Accredited Wealth Management Advisor Practice Exam

Under a nonqualified deferred compensation plan, when does an employer receive a deduction for contributions?

1. When contributions are made to informally fund a plan.

2. For plan contributions when paid.

3. When the employee recognizes income.

4. For plan distributions when paid.

The correct answer is: When the employee recognizes income.

In the context of a nonqualified deferred compensation plan, an employer receives a deduction for contributions when the employee recognizes income. This is because the tax treatment of nonqualified deferred compensation differs from that of qualified plans. In nonqualified plans, contributions are not tax-deductible to the employer at the time they are made. Instead, the tax deduction occurs when the employee actually receives the compensation and recognizes it as taxable income. This approach aligns with the principle that employers can only deduct expenses associated with compensation when those expenses are ultimately incurred, which in this case means when the deferred amount is paid out and taxable. Therefore, the timing of the deduction for the employer is dependent on the employee's recognition of income from the plan, reinforcing the concept that deductions for deferred compensation are delayed until the payout occurs. Other options do not accurately reflect the tax treatment of nonqualified deferred compensation plans. For example, deductions for contributions made to informally fund a plan do not occur at that time, and contributions and distributions when paid do not represent the necessary recognition of income by the employee.