject to income tax.

Key Takeaways

1. Nonqualified Plan Reporting:

There are two scenarios for reporting nonqualified deferred compensation on Form W-2 box 11:

1. 1. 1. Actual payments that should be reported as wages in box 1.
      2. Unpaid amounts that are subject to FICA taxation when vested but are not subject to income taxes until distributed.

Reporting nonqualified deferred compensation as "additional income" on Form 1040 Schedule 1 is inappropriate in both scenarios because it leads to an unnecessary and confusing duplication of taxes.

2. Form 1040 Filing Instructions: For 2023, a new line, line 8t of Schedule 1, requires taxpayers to report certain nonqualified deferred compensation amounts. However, the instructions incorrectly imply that all amounts in box 11 should also be reported on this line, potentially leading to double taxation for paid amounts and incorrect taxation for unpaid amounts.
   
   
3. Double Taxation Issue: Nonqualified plan participants may face double taxation on nonqualified deferred compensation payments because instructions for filing Form 1040 require amounts reported in box 11 to be treated as "wage" income and also as "additional income" on the new line 8t of Schedule 1.
   
   
4. Participant Complaints: Participants, especially participants who are active employees, may complain to plan sponsors if they correctly ignore the 1040 instructions regarding new line 8t, and may request a revised W-2 without deferred compensation payments reported in box 11.
   
   
5. IRS Audit Concerns: Potential IRS audit risk arises for nonqualified plan participants if they do not report amounts in box 11 on the new line 8t of Schedule 1 as "additional income."
   
   
6. Additional Guidance or Changes are Needed: The complex and confusing filing instructions have resulted in frustration among taxpayers which will likely continue into future tax years unless corrected by the IRS.

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Nonqualified deferred compensation plans, such as 401(k) excess plans, have the same deferred income tax treatment as their qualified counterparts (e.g.: 401(k) plans) as long as future payment of benefits is subject to a “substantial risk of forfeiture.” This means that the employer/plan sponsor retains deferred compensation on its balance sheet – and not in a secure/qualified trust - making the employee an unsecured creditor of the employer. If the employer were to become bankrupt, the compensation deferred by the employee into the nonqualified plan would be subject bankruptcy proceedings and could be forfeited.

As long as this substantial risk of forfeiture exists, nonqualified plan participants are not subject to federal and state income taxes on the amounts they have deferred. Rather, participants are liable for paying income tax on the deferred compensation when they collect distributions from the nonqualified plan, similar to payments from a 401(k) plan. FICA taxes on deferred compensation are treated differently: these are due as soon as the participant becomes vested in the deferred amounts, even if payment will occur at a later date. Until recently, IRS Form W-2 has effectively differentiated which compensation is received and which is deferred into a nonqualified plan, as well as what compensation is subject to FICA taxes. However, the introduction of a new line item on Schedule 1 (Form 1040) has created a dilemma whereby nonqualified plan participants may be subject to incorrect taxation, double taxation or unnecessary audits.

Changes to Form 1040
On January 20, 2023, the Internal Revenue Service published 1040 (and 1040-SR) Instructions for Tax Year 2022. Among the changes to the 2022 tax law outlined in the ‘What’s New’ section is information about new lines on Form 1040 and adjustment to Schedule 1. Regarding nonqualified deferred compensation, the guidance states on page 6: “Pension or annuity from a nonqualified deferred compensation plan or a nongovernmental section 457 plan are now reported on Schedule 1, line 8t.”

The guidance restates the requirement to report nonqualified plan compensation on line 8t in several instances. The requirement is restated on page 24, and on page 86 the guidance states:

Pension or annuity from a nonqualified deferred compensation plan or a nongovernmental section 457 plan. Enter the amount that you received as a pension or annuity from a nonqualified deferred compensation plan or a nongovernmental 457 plan. This may be shown in box 11 of Form W-2. If you received such an amount but box 11 is blank, contact your employer or the payer for the amount received.

Importantly, further along in the guidance, completely contradictory (but correct) instructions are provided on page 90, on Adjustments to Income – Line 20, IRA Deduction, which states the following:

If you received income from a nonqualified deferred compensation plan or nongovernmental section 457 plan that is included in box 1 of your Form W-2, or in box 1 of Form 1099-NEC, don’t include that income on line 8 of the worksheet. The income should be shown in (a) box 11 of your Form W-2, (b) box 12 of your Form W-2 with code Z, or (c) box 15 of Form 1099-MISC. If it isn't, contact your employer or the payer for the amount of the income.

The Crux of the Issue
Employers are required to report deferred compensation in W-2 box 11 in two different situations: 1) for the actual payment of deferred compensation, and 2) for the unpaid deferred compensation that becomes subject to FICA taxation when vested.

• Actual Payment – when a nonqualified plan participant receives plan distributions, their Form W-2 for that year will report nonqualified plan distributions as wages in box 1, as well as box 11 on nonqualified plans. Boxes 1 and 11 may or may not be the same depending on whether or not the participant was paid other compensation from the employer during the year. The issue of double taxation arises if/when the participant lists the Form W-2 box 11 amount on Form 1040, Schedule 1, line 8t, as stated on IRS guidance pages 24 and 86. If so, the distribution will be taxed twice. Savvy tax filers may heed the guidance on page 90, Adjustments to Income, and forgo listing the distribution on line 8 to avoid this double tax but, unfortunately, many may not.
  
  
• Unpaid Deferred Compensation Subject to FICA Taxation – Nonqualified deferred compensation plans use a special timing rule for FICA taxes. The special timing rule stipulates that participant deferrals and employer contributions are subject to FICA taxes in the year in which they are vested even though the participant may not receive distributions in that year. A record of payment of the FICA taxes is recorded via Form W-2 box 11, and the vested deferred compensation is included in box 3 for Social Security wages and box 5 for Medicare wages. However, per the IRS guidance on Form 1040, values marked in box 11 may be added to Form 1040, Schedule 1, line 8t even though the employee actually deferred the compensation and did not receive it. Therefore, the taxpayer will be liable for income tax per its inclusion on line 8t, and will again be liable for tax when they receive distributions of that deferred income in the future.

Resolution is Needed
As of December 30, 2024, the IRS “Known issues and solutions” webpage does not address the conflicting nonqualified deferred compensation reporting requirements between Forms W-2 and 1040. However, there are a few potential remedies the IRS can consider to alleviate this double taxation dilemma:

• Re-issue instructions for employers completing Form W-2 that do not require them to declare payments from a nonqualified plan in boxes 1 and 11; amend the instructions to have applicable payments only declared in box 1.
• Remove line 8t, and any associated nonqualified plan reporting requirements, from Form 1040. Schedule 1.
• If Form 1040, Schedule 1, line 8t is not removed, the IRS should provide greater clarity in its issued guidance about the reporting requirements for 8t and which payments apply.

If the IRS does not make changes or provide more information, it is highly likely that nonqualified plan participants will be exposed to a double taxation risk and/or a high audit risk if their filings do not adhere to the conflicting guidance. Nonqualified plan participants and plan sponsors can file complaints to the IRS alerting them of this issue and its undue burden on companies and their employees.

This blog is for informational purposes only and does not constitute legal, tax, or accounting advice. Please consult with a qualified professional before taking any action based on the information provided in this blog. The author and publisher are not responsible for any errors or omissions, or for any actions taken based on this information.