PORTFOLIO

Deferred Compensation Arrangements (Portfolio 385)

Tax Management Portfolio, Deferred Compensation Arrangements, No. 385-5th, analyzes the federal income and employment tax treatment of nonqualified deferred compensation arrangements. Both funded and unfunded plans for taxable employers are addressed as well as eligible and ineligible deferred compensation plans of tax-exempt organizations and state and local governments.

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DESCRIPTION

Tax Management Portfolio, Deferred Compensation Arrangements, No. 385-5th, analyzes the federal income and employment tax treatment of nonqualified deferred compensation arrangements. Both funded and unfunded plans for taxable employers are addressed as well as eligible and ineligible deferred compensation plans of tax-exempt organizations and state and local governments. The Portfolio describes employment contracts, agreements, plans, and other arrangements under which the payment of a portion of the compensation for services currently performed by one or more employees is deferred until a later date. The tax consequences to both the employee and the employer of unfunded promises to pay deferred compensation are discussed along with the tax consequences of providing an employee with a vested right in a trust or annuity contract. Nonvested beneficial interests in trusts and annuity contracts are also addressed. The Portfolio additionally compares the results of nonqualified deferred compensation arrangements with those applicable to qualified plans, statutory stock options, nonqualified stock options, and restricted stock plans.
Tax Management Portfolios on related matters include 383 T.M., Nonstatutory Stock Options, and 384 T.M., Restricted Property — Section 83.
The Worksheets contain relevant practitioner aids, including examples of deferred compensation arrangements.


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AUTHORS

A. THOMAS BRISENDINE
A. Thomas Brisendine, Director (retired), Employee Benefits Tax, Washington National Tax Office, Deloitte Tax LLP; B.A., J.D., Emory University.

ELIZABETH DRIGOTAS
Elizabeth Drigotas, Principal, Employee Benefits Tax, Washington National Tax Office, Deloitte Tax LLP; A.B., Bowdoin College; J.D., University of North Carolina at Chapel Hill.

THOMAS R. PEVARNIK
Thomas R. Pevarnik, Director, Employee Benefits Tax, Washington National Tax Office, Deloitte Tax LLP; B.S., Duquesne University; J.D., Case Western Reserve University; LL.M. Georgetown University Law Center.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

