Nonqual Tax Measures Float Around Congress

August 17, 2004 ( - Both the US House of Representatives and the Senate have passed legislation that would impact the taxation of nonqualified deferred compensation arrangements.

>The two bills, S 1637  and  HR 4520 , have differences that must be ironed out before the legislation would become law.    Currently, the bills have been sent to a conference committee that was appointed in early July, with the expectations a bill will emerge from the committee in early Fall.

>Both of the measures have a core function to change the rules for compensation under deferred nonqualified plans.   Under the proposals, compensation would be subject to tax (and interest assessments) in the year of deferral unless the plan prohibits distributions prior to the disability, death, or separation from service of the employee.  

The House bill also subjects distributions to tax if authorized before a time specified by the plan (at the date the compensation is deferred), a change in ownership or effective control of the corporation (as defined by guidance to be issued by the Treasury), a change in the ownership of a substantial portion of the assets of the corporation, or the occurrence of an unforeseeable emergency.  

By comparison, the Senate’s versionimposes a one-year delay for distributions upon a change of control to corporate officers and directors who are subject to the reporting obligations of Section 16 of the Securities Exchange Act of 1934. Also, under the Senate bill, a distribution to a Section 16 officer or director within one year from the change of control would be treated as an excess parachute payment under section 280G of the Code and subject to the 20% excise tax under section 4999 or the occurrence of an unforeseeable emergency, according to an analysis released by EBIA.

Deferral Elections

Both measures lay out that the initial deferral election must be made no later than the close of the taxable year preceding the taxable year in which the participant performs the services giving rise to the compensation to be deferred, EBIA found. In the first year of participation, the election may be made within 30 days after the date the participant becomes eligible under the plan. The time and form of distribution must be specified at the time of the initial deferral.

Additionally, with plans that allow subsequent elections, the election cannot take effect until at least 12 months after the date of the election, under the legislation.   Except in the case of elections relating to distributions on death, disability or unforeseeable emergency, the first payment with respect to which the election is made must be deferred for at least five years from the date payment would otherwise have been made under the initial election. An election related to a distribution to be made at a specified time may not be made less than 12 months prior to the date of the first scheduled payment, according to EBIA.

The Senate bill only permits one subsequent election with respect to an amount deferred. There is no restriction on the number of subsequent elections in the House bill.


The two versions diverge on the penalty phase if a nonqualified deferred compensation plan violates any of the requirements.   The House bill imposes interest at the underpayment rate plus 1% on underpayments that would have occurred had the amount been taxable when first deferred or, if later, when the amount is no longer subject to a substantial risk of forfeiture. The Senate bill imposes interest at the underpayment rate on underpayments that would have occurred had the amount been taxable when first deferred or, if later, when the amount is no longer subject to a substantial risk of forfeiture, and an additional 10% penalty tax applies to amounts required to be included in income.

Additionally, the Senate bill prohibits the deferral of stock option and restricted stock gains by providing that any exchange of an option, restricted stock or any other property based on employer stock for deferred payments will result in the present value of that right being included in gross income in the year of the exchange. It does not matter whether the participant or the employer initiated the transfer.

Effective Dates

The House bill would be applicable to amounts deferred afterJune 3, 2004, except for amounts deferred before January 1, 2005 under an irrevocable election or binding arrangement made before June 4, 2004. The Senate bill would be applicable to amounts deferred or exchanged after December 31, 2004.