At the time of grant no compensation is being earned. Even when an employee is vested in an account balance income taxes do not generally apply as long as the plan retains a “substantial risk of forfeiture.” This clause typically means that the account value is not secured. That is, the plan promise, along with any assets set aside to fund the promise, remain subject to the claims of creditors. Participants are, in essence, general creditors. By retaining this degree of plan uncertainty, income taxes are deferred until the employee actually takes receipt of funds.
The same timing principle relates to the employer’s tax deduction. The timing of the employer’s deduction is concurrent with the taxation event for the employee.
The same principle would apply to installment payments. As long as the plan does not make the installment payments available to the employee (i.e., the installment election was established irrevocably by the employer or the employee elected installment payments well in advance of the payment event) the employee will only be taxed on the payments as they are received.