Feds Release NQDC Plan Guidance

December 20, 2004 (PLANSPONSOR.com) - In long-awaited specific guidance to the benefits and compensation community, federal officials declared Monday that non-qualified deferred compensation (NQDC) payments are taxable to the extent they are not subject to a substantial risk of forfeiture and have not previously taxed.

>The declaration by the US Treasury Department and the Internal Revenue Service (IRS) came in the release of  IRS Notice 2005-1 , which provides a variety of details about the new rules for NQDC plans. The rules are part of a new IRS Code Section 409(a), which asserts that, except for the “substantial forfeiture” issue and unless specified requirements are met , all amounts deferred under a NQDC are currently includible in gross income and, therefore, taxable. The new section grows out of Section 885 of the recently enacted American Jobs Creation Act of 2004 (See  American Jobs Creation Act Includes Non Qual Changes ).

>Monday’s guidance release follows Congressional mandates for the Secretary of the Treasury to put out additional details on the termination and amendment of certain nonqualified deferred compensation arrangements as well as to define a change in ownership or control. In addition, the guidance defines the arrangements that will be considered deferred compensation subject to the new rules and outlines the new reporting and employment tax obligations of employers in connection with the new provisions.

“Given the significant changes that section 409(a) will require for nonqualified deferred compensation plans, we developed this guidance being mindful to avoid establishing rules that could become traps for the unwary,” said IRS Chief Counsel Donald Korb in a  Treasury Department statement .

>The new guidance come at a time when NQDC programs seem positioned to emerge as the executive compensation program of choice for many companies (See  Non-Qual Plans Blossoming In Popularity ).   With the recently released stock-option expensing rules from the Financial Accounting Standards Board (FASB) (See  FASB Releases Stock Option Expensing Rule ), “Stock options are no longer as attractive,” noted Tom Johnson, of MassMutual in an interview with PLANSPONSOR. “Cash is back to being more valuable than stock and the logical place to pick up the slack is deferred compensation.”    

Key Provisions

>Provisions included in the government document released Monday include:

  • a definition about when a deferred amount is subject to a substantial risk of forfeiture. Namely, “entitlement to the amount is conditioned on the performance of a substantial future services by any person or the occurrence of a condition related to a purpose of the compensation and the possibility of forfeiture is substantial.” The government said an amount will not be considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the amount subject to a substantial risk of forfeiture (ignoring earnings) is materially greater than the amount the recipient otherwise could have elected to receive.
  • a discussion about when payments will be permitted in a corporation’s effective change in ownership or effective control. The IRS document said the change in control event must be “objectively determinable and any requirement that any other person, such as a plan administrator or board of directors compensation committee, certify the occurrence of a Change in Control Event must be strictly ministerial and not involve any discretionary authority.” What constitutes a change of ownership? According to the IRS guidance, it is “a change in the ownership of a corporation (that) occurs on the date that any one person or more than one person acting as a group acquires ownership of stock of the corporation that, together with stock held by such person or group, constitutes more 50% of the total fair market value or total voting power of the stock of a corporation.”
  • definitions of “change in the effective control of a corporation” and of “a change in the ownership of a substantial portion of a corporation’s assets.”
  • the conditions under which a plan may permit the acceleration of the schedule of any plan payment. Except for the circumstances specified by the government, a NQDC may not allow plan payment acceleration, the document said.
  • the effect of the near 409(a) section on 457 plans.
  • effective dates for the new rules. The new IRS Section 409(a) applies to amounts deferred on or after January 1, 2005, subject to several special effective date rules, the government statement said.