A. In General

B. Why Deferred Compensation?

C. Plans of Deferred Compensation Defined

II. Types of Deferred Compensation Plans

A. Introduction

B. Voluntary Salary Reduction and Bonus Deferral Plans

C. Incentive Plans

D. Stock Appreciation Rights

E. Phantom Stock Plans

F. Supplemental Executive Retirement Plans

G. Excess Benefit Plans

H. Discounted Options to Purchase Property - General Rules

1. Introduction

2. Discounted Options and Deferred Compensation: Similarities and Differences

3. Extent of Discount

I. Discounted Options to Purchase Property - Tax-Exempt Organizations

J. Shadow and Tandem § 401(k) Plans

III. Overview of the Tax Treatment of Deferred Compensation Plans

Introductory Material

A. Employees' Income

B. Employers' Deductions

C. The Dilemma

IV. Unfunded Promises and the Constructive Receipt Doctrine

A. Introduction

B. Rev. Rul. 60-31 et seq.

C. IRS Rulings Position

1. Rev. Proc. 71-19

2. Efforts to Update, Modify, or Supersede Rev. Proc. 71-19

3. General Principles for PLRs and Beyond

4. The Case Law

a. Veit I

b. Veit II

c. Robinson

d. Oates

e. Martin

f. Goldsmith

g. Metcalfe

h. Conclusions

5. ABA Suggestions and Recommendations

6. The Regulations - § 457

7. Conclusions on Rulings Posture

D. Revenue Act of 1978

E. SARs

1. Rev. Rul. 80-300

2. Rev. Rul. 82-121

3. GCM 36456

4. Discussion

F. Haircuts

1. Regs. § 1.451-2 Examples

2. Qualified Plan Revenue Rulings

3. Cases

4. Discussion

5. Conclusions

G. Unforeseeable Emergency/Hardship Withdrawals

H. Discretionary Distributions

I. Deferrals by Controlling Shareholders

J. Loans

K. Portability

L. Tandem § 401(k) Arrangements

1. In General

2. IRS Position

3. Technical Issues

a. Constructive Receipt

b. Valid Cash or Deferred Election

c. Section 401(k) Nondiscrimination Testing

d. Contingent Benefit Rule

e. Section 415 Testing

f. FICA Taxation

V. Economic Benefit, Cash Equivalency, and Assignment of Income

A. Introduction

B. Economic Benefit

1. Escrow Accounts

2. Trusts

3. Annuities and Life Insurance Contracts

C. Cash Equivalency

D. Section 83

E. Assignment of Income

1. Introduction

2. Lucas v. Earl

3. Helvering v. Horst and Comr. v. P. G. Lake, Inc.

4. U.S. v. Basye

5. Revenue Rulings

6. PLR 9810005

a. Ruling Facts

b. Ruling Conclusions

c. Ruling Rationale

d. Comparison of PLR 9810005 and Basye

F. The Dominion and Control Theory

1. GCM 36998

2. Prop. Regs. § 1.61-16

3. Revenue Act of 1978

4. ERISA

a. The Manfreda Letter

b. ERISA Case Law

c. ERISA Analysis

5. Conclusion

VI. Securing the Promise to Pay

A. Introduction

B. Rabbi Trusts

1. The Concept

2. Rabbi Trust with Employer Stock

a. Background

b. The Rulings

(1) PLR 9235006 - Initial Ruling

(2) PLR 9404008 - Reconsideration Notice Ruling

(3) PLR 9609010 - Amended Ruling

(4) Issues

(a) The § 83 Question

(b) The Grantor Trust Issue

(c) The § 1032 Question

(5) Rev. Rul. 80-76

(6) Prop. Regs. § 1.1032-3

(7) Final Regs. § 1.1032-3

(8) Alternative

C. Guarantees

D. Secular Trusts

E. Springing Rabbi or Rabbicular Trusts

F. Surety Bonds and Letters of Credit

G. Insurance Arrangements

VII. Funded Arrangements-§ 402(b)/Secular Trusts and § 403(c) Annuities

A. Introduction

B. Section 402(b)

1. Employer § 402(b)/Secular Trusts

a. Tax Consequences to the Trust

b. Tax Consequences to the Employer

c. Tax Consequences to the Employee

d. Rev. Rul. 2007-48

(1) Income Tax Treatment

(2) Employment Tax Treatment

2. Employee Grantor Secular Trusts

C. Section 403(c) Annuities

VIII. Employer's Deduction for Deferred Compensation

A. Introduction

B. Section 404

1. Section 404(a)(5)

2. Section 404(d)

3. Section 404(b)

4. Regs. § 1.404(b)-1T

5. Rev. Rul. 88-68

6. PLRs

7. TAM 199923045

C. Section 83(h)

1. Tax Reform Act of 1969

2. Final § 83 Regulations

D. Phantom Stock and SARs

E. Observations

F. Schmidt Baking Co. v. Comr.

1. The Court's Opinion

2. IRS Restructuring and Reform Act of 1998

3. IRS Guidance

G. Albertson's, Inc. v. Comr.

H. Reduced Deduction Limit Under the Emergency Economic Stabilization Act of 2008

IX. ERISA Considerations

A. Introduction

B. Meaning of "Pension Plan"

C."Top-Hat" Plans

D. "Funding" Under ERISA

X. Exchanges and Dispositions

A. Introduction

B. Exchanging Restricted Property for Other Restricted Property, Options, or Deferred Compensation

C. Exchanging Options for Options

D. Exchanging Options for Deferred Compensation

1. Constructive Receipt

2. Binding Contract

3. Section 1001

4. Assignment of Income

5. Agency

6. EITF/FASB Reaction

E. Exchanging Deferred Compensation for Options

F. Exchanging Deferred Compensation, Options, or Restricted Property for Split-Dollar Life Insurance

XI. Deferred Compensation in Mergers and Acquisitions

A. Introduction

B. General Overview

1. The Agreements

2. Treatment of Employees

3. Overview of Employer Deductions

4. A Short Overview of § § 280G and 162(m)

C. Assumptions in Asset Transactions

D. Deductions in Liquidation Transactions

E. Deductions in Stock Transactions

F. Consolidated Return Regulations

XII. Tax-Exempts and Governmental Employers - § 457

A. Introduction

B. Eligible Plans

1. Limitations Under § 457(b)

2. Eligible Plans - Funded and Unfunded

3. Loans

4. Eligible Plans - Coordination Rules

5. Eligible Plans - Distribution Rules

a. Commencement of Payments

b. Sick, Vacation, and Back Pay

c. Independent Contractors

d. Unforeseeable Emergency

e. Minimal, Dormant Accounts

f. Plan-to-Plan Transfers and Rollovers

g. Minimum Distribution Requirements

6. Eligible Governmental Plans - Excise Tax on Prohibited Tax Shelter Transactions

7. Applicability of § 409A to Eligible Plans

C. Ineligible Plans - § 457(f)

1. Substantial Risk of Forfeiture

a. Unilateral Election to Defer Compensation Under § 457(f)

