Reporting Deferred Compensation on Form 990
Tax-exempt organizations often provide deferred compensation to their officers, key employees, and most highly compensated employees. Like current compensation payable to such employees, deferred compensation must be reported annually on Form 990, Schedule J. For the most part, Schedule J is straightforward. However, it is not always obvious how to apply the rules for reporting deferred compensation. This blog post describes the rules and gives an illustrative example.
The instructions for Part II of Schedule J state that column (C) is the place to enter “all current-year deferrals of compensation.” They explain that deferred compensation is “compensation that is earned or accrued in, or is attributable to, one year and deferred for any reason to a future year.” However, short-term deferrals are expressly excluded from the reporting obligation: “don’t report in column (C) a deferral of compensation that causes an amount to be deferred from the calendar year ending with or within the tax year to a date that isn’t more than 2½ months after the end of the calendar year ending with or within the tax year.”
The instructions also explain when deferred compensation is reportable: “do not report deferred compensation in column (C) before it is earned or accrued under the principles described.” They go on to explain that deferred compensation “is generally treated as earned or accrued in the year that services are rendered,” and that “if the payment of an amount of deferred compensation requires the employee to perform services for a period of time, the amount is treated as accrued or earned ratably over the course of the service period.”
Let’s see how these rules apply to one common scenario, a deferred bonus program for an employee who manages a university endowment. In this example, the university has an August 31 fiscal year end, and the employee has a deferred bonus of $100,000 for each of FY2020, FY2021 and FY2022. Each deferred bonus vests over three years, based on continued service from the first day of the fiscal year following the bonus year through the last day of the third fiscal year following the bonus year. Following the rules set out above, each deferred bonus is treated as being earned ratably over the course of the service period that must be completed for the right to payment to become vested. How are these deferrals reported on Form 990?
The bonus for FY2020 is earned over a 36-month service period that spans four calendar years: the last four months of 2020, all 12 months of 2021, all 12 months of 2022, and the first eight months of 2023. The deferred bonus then becomes payable in September of 2023. Thus, if the university adopts a monthly prorating approach, it would report 4/36 of the $100,000 on Form 990 for the university’s tax year in which the last day of 2020 falls, i.e. FY2021. Similarly, the university would expect to report 12/36 of the $100,000 on Form 990 for FY2022, 12/36 of the $100,000 on Form 990 for FY2023, and 8/36 of the $100,000 on Form 990 for FY2024. However, the rule for short-term deferrals would appear to say that the amount that is treated as earned in 2023 does not have to be reported as deferred compensation, because it is also paid in 2023.
The bonuses for FY2021 and FY2022 would be reported in the same manner as the bonus for FY2020. The following chart shows what amount would be reported on each Form 990 for the years over which deferred compensation becomes vested:
For those who have not gone through the exercise of reporting deferred compensation on Form 990, Schedule J has several non-intuitive features that are highlighted by this example. First, it treats the three years of bonuses as being earned not in the three years for which the bonuses were awarded – FY2020, FY2021, and FY2022 – but over the six years in which services must be performed for all amounts to vest. Second, some amounts, it seems, are never reported as deferrals. Specifically, assuming the rule for short-term deferrals works as described, the $22,222 of each bonus that is treated as earned in the year of payment is not reportable in column (C) for that year, although it would be reported elsewhere along with the rest of the bonus that vests and is paid out. Finally, nowhere does it appear that a deferral as large as $100,000 was made, even though three $100,000 bonuses were deferred.
The foregoing is a simple application of a set of rules that seem straightforward enough, but that can produce surprising results. Tax-exempt organizations should exercise care in working through their Form 990 deferred compensation reporting and should consult counsel where the application of the rules is not self-evident.
Please contact a member of our Employee Benefits & Executive Compensation Group if you have questions regarding the reporting of deferred compensation on Form 990, Schedule J.