An amount reported in Box 12 of W-2 with code Z indicates a violation Section 409(A). A section 409(A) violation results in substantial tax penalties for the employee, independent contractor, or director affected. All of the tax penalties for violations are imposed on the service provider. There are no penalties imposed on the company or organization making the payments; however, the payor has reporting requirements and employers have withholding requirements.
When there is a violation of Section 409(A), the non-qualified deferred compensation in question becomes fully taxable as soon as the service provider becomes vested. In addition, there is a 20% tax penalty on the value of the non-qualified deferred compensation imposed at the time of vesting.
Since the 409(A) violation was reported on your W-2, your employer is responsible for both reporting and withholding. Therefore, in addition to an amount reported in Box 12 with code Z of your W-2, that amount should be included in Box 1 of your W-2 as wages. Federal Income tax should have been withheld at a rate of 25%, and 35% if on the amount of wages that exceed $1,000,000. The 20% excise tax (penalty) is reported on line 17h of Schedule 2 (Form 1040). Employers are not required to withhold for the excise tax (penalty).
You can report this yourself using TurboTax Desktop software. The desktop version of TurboTax has a "Forms" view which allows you to make entries directly on forms and schedules. You can also transfer your TurboTax Online return to TurboTax Desktop. For instructions on how to do so see the following TurboTax help article: How do I switch from TurboTax Online to TurboTax Desktop?
To report the 20% excise tax (penalty) in TurboTax Desktop:
- Enter your Form W-2
- Click on the "Forms" icon in the upper right hand portion of your screen
- Select "Form 1040" under Forms in My Return on the left side of your screen
- Scroll to line 23 - Other Taxes... and select it
- Click on the magnifying glass. This will take you to Schedule 2 (Form 1040)
- On line 17h of Schedule 2, enter 20% of the amount reported in Box 12 of your W-2 with Code Z.
- The amount of your excise tax (penalty) will now appear/be included in line 23 of Form 1040.
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