b. Unilateral Election - PLR 9815039

(1) Ruling Facts

(2) Ruling Conclusions

(3) Observations

2. Rolling Vesting

3. Bilateral Extensions of Substantial Risks of Forfeiture

4. Covenants Not to Compete

5. Consulting Services

6. Earnings - Before and After Vesting

D. Exemptions from § 457

1. Tax Reform Act of 1986

2. Technical and Miscellaneous Revenue Act of 1988

3. Small Business Job Protection Act of 1996

4. Severance Pay

a. Announcement 2000-1

b. TAM 199903032's Rationale

(1) Department of Labor Guidance

(2) Sections 404 and 419

(3) Section 501(c)(9) VEBAs

XIII. FICA Treatment of Deferred Compensation

A. In General

1. Overview of FICA

2. History of Statutory Provision (§ 3121(v)(2))

3. Special FICA Timing Rule for Deferred Compensation

a. When Deferred Compensation Is Includible in FICA Wages

b. Meaning of "Vesting"

c. Nonduplication Rule

4. Determining When Withholding Must Occur

a. When Deferrals Are Required To Be "Taken into Account"

(1) General Rule

(2) Rule for Deferrals Subject to a Substantial Risk of Forfeiture

(3) Special Rule for Deferrals Under Nonaccount Balance Plans

(4) Rule of Administrative Convenience

b. Date When Employer Must Withhold

(1) General Rule

(2) Withholding from Other Wage Payments

(3) Reasonable Estimates

(4) Lag Method

c. "Taken into Account" and Withholding Rules Illustrated

d. Effect of Failure to Withhold and Remit FICA Contributions

B. Deferred Compensation Subject to the Special Timing Rule

1. Definition of "Nonqualified Deferred Compensation Plan"

a. Plan Establishment Formalities

b. "Deferral of Compensation"

2. Types of Plans

a. Account Balance Plans

b. Nonaccount Balance Plans

3. Arrangements Not Subject to § 3121(v)(2)

a. Stock Options

b. Stock Appreciation Rights and Stock Value Rights

c. Transfers of Property Subject to § 83

d. Severance Pay Plans and Other Welfare Benefits

(1) Severance Pay Plans

(2) Death and Disability Pay

e. Benefits Established in Connection with an Impending Termination of Employment

f. Excess Parachute Payments

C. Calculation of the Amount Deferred

1. Account Balance Plans

a. General Rule

b. Income Included in the Amount Deferred

c. Determining Income

2. Nonaccount Balance Plans

a. General Rule

b. Determining Income

c. Resolution Date

d. Early Inclusion Date

e. Assumptions Used to Determine Present Value

D. Calculation of Income Subject to the Nonduplication Rule

1. In General

2. Account Balance Plans - Income Subject to the Nonduplication Rule

a. In General

b. Reasonable Income for an Account Balance Plan - In General

(1) Predetermined Actual Investment

(2) Predetermined Interest Rate

c. Effect of Unreasonable Income Credits

3. Nonaccount Balance Plans - Income Subject to the Nonduplication Rule

a. In General

b. Effect of Unreasonable Assumptions

E. Transition Rules

1. Regulatory Transition Rules

a. In General

b. Application of a Reasonable, Good Faith Standard

c. Optional Adjustments

(1) In General

(2) Optional Adjustments for Plans that Are Not Nonqualified Deferred Compensation Arrangements

(3) Optional Adjustments for Plans that Are Nonqualified Deferred Compensation Arrangements

d. Unwritten Plans

2. Statutory Transition Rules

a. In General

b. Specific Transition Rules

(1) Transition Rules for Benefits Payable Under an Agreement Effective as of March 24, 1983

(2) Transition Rules for Benefits Payable Under an Agreement Adopted Between March 24, 1983, and December 31, 1983

c. Determination of Transition Benefit Amounts

XIV. Other Considerations

A. Securities Law Issues

1. Treatment of Interests in Deferred Compensation Plans as Securities

a. The "Howey" Test

b. The SEC Release

c. The SEC's Position of "No-Action"

d. Other Provisions of the Securities Regulatory Framework

2. Registration Exemptions

a. Rule 701

b. Section 4(2)

c. Regulation D

d. Section 3(a)(11)

