Let’s start with the definition of deferred wages – any arrangement where an employee receives wages after they have earned them.
There are rules concerning deferred compensation, both on the government contract accounting side, and on the Internal Revenue Service (IRS) side. Be sure that you research both sides of the equation prior to entering into an agreement to defer compensation (whether you are the employer or the employee).
Let’s first talk about the IRS implications. Here at ReliAscent, we are not tax accountants, so please do your research and ask your tax preparer before you enter into any deferred compensation agreement. However, under the IRS code there are two types of deferred compensation, qualified and unqualified. Qualified deferred compensation isn’t what we are talking about in this blog. In fact, most companies participate in qualified deferred plans, such as a retirement plan under the 401k rules. Unqualified deferred compensation is the issue that this blog is discussing. The IRS offers some rules (see IRC Section 409A) concerning unqualified deferred compensation that are very important. The big one is that employees must pay taxes on deferred compensation at the time such compensation is eligible to be received, not when it is eventually paid. There is a caveat with the IRS, as they don’t seem to care unless you are deferring compensation from one tax year to another. That is when this rule actually “kicks in”. Please consult your tax advisor to ensure that you are following the IRS rules when deferring compensation.
Now let’s switch to government contract concerns (DCAA, NSF, NIH, DOE, etc.). The government expects to pay the contractor for expenses that have already occurred or will occur within the next 30 days (FAR 32.504(b)). If you are reporting time on an employee’s timecard against a project, use that information to bill the government, receive that money, but if you are deferring the wages, you may have just committed fraud. The following three examples are where you may defer wages without getting into trouble:
- If you are only deferring the wages for a short period of time, like deferring the mid month amount to be paid at the end of month then you should be okay.
- If you are deferring wages and not billing the government for the deferred wages, then you are also okay. (But then, what’s the point!)
- If you are deferring wages and the employee fills in their timecard and then agrees not to take any or part of their wage, the unpaid part is credited to deferred wages liability and the wages are paid prior to contract close you are okay with the contracting agency or DCAA. However in this example, you may have problems with the IRS if you extend the deferral past the end of your fiscal year without paying the tax obligation for the deferral.
Normally, wages are deferred in order to make up for cash-flow shortages. However, if you choose to defer wages you must be careful to know the ‘rules of the road’ with the DCAA and IRS. If you get this wrong, you will owe that money back to the government agency and can be penalized by the IRS. To get the government contracting rules on deferral, contact Brian Ormsby at ReliAscent (303) 999-3813.
- Brian Ormsby, ReliAscent