NQDC Plans a Target of Tax Reform Recommendations

A U.S. Senate committee report calls NQDC plans a “tax avoidance” strategy.

A report from Democratic staff of the U.S. Senate Committee on Finance says nonqualified deferred compensation (NQDC) plans raise a number of issues of fairness.

The report notes that these plans are generally only provided to highly compensated employees and give these employees some control over the timing of the inclusion of income for tax filing purposes. Using an example identified for Senator Ron Wyden (D-Oregon), ranking member of the committee, by the nonpartisan staff of the Joint Committee on Taxation (JCT) and outside independent experts, the report states that a high-income earner can choose to avoid paying taxes on compensation for 20 years or even longer. In addition, these employees have the compounding benefit of accruing earnings tax-free during the deferral period.

The report contrasts this with rank and file employees who only have the opportunity to defer compensation within limits, such as under a qualified defined contribution (DC) plan or by contributing to an individual retirement account (IRA).

Among recommendations included in the report, is a proposal in a tax reform discussion draft put forth by U.S. Representative Dave Camp (R-Michigan) which provides that under a NQDC plan, all compensation deferred under the plan would be included in gross income for the taxable year of vesting. When estimated as a part of Camp’s tax reform plan, this proposal would raise $9.2 billion over ten years, the report said.

The committee’s Democratic staff also recommended adopting a proposed $1 million cap on deferred compensation and closing an Internal Revenue Code Section 162(m) “loophole.” The letter explains that under 162(m), subject to a number of limitations, compensation paid to certain senior executives in excess of $1 million is nondeductible by the employer. However, if an employee’s compensation is deferred until retirement when the employee is no longer a senior executive, the compensation will not be subject to the $1 million cap. This is because 162(m) only applies to compensation paid during a year if the employee is a senior executive on the last day of the year.