3. Filing Requirements for a Participation Interest

a. Public Company Requirements

b. Private Company Requirements

B. Accounting Treatment

1. Accounting for Private Employer Deferred Compensation

2. Accounting for Governmental Employer Deferred Compensation

C. State Taxation of Pension Income Act

XV. Section 409A and the American Jobs Creation Act of 2004

A. Overview

B. Nonqualified Deferred Compensation Plans

1. General Definition of Deferral of Compensation

2. Exclusions for Qualified Plans and Welfare Plans

3. Plans of Tax-Exempt Entities

4. Partnerships

5. Nonresident Aliens and Participation in Unfunded Foreign Plans

C. [Reserved]

D. [Reserved]

E. Requirements of § 409A

1. In General

2. Timing of Deferral Elections

3. Permissible Distributions

a. In General

(1) Separation from Service

(2) Disability

(3) A Specified Time (or Pursuant to a Fixed Schedule) Specified Under the Plan

(4) Unforeseeable Emergency

(5) Change in Ownership or Control of a Corporation

b. Interaction Among Distribution Events

4. Redeferral Elections

5. Prohibition on Acceleration of Distributions

F. Funding

1. In General

2. Offshore Trusts

3. Asset Restrictions Based on the Employer's Financial Health

4. Special Grace Period Relief for § 409A(b)

G. Deduction by the Service Recipient

H. Reporting and Withholding Obligations

1. Reporting Requirements

a. Deferral of Compensation

b. Payment of Deferred Compensation

2. Wage Withholding

3. SECA and FICA Tax

4. Reporting and Withholding for 2005 through 2008

a. In General

b. Calculating Amounts Includible in Income Under § 409A(a)

c. Wage Payment Date

d. Account Balance Plans

e. Nonaccount Balance Plans

f. Amounts Deferred Under Stock Rights Covered by § 409A

g. Other Deferred Amounts

h. Mandatory Bifurcation

i. 2005 Amounts Includible in Gross Income under § 409A(a)

j. Calculating Amounts Includible in Income Under § 409A(b)

I. Effective Date

J. [Reserved]

K. IRS Regulations

1. In General

2. Definition of a Nonqualified Deferred Compensation Plan

a. § 457 Plans

b. Arrangements with Independent Contractors

3. Definition of Nonqualified Deferred Compensation

a. In General

b. Short-Term Deferrals

c. Stock Options, Stock Appreciation Rights and Other Equity-Based Compensation

d. Restricted Property

e. Foreign Arrangements

f. Separation Pay Plans

g. Split-Dollar Life Insurance Arrangements

4. Definition of a Plan

5. Definition of a Substantial Risk of Forfeiture

6. Deferral Elections

a. Initial Deferral Elections

b. Fiscal Year of Employer

c. Performance-Based Compensation

d. Subsequent Changes in Deferral Elections

e. Recurring Part-Year Compensation

7. Time and Form of Payment

a. In General

b. Payment Treated as Made on Designated Payment Date

c. Substitutes, Forfeitures and Voluntary Relinquishments

d. Disputed Payments and Refusals to Pay

e. Specified Time or Fixed Schedule

f. Separation from Service

g. Unforeseeable Emergency

h. Disability

i. Change in Ownership or Effective Control of a Corporation or Change in Ownership of a Substantial Portion of Corporate Assets

8. Prohibition on Acceleration of Payments

9. Application of Rules to Nonqualified Deferred Compensation Plans Linked to Qualified Plans

10. Statutory Effective Dates

a. In General

b. Calculation of Grandfathered Amount

c. Material Modifications

(1) In General

(2) Adoptions of New Arrangements

(3) Suspension or Termination of a Plan

(4) Changes to Investment Measures for Account Balance Plans

(5) Rescission of Modifications

11. Transition Relief

a. Amendment and Operation of Plans Adopted on or Before December 31, 2008

b. Change in Payment Elections or Conditions on or Before December 31, 2008

c. Payments Linked to Qualified Plans and Certain Other Plans

d. Initial Deferral Elections

e. Cancellation of Deferrals and Termination of Plan Participation

f. Terminations of Grandfathered Plans

g. Substitutions of Nondiscounted Stock Options and SARs for Discounted Stock Options and SARs

h. Collective Bargaining Agreements

12. 2008 Proposed Regulations on Calculation of Amount Includible in Income and Additional Income Taxes

a. In General

b. Total Amount Deferred Under a Plan for a Taxable Year

c. Application of Amounts Included in Income to Payments of Amounts Deferred

d. Forfeiture or Other Permanent Loss of Right to Deferred Compensation

L. Transition Relief and Guidance on Corrections of Certain § 409A Operational Failures

1. Eligibility Requirements

2. Corrections of Certain Operational Failures in the Same Taxable Year as the Failure Occurs

a. Failure to Defer Amount or Incorrect Payment of Amount Payable in a Subsequent Taxable Year Corrected in Same Taxable Year as Failure

