Deferred Compensation Proposed Rules Offer Clarity

By Kristen Ricaurte Knebel

June 21 — Long-awaited proposed rules on nonqualified deferred compensation plans and state and local government deferred compensation plans offer much-needed clarifications and technical corrections, attorneys said.

The proposed rules on nonqualified deferred compensation plans under tax code Section 409A, issued by the Internal Revenue Service on June 21, aim to clarify and modify 9-year-old final rules under that section, the IRS said. Nonqualified deferred compensation plans are plans in which a portion of an employee's current compensation is payable in a later taxable year.

There aren't a lot of surprises included in the proposed rules and there are some very welcome changes, many of which are taxpayer-friendly, Daniel L. Hogans, a principal with Groom Law Group Chartered in Washington, told Bloomberg BNA June 21. Hogans worked on the development of the 409A regulations as an attorney adviser with the Treasury Department's Office of Benefits Tax Counsel from 2003 to 2007.

The Treasury Department and the IRS said in the proposed rules that they hope the clarifications and changes to the income inclusion regulations will help taxpayers comply with the requirements of Section 409A. Section 409A imposes restrictions on the timing of elections to defer compensation and distributions and prohibits accelerations.

The proposed rules “are very helpful in clarifying the application of these extremely complex rules in circumstances in which they have proven particularly challenging,” Regina Olshan, a partner with Skadden Arps Slate Meagher & Flom LLP in New York, told Bloomberg BNA in a June 21 e-mail.

The clarifications are “consistent” with what practitioners have done in most cases, Olshan said. In addition, the proposed rules also appear to be trying to stop some current practices that many attorneys thought to be consistent with the existing 409A rules, she said.

Income Inclusion Rules

While the proposed rules contain many technical corrections, “there are some potentially significant points,” Andrew L. Oringer, co-chair of Dechert LLP's ERISA and executive compensation group and head of the firm's national fiduciary practice in New York, told Bloomberg BNA in a June 21 e-mail.

The rules are “clearly” trying to reduce practices that the IRS and Treasury perceive as abusive, Oringer said.

One of the most “significant” changes in the rules is the amendment to the proposed income inclusion regulations, Olshan said.

Under the current rules, certain changes could be made to a benefit in the year that it was unvested without penalty. The proposed rules would limit the ability to make any changes to unvested benefits without incurring a penalty, she said.

Hogans agreed that this was a portion of the guidance that stood out as having the potential to be more restrictive, but from his perspective, the existing rule was clear enough that “it didn't intend to allow opportunistic use of the rule.”

However, the change the IRS made shows that it felt the need to more aggressively shut down that use, which makes the rule “less valuable” by changing the correction process, Hogans said.

State and Local Plans

The other set of proposed rules for state and local government deferred compensation plans under Section 457, address how these types of plans are taxed, the IRS said. The proposed regulations address how to determine when amounts deferred under these state and local plans are includible in income—and the amounts that are includible—the IRS said.

Oringer said the rules allow commonly used deferred compensation techniques such as noncompete agreements to establish a forfeiture condition and rolling risks of forfeiture to put off vesting, but the rules do “substantially” limit this ability by imposing conditions.

“These rules diverge to one extent or another from the rules that apply under 409A, possibly resulting in some additional complexity in actual application,” Oringer said.

He also said the IRS and Treasury are trying to coordinate the 409A and 457 rules “in terms of operation and administration.” And while there are some difference to the rules, it is clear they are trying to coordinate these rules, he said.

To contact the reporter on this story: Kristen Ricaurte Knebel in Washington at

To contact the editor responsible for this story: Jo-el J. Meyer at

For More Information

The proposed regulations for Section 409A are at The proposed 457 regulations are at:

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