United States: IRS Proposes Regulations On 457(f) Plans For Tax-Exempt Employers

It took only 9 years since first announcing its intention to issue regulations, but the IRS has finally issued proposed regulations for deferred compensation arrangements sponsored by tax-exempt and governmental employers.  These special deferred compensation rules, which apply in addition to the deferred compensation rules in Internal Revenue Code (“Code”) Section 409A, are embodied in Code Section 457.  This alert focuses on how the proposed regulations would affect tax-exempt (rather than governmental) employers under “ineligible” 457(f) deferred compensation plans.  Employers typically use 457(f) plans to provide deferred compensation to executives above IRS limits that apply to tax-qualified plans and Section 457(b) “eligible” deferred compensation plans.  Using a 457(f) arrangement has the benefit of having no limit on the amount of deferred compensation provided (subject to other concerns such as the intermediate sanction rules).  However, Section 457(f) taxes the deferred compensation when it is no longer subject to a substantial risk of forfeiture - i.e., when the compensation becomes vested.

The good news for sponsors of these plans is that there are no major surprises in the proposed regulations.  As expected, the new 457(f) regulations borrow concepts and definitions heavily from the final regulations under Code Section 409A, which will, in most cases, allow 457(f) plans that also are subject to Section 409A to comply without the need for a set of different provisions for each Code Section.  This alert will discuss some of the highlights of the proposed regulations.

What plans are subject to Section 457(f)?

The proposed regulations define what is “deferred compensation” subject to 457(f).  Consistent with the Section 409A regulations, a plan provides for Section 457 “deferred compensation” if a participant has a legally binding right to compensation that, under the terms of the plan, is or may be payable in a later taxable year, subject to the following exceptions:  

  • Short-term deferrals:  Similar to Section 409A, an arrangement that requires payments to be made within 2½ months after the end of the year in which vesting occurs is exempt from Section 457(f) as a short-term deferral.  One important distinction from Section 409A is that, for 457(f) purposes, broader rules regarding substantial risk of forfeiture (described below) apply instead of the narrow Section 409A definition.
  • Bona fide severance pay plans:  Bona fide severance pay plans also are exempt from Section 457(f), and the proposed 457 regulations adopt terms similar to the Section 409A exemption for severance pay plans, including allowing Section 409A “good reason” terminations to be treated as involuntary terminations.  However, unlike the 409A regulations, the proposed 457 regulations do not limit the amount of severance to twice the annual limit under Code Section 401(a)(17) - currently $265,000.
  • Bona fide sick leave and vacation leave plans:  A sick or vacation leave plan is treated as “bona fide” if the primary purpose of the plan is to provide employees with paid time off for sickness, vacation, or other personal reasons.  For better or worse, the proposed regulations do not clarify when a carryover or cash-out feature for unused vacation or leave time may impact the plan's “bona fide” status, an issue that has been of significant concern to tax-exempt employers.
  • Death and Disability Plans:  For disability plans, the proposed 457 regulations adopt the definition of “disability” from the Section 409A regulations.
  • Recurring part-year compensation:  The most common example of this compensation applies to teachers who are paid over the course of the entire year but only work during the 10-month school year.  The 457 exemption applies if the arrangement does not defer payment of any amount to a date beyond the last day of the 13th month following the first day of the service period for which the recurring part-year compensation is paid, and the amount of the recurring part-year compensation does not exceed the annual compensation limit under Code Section 401(a)(17).

Substantial Risk of Forfeiture under Section 457(f)

Similar to Section 409A, a substantial risk of forfeiture exists under Section 457(f) if entitlement to the compensation is conditioned on the future performance of substantial services or on the occurrence of a condition that is substantially related to a purpose of the compensation, provided that the possibility of forfeiture is substantial.  However, unlike Section 409A, a covenant not to compete is a substantial risk of forfeiture for Section 457 purposes if the following three conditions are met:

  • The right to payment is expressly conditioned on the employee refraining from providing future services pursuant to an enforceable written agreement;
  • The employer makes reasonable ongoing efforts to verify compliance with the noncompetition agreement; and
  • The employer has a bona fide interest in the employee refraining from competing, and the employee has a bona fide interest in, and the ability to, engage in the prohibited competition.

Rolling Risks of Forfeiture:  In general, the IRS has viewed “rolling risk of forfeitures” (i.e., the postponement of the vesting event) with disfavor, by requiring that the "new" forfeiture risk be disregarded in applying tax rules.  However, the proposed 457 regulations allow a further risk of forfeiture if certain conditions are met:

  • The “new” deferred amount (i.e., the amount subject to the new forfeiture risk) must be materially greater than the amount that would have vested without regard to the new forfeiture risk.  The proposed regulations provide that the present value of the new deferral must be more than 125% greater;
  • The period for the additional risk of forfeiture must be at least two years after the date the original risk of forfeiture was scheduled to lapse; and
  • The agreement for the initial risk of forfeiture must be in place prior to the beginning of the year in which services are rendered, and the agreement to extend the existing risk of forfeiture must be made at least 90 days before the existing risk of forfeiture was scheduled to lapse.

Determining the Amount Subject to Tax

The proposed regulations provide rules for how the amount that is subject to tax under Section 457(f) is to be determined.  If the deferred amount may be paid or available at different times or in different forms under the plan, the amount is treated as payable at the time and form where the present value is highest.  However, if payment has commenced, or a time and form of payment have been elected and cannot be changed without both party’s consent, the time and form of payment as commenced or elected is utilized.  More specific guidance is provided for determining the amount subject to tax for account-based and non-account-based plans, formula-based plans, reimbursement arrangements and split dollar life insurance arrangements.

Losses of Amounts Previously Taxed:  The proposed regulations adopt the Section 409A tax treatment should an individual include an amount in income under Section 457(f) before it is distributable, but the amount ultimately distributed is less.  In this case, the participant may take a miscellaneous itemized deduction for the loss (the difference between the amount previously taken into income and the amount actually received in the taxable year in which the remaining right to the amount is permanently forfeited or lost).

Effective Dates

The 457 proposed regulations are scheduled to apply for calendar years beginning after the date the final regulations are published in the Federal Register, including with respect to amounts deferred or accrued in prior years that were not previously included in income, with several exceptions:

  • A delayed effective date applies to compensation deferred under a collectively bargained plan.
  • For recurring part-year compensation for periods before the effective date of the regulations, taxpayers may rely on either the rules set forth in the proposed regulations or the rules set forth in IRS Notice 2008-62.

Nevertheless, taxpayers may rely on the proposed regulations until the effective date.  

Conclusion

There is no telling how long the IRS will take to issue final 457 regulations.  Treasury has requested comments, and a public hearing is scheduled for October.  Even so, sponsors of plans subject or potentially subject to Section 457(f) should review their plans to determine how the proposed rules will affect them, and consider modifications to plan design to reflect the proposed regulations.

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
Similar Articles
Relevancy Powered by MondaqAI
McLane Middleton, Professional Association
Reinhart Boerner Van Deuren s.c.
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
McLane Middleton, Professional Association
Reinhart Boerner Van Deuren s.c.
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions