1. David I. Walker diwalker@bu.edu
The Practice and Tax Consequences of Nonqualified Deferred Compensation
David I. Walker

2. NQDC joint tax advantage…
Nonqualified Deferred Compensation
2/3/08 2
NQDC joint tax advantage…
Arises when employer can earn a higher after tax return on deferred funds than an employee could earn on her own
Is significant when, e.g.:
Employer invests freed up funds in own-company stock (utilizing IRC 1032)
Employer invests in dividend paying stock (utilizing DRD)
Employer faces a low effective marginal rate

3. Nonqualified Deferred Compensation
2/3/08 2
My approach
Joint tax consequences depend on notional investments by employees and actual use of freed up funds by employers
Rely on employer surveys, interviews with compensation consultants, and proxy statement disclosures

4. Participant notional investment
Nonqualified Deferred Compensation
2/3/08 2
Participant notional investment
Notional investment options
Often same/similar to 401(k) investment menu
Minority of firms allow notional investment in own company stock
Actual (notional) investments
Generally consistent with life cycle investment theory; but with somewhat shorter term focus
Little in own company stock

5. Employer informal funding/use of freed up funds
Nonqualified Deferred Compensation
2/3/08 2
Employer informal funding/use of freed up funds
Vehicles
Rabbi trusts
COLI
Taxable segregated accounts
Investments
Generally hedging notional investment portfolios of participants
Little set aside in the form of own company stock

6. Nonqualified Deferred Compensation
2/3/08 2
Barriers to joint tax minimization (and, in particular, utilization of IRC 1032)
Accounting

7. Participant diversification and efficient asset allocation
Nonqualified Deferred Compensation
2/3/08 2
Barriers to joint tax minimization (and, in particular, utilization of IRC 1032)
Accounting
Participant diversification and efficient asset allocation

8. How I learned to stop worrying and love NQDC (?)
Nonqualified Deferred Compensation
2/3/08 2
How I learned to stop worrying and love NQDC (?)
IRC 1032
COLI
Low MTR employers

9. Distributional consequences
Nonqualified Deferred Compensation
2/3/08 2
Distributional consequences
NQDC plan terms often mirror qualified plan terms.
In first instance, participants receive qualified plan-like returns.
Any reason to think that the benefit of these advantageous terms are shifted back to shareholders?

10. Other tax considerations.
Nonqualified Deferred Compensation
2/3/08 2
Why do firms offer NQDC?
Not a managerial power paper, but this looks like stealth compensation for senior execs to me.
Paternalism.
Competition.
Other tax considerations.

11. Executive Pay (R)evolution
Nonqualified Deferred Compensation
2/3/08 2
Executive Pay (R)evolution
ERt=0; Pt=25%
Ert=35%; Pt=45%
Ert=0; Pt=25-45%
Ert=35%; Pt=25%
Ert=35%; Pt=45%
Ert=10-35%; Pt=25%

12. Nonqualified Deferred Compensation
2/3/08 2