United States: Nonqualfied Deferred Compensation Plan Update

In June 2015, the Internal Revenue Service released updated audit guidelines for nonqualified deferred compensation plans. Basically, audit guidelines are used by the IRS to communicate with the agents in the field who are actually performing audits. The guidelines tell the agents what it is they should be investigating. Accordingly, employers who sponsor NQDC plans should make sure they are in compliance with the guidelines. As will be discussed in more detail below, the guidelines focus on many issues other than Section 409A of the Code.

The audit guidelines informally break NQDC plans into four or five types (depending on how you count).

  1. Salary Reduction Arrangements. A plan where participants can elect to have their current salary reduced, and replaced by an equivalent amount to be paid in the future. So, similar in design to 401(k) plans except that the employer does not get a current deduction and the employee's deferral is at risk if the employer becomes insolvent.
  2. Bonus Deferral Plans. Similar to salary reduction arrangements, except participants choose to defer their bonus instead of their salary. Obviously, many companies combine these first two types of plans into a single program.
  3. Top Hat Plans. As used by the IRS, in this type of plan, the employer allocates a specific amount to the plan participants. This can be done on a defined benefit or a defined contribution basis. Under ERISA, such plans must be maintained primarily for a select group of management or highly compensated employees (known as the "top hat" group). Note that this last requirement is technically under the jurisdiction of the Department of Labor, and not the IRS.
  4. Excess Benefit Plans. The guidelines describe these plans as providing benefits in excess of those provided under the employer's qualified plan, due to the limitations that apply under Section 415. Some plan sponsors occasionally lose sight of the fact that these types of plans are not limited to the top-hat group.
  5. Phantom Stock Plans. The guidelines point out that such plans, sometimes called restricted stock unit plans, may also be subject to the same rules that apply to the arrangements described above.

With that background, the guidelines identify the following issues:

Funding

For a NQDC plan to "work" (i.e., to obtain the benefit of the tax deferral), it is important that amounts are not "set aside" from the employer's creditors for the benefit of the participants. Specifically, the guideline states that for NQDC purposes, it is not relevant whether the assets have been identified as belonging to the employee. What is relevant is whether the employee has a beneficial interest in the assets, such as having the amounts shielded from the employer's creditors or whether the employee has the ability to use these amounts as collateral. Although this is not discussed in detail in the guidance, often this issue comes down to what was communicated to plan participants about to whom do the "assets" of the plan belong.

Constructive Receipt/Cash Equivalency

Under the constructive receipt doctrine, plan participants can be taxable on deferred amounts that they have not actually received, if the amounts were "constructively" received. Most constructive receipt issues have become obsolete since the enactment of Section 409A. However the guidelines do raise a few issues that plan sponsors should consider. For example, the guidelines suggest that devices tied to deferred compensation accounts, such as debit cards, credit cards and checkbooks may provide employers with sufficient control over their deferred compensation, such that they are in constructive receipt.

The cash equivalency doctrine raises issues somewhat similar to the constructive receipt issue described above. If a solvent obligor's promise to pay is unconditional and assignable, not subject to setoff, and is of a kind that is frequently transferred to lenders or investors, such promise is the equivalent of cash, and will be subject to current taxation. This doctrine has likely been more or less superseded by Section 409A.

Timing of Deductions

As a reminder, the guidelines note that any interest or earnings credited to deferred compensation are not deductible until the deferred compensation is taxable to the participant.

FICA/FUTA Taxes

For purposes of FICA (and FUTA) taxes, NQDC is taxable when the amounts vest, not when amounts are distributed. This can often be helpful to plan participants, as earnings typically exceed the Social Security taxable wage base (though there is no base for Medicare taxes), and subsequent earnings escape FICA (and FUTA) taxes completely. This assumes that earnings are tied to a reasonable rate of return – typically based on a predetermined actual investment or a reasonable rate of interest.

Rabbi Trust Funding

Funding of a "rabbi trust" is limited for plan sponsors who maintain "at risk" defined benefit plans. This provision can be overlooked, particularly in large controlled groups or following an acquisition.

Impermissible Coordination with 401(k) Plans

Another provision that is frequently overlooked by NQDC plan sponsors is the requirement that an employer may not condition any other benefit (including participation in a NQDC plan) upon an employee's participation (or nonparticipation) in the 401(k) plan. Accordingly, the guidelines alert auditors to look for any plan provisions that limit the total amount that can be contributed to a 401(k) and NQDC plan, or any provision limiting participation in a NQDC plan to employees who elect not to participate in the 401(k) plan.

Next Steps

NQDC plan sponsors should perform a self-audit of their plans to make sure they are in compliance with all of the issues identified in these guidelines. In addition, sponsors should make sure they are organized and have retained (and have available) all of the documents the IRS requires as documentary substantiation under the guidelines. 

Previously published in the Employee Benefit Review - October 2015

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.