1. Non-Qualified Deferred Compensation

2. Nonqualified Deferred Compensation
NQDCP’s allow employees to postpone current taxation of wages.
Similar to qualified plans (i.e. 401k)
Do not have to meet requirements of a qualified plan

3. Tax Strategy
Employee elects to defer wages – avoid constructive receipt
– wages are included in taxable income when tax rates are lower
Deferred amounts are subject to FICA but not FWT
– wages are subject to FICA in year regular wages exceed Social Security wage limit; subject to Medicare only

4. Covered Employees Highly compensated EE’s Key EE’s
Select management EE’s
EE’s with limited qualified benefits
EE’s the ER wishes to reward
Plan can be discriminatory

5. Types of NQDC Plans Salary Reduction Bonus Deferral SERP
Excess Benefit

6. NQDC Funds Unfunded Funded Not secured Secured Remains ER asset
Creditor accessable
Funded
Secured
EE has access

7. Arrangements Rabbi Trusts Secular Trusts Deferred Comp. Ins.
Surety Bonds
Letters of Credit

8. Plan Requirements Plan must be in writing and include:
Method for determining amount to be deferred
When deferred amounts may or will be paid
How deferred amounts may or will be paid
Treas. Reg. § (v)(2)-1(b)(2)(i)

9. Election Requirements
Timeliness of the election:
Generally, election must be made before calendar year in which income is earned
Exceptions:
New plan – election must be made within 30 days of plan’s inception
First year of eligibility – election must be made within 30 days of becoming eligible
Rev. Proc and 92-65

10. Election Requirements
Specification of Amount Deferred:
Specified in dollars, or
Specified by formula

11. Election Requirements
Specification of Payout Method:
Specify how deferred compensation is to be paid (i.e. lump sum, amount per month)
Right to change payout timing may result in constructive receipt

12. Account Balance Plan
An accounting record is kept for each participant on company books
Amount deferred is credited to the account
Related earnings are credited to the account
Bookkeeping entry only – funds are not set aside
Earnings are not subject to FICA
Treas. Reg. § (v)(2)-1(c)(1)

13. Non-Account Balance Plan
Amount deferred is not an amount the worker has elected not to receive
Amount deferred is present value of payments the worker has the right to receive in the future
Subject to FICA at the time the amount to be received is ascertainable
Treas. Reg. § (v)(2)-1(c)(2)

14. ET Taxes – Special Timing Rule
FICA and FUTA
The later of:
Services performed OR
No substantial risk of forfeiture
IRC §3121(v)(2) and §3306(r)(2)
FITW
When actual or constructive receipt

15. Advantages ER No rules (prior to §409A) No current spending
Attract EE’s
Early retirement incentive EE
Supplement qualified retirement plan
Personally customized
Current tax deferral
Tax-free growth
Possible reduced taxation
No early distribution tax

16. Disadvantages ER EE May be taxed on deferral build-up
Expense deduction follows income inclusion EE
ER retains asset
Mere ER promise
No control of investment
Elections made prior to services

17. IRC §409A Added to Code by Section 885 of AJCA of 2004
Provides that amounts deferred under a NQDCP are includable in income unless certain requirements are met
Provides for substantial penalties
Does not affect IRC §3121(v)
Effective for amounts deferred after 12/31/2004

18. IRC §409A Notice 2005-1 provides guidance New rules for: Distributions
Elections
Offshore and “financial health” trusts
Withholding and reporting requirements

19. IRC §409A Distributions must be for: Separation from service Death
Disability
Pursuant to a fixed schedule or at specified times
Following a change of ownership or control of the corporation
The occurrence of an unforeseeable emergency
IRC §409A(a)(2)(A)

20. IRC §409A Deferral Election Rules (IRC §409A(a)(4)(B))
Must be made by the close of the taxable year preceding the year in which the services are performed, or
Within 30 days EE becomes eligible to participate in the plan
Exception: Election to defer performance-based compensation for services performed over a period of at least 12 months can be made no later than 6 months before the end of the service period.

21. IRC §409A Distribution Election Rules (IRC §409A(a)(4)(c))
Timing and form of distributions must be specified at the time of the initial deferral
Election can be changed if:
Made not less than 12 months before a scheduled payment
Not effective until at least 12 months after the election, and
Provides for an additional deferral of at least 5 years

22. IRC §409A Offshore and Financial Health Trusts (IRC §409A(b))
Offshore Trust – funds put in a foreign trust are includable in income tax wages
Exception: Not taxable if services are performed in the foreign country
Financial Health Trust - ???
Ask Counsel if you find one of these

23. Reporting Information
Form W-2
Box 1
Gross Income Tax
Box 3
SS Wages
Box 5
Medicare Wages
Box 12
Deferrals – code Y
Distributions – code Z

24. IRC §409A Failure to Satisfy New Rules
Amount deferred is includable in income in the year earned (i.e. no deferral)
Amount deferred is subject to both FICA and FWT
Subject to an additional 20% tax
Subject to interest penalty (interest at underpayment rate plus 1%)