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Non-Qualified Deferred Compensation Plans


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"Non-Qualified Deferred Compensation Plans" was presented by Tom Sigmund on December 18, 2014, at the CPA Mega Tax Conference.

Tom discussed the details of non-qualified deferred compensation plans, including social security taxes, informal funding and penalties.

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Non-Qualified Deferred Compensation Plans

  1. 1. z Non-Qualified Deferred Compensation PLANS presented by Tom Sigmund December 18, 2014
  2. 2. z “undermine integrity/reputation of legal professionals” are we talking about? WHAT
  3. 3. z Deferred Compensation Arrangement An unsecured, unfunded promise to pay to a select group of management or highly compensated employees
  4. 4. z Comes in All Shapes + Sizes Defined Contribution Plan Defined Benefit Plan Equity- Based Plan SARs Stock Options Phantom Stock Plans
  5. 5. z “undermine integrity/reputation of legal professionals” does it mean to be non-qualified? WHAT
  6. 6. z Not Subject to Rigid IRC Rules Vesting requirements Participation requirements Eligibility requirements Coverage requirements Minimum funding
  7. 7. z Not Granted Favorable Tax Treatment Deduction for contribution Tax deferral to participant until paid Tax-free growth
  8. 8. z “undermine integrity/reputation of legal professionals” do we use it + why? WHEN
  9. 9. z Want to compensate key employee(s) in a manner that would be discriminatory if a qualified plan or which exceeds the benefits that could be provided in a qualified plan.
  10. 10. z Incentivize Key Employees 1. Golden Handcuffs 2. Work with a long-term goal to make company more profitable 3. Work with an owner’s mentality 4. Keep those employees happy long term
  11. 11. z Buyout
  12. 12. z “undermine integrity/reputation of legal professionals” is the objective tax-wise + otherwise of these plans? WHAT
  13. 13. z Objective Avoid complexity of Internal Revenue Code Custom design plan for each employee in question Defer taxation of benefits to employee until paid Avoid ERISA requirements
  14. 14. z Avoid ERISA Requirements Trust/funding Minimum participation Vesting Extensive report/disclosure requirements Fiduciary obligations
  15. 15. z “undermine integrity/reputation of legal professionals” Informal FUNDING
  16. 16. z Use of life insurance Rabbi trust Creditor Claims
  17. 17. z “undermine integrity/reputation of legal professionals” IRC §409A
  18. 18. z Legislation enacted in response to Enron debacle
  19. 19. z 409A Requirements (if not exempt) Timing of deferrals by employee Designation of time and form of payment Permissible payment events Extension of deferral Separation pay
  20. 20. z Permissible Payment Events Disability Death Change of Control Unforeseeable emergency Separation from service Fixed time
  21. 21. z Notable Exceptions Equity compensation Short-term deferrals Separation pay
  22. 22. z PENALTIES for Non-Compliance
  23. 23. z “undermine integrity/reputation of legal professionals” Social Security TAXES
  24. 24. z Social Security Taxes Subject to FICA when no longer subject to substantial risk of forfeiture (as opposed to when paid) 1. Taxable wage base 2. Medicare portion
  25. 25. z Recurring Problems + Complexity
  26. 26. z Structuring business-driven compensation arrangements that have no tax motivation. Example: Executive’s base salary would be defined and paid at the earlier of a specified date or the Company’s closing of a capital raise in excess of a specified dollar amount.
  27. 27. z Severance Arrangements 1. Non-compliance tends to occur when the severance arrangement isn’t designed to fall within the exception of Section 409A. 2. The most common problem is the failure to include the 6- month delay rule and the impact of release delivery requirements that would impermissibly allow an executive to potentially affect the year of payment.
  28. 28. z Restricted Stock Unit 1. Vesting when executive reaches retirement age but at the time of grant the executive has already reached retirement age or will at a point early enough in the award period that the restricted stock units don’t qualify under the short-term deferral rules. 2. When Restricted Stock Unit does not meet short-term deferral exception, failure to include the 6-month delay provision or acceleration in the event of a change of control that doesn’t comply with the definition found in 409A.