b. Incorrect Payment of Amount Payable in Same Taxable Year or Incorrect Payment in Violation of § 409A(a)(2)(B)(i) Corrected in Same Taxable Year as Failure

c. Excess Deferred Amount Corrected in Same Taxable Year

d. Correction of Exercise Price of Otherwise Excluded Stock Rights

3. Corrections of Certain Operational Failures Involving Non-Insider Service Providers in Taxable Year Immediately Following Taxable Year in Which Failure Occurs

a. Failure to Defer Amount or Incorrect Payment of Amount Payable in a Subsequent Taxable Year Corrected in Taxable Year Immediately Following Failure

b. Incorrect Payment of Amount Payable in Same Taxable Year or Incorrect Payment in Violation of § 409A(a)(2)(B)(i) Corrected During Subsequent Taxable Year

c. Excess Deferred Amount Corrected in Taxable Year Immediately Following Year of Failure

d. Correction of Exercise Price of Otherwise Excluded Stock Rights

4. Relief for Certain Operational Failures Involving Limited Amounts

a. Failure to Defer Limited Amount Not Corrected in the Same Taxable Year and Certain Erroneous Payments of Limited Amounts

b. Limited Excess Deferred Amount Not Corrected in the Same Taxable Year

5. Relief for Certain Other Operational Failures

a. Failure to Defer Amount Not Corrected in Same Taxable Year and Certain Erroneous Payments

b. Incorrect Payment of Amount Payable in Same Taxable Year or Incorrect Payment in Violation of § 409A(a)(2)(B)(i) Not Corrected in Same Taxable Year as Failure

c. Excess Deferred Amount Not Corrected in the Same Taxable Year

6. Special Transition Rule for Non-Insiders

7. Information and Reporting Requirements

a. Information Required with Respect to Correction of an Operational Failure in Same Taxable Year as the Failure Occurs

(1) Attachment to Service Recipient Tax Return for Failures Described in § IV of Notice 2008-113

(2) Information to Be Provided to Service Provider for Failures Described in § IV of Notice 2008-113

b. Information Required with Respect to Relief for Certain Operational Failures

XVI. Limits on Deferral of Offshore Compensation Under § 457A

A. In General

1. Nonqualified Entity Defined

2. Nonqualified Deferred Compensation Plan Defined

B. Coordination with § 409A

C. Effective Date and Transition Relief


WORKING PAPERS

Working Papers

Table of Worksheets

Summaries of Deferred Compensation Model Plans 1 through 9.

Worksheet 1 Employment Agreement Deferring a Portion of Employee's Compensation - Prior to § 409A

Worksheet 1A Employment Agreement Deferring Portion of Employee's Compensation - Amended for § 409A

Worksheet 2 Employment Agreement Deferring Compensation Determined Pursuant to a Formula - Prior to § 409A

Worksheet 2A Employment Agreement Deferring Compensation Determined Pursuant to Formula - Amended for § 409A

Worksheet 3 Employment Agreement with Deferred Bonus - Prior to § 409A

Worksheet 3A Employment Agreement with Deferred Bonus - Amended for § 409A

Worksheet 4 Incentive Compensation Plan - Prior to § 409A

Worksheet 4A Incentive Compensation Plan - Amended for § 409A

Worksheet 5 Performance Share (Phantom Stock) Plan

Worksheet 6 Performance Unit (Phantom Stock) Plan

Worksheet 7 Deferred Bonus Plan

Worksheet 8 Eligible Deferred Compensation Plan Under Section 457(a) & (b) for a Governmental Entity

Worksheet 9 Tandem 401(k)/Nonqualified Plan

Worksheet 9A Equity Compensation Plan

Worksheet 10 Constructive Receipt & Economic Benefit Summary

Worksheet 11 Rabbi Trusts Summary

Worksheet 12 Section 457 Plan Summary of IRS Guidance

Bibliography

OFFICIAL

Statutes:

Legislative History:

Treasury, Labor and SEC Regulations:

Proposed and Temporary Regulations:

Treasury Rulings:

Cases:

SEC Materials:

Opinions:

Releases:

Other documents:

Department of Labor Materials:

Advisory Opinions:

General Counsel Memoranda:

News Releases and Other Materials:

State Statutes:

UNOFFICIAL

Miscellaneous Materials:

Tax Management Portfolios:

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