  29. 29. z Due diligence reviews of target company compensation and benefit arrangements.
  30. 30. z In merger and acquisition, target executive wants to be paid out under his deferred compensation agreement that requires severance from service but the acquiring corporation wants to retain the executive. Often the change of control/termination rule needs to be relied on.
  31. 31. z Section 409 basically adds additional costs and time to transactions that it applies to without accomplishing much, if anything, of significance. Almost no one ends up paying the excise tax and most transactions occur almost exactly as before.
  32. 32. z Modifications to the terms of stock options and whether or not such a modification is treated as a modification under 409A which could cause a problem if the stock value has gone up since its grant.
  33. 33. z Practitioners that spend large portions of their day thinking about 409A frequently struggle to come to conclusions and then often do not agree with each other when they do so. Sometimes the best that can be done is to identify risks, positions, stress points and uncertainty.
  34. 34. z The rules for payment at a specified time or a fixed schedule, require payment on date or dates that are nondiscretionary and objectively determined at the time the amount is deferred. Therefore, they cannot generally be based on the occurrence of an event.
  35. 35. z There has been little change in the prevalence of non-qualified deferred compensation plans and the popularity has been steady.
  36. 36. z Anti-acceleration rules put limitations on de-risking in the non-qualified deferred compensation arena (as opposed to the qualified plan arena).
  37. 37. z Anti-acceleration rules put limitations on de-risking in the non-qualified deferred compensation arena (as opposed to the qualified plan arena).
  38. 38. z The requirements of 409A can cause impediments to succession planning during the transition period.
  39. 39. z 409A Can Impact Reimbursement Arrangements 1. If a relocation package is available over multiple years, the amounts available in a later year cannot depend on what was spent, reimbursed or incurred in an earlier year. 2. The payment of reimbursements cannot depend on a payment trigger that is not permissible under 409A (e.g., when the current residence is sold). 3. Acceleration or further deferral of payments must comply with 409A unless an exception applies.
  40. 40. z RECENT Developments
  41. 41. z On February 25, 2014 the IRS issued final regulations clarifying the meaning of “substantial risk of forfeiture” under IRC §83. In summary, the IRS stated that “further, Treasury and the IRS believe that these regulations should not be modified to state that an involuntary separation from service without cause may qualify as a substantial risk of forfeiture under §83.” RECENT Developments
  42. 42. z IRS Field Attorney Advice (FAA 20134301F) on employee bonus deductions. If bonus plan states that the employer retains the right to eliminate or modify the bonuses at any time prior to payment, the all events test is not met. RECENT Developments
  43. 43. z U.S. Department of Treasury, Semi-Annual Regulatory Agenda Release (5/23/14). Among items scheduled for release are: 1. A final rule on the definition of “highly compensated employee.” 2. A final rule on further guidance on the application of §409A to non-qualified deferred compensation plans. 3. Combining correction programs and expanding violations covered. RECENT Developments
  44. 44. z IRS Initiates Limited Scope Audit of Non-Qualified Deferred Compensation Plan Compliance with §409A. 1. IRS has stated it will send information document requests to a limited number of companies (fewer than 50) from a group of large employers that have been previously selected for an employment tax audits. 2. The IRS’s intent is to refine audit techniques and test compliance in three areas. Initial elections to defer compensation; Subsequent elections to re-defer compensation; and Plan distributions and compliance with §409A, including the requirement that distributions to “specified employees” of public companies be delayed for at least 6 months. RECENT Developments
  45. 45. z Proposed Legislation to tax deferred compensation when no longer subject to a “substantial risk of forfeiture.” RECENT Developments
  46. 46. z Thank You! Tom Sigmund, Director Kegler Brown Hill + Ritter 614.462.5462