• Proposed Tax Legislation Affecting Non-Qualified Deferred Compensation Plans
  • July 7, 2004
  • Law Firm: Parr Waddoups Brown Gee & Loveless, A Professional Corporation - Salt Lake City Office
  • On June 17, the House of Representatives passed the American Jobs Creation Act of 2004 (AJC). If enacted in its current form, AJC will significantly change the tax rules applicable to non-qualified deferred compensation plans. The provisions in AJC are very similar to the provisions in a tax bill that the Senate passed in May. Observers expect the House and Senate to meet in conference to reconcile differences in the two bills shortly.

    Under AJC, once an employee's or consultant's deferred compensation amounts vest, he or she will be subject to immediate income taxation on the full accrued benefit (plus an additional interest charge at a punitive rate on any prior tax deferrals associated with the deferred compensation) unless certain new conditions are met. Those proposed new requirements for effective tax deferral are as follows.

    New Requirements

    (a) The employee's initial election to defer must be made during the calendar year prior to the year in which the compensation is earned, unless otherwise provided in regulations (or within 30 days after initial participation in the deferred compensation plan). For example, the election to defer a bonus earned in 2005 which would be paid in 2006 must be made before the end of 2004. According to the House Ways and Means Committee report (but not the Senate report), the IRS is to issue regulations providing that, in appropriate circumstances, the election to defer a long-term bonus earned over a multi-year performance period could be made after the beginning of the performance period, provided the election is made at least 12 months before the bonus is otherwise payable.

    (b) A subsequent election to further defer payment or change the form of payment could not be effective for at least 12 months and, under the Senate bill, only one such subsequent election would be permitted.

    (c) Payment under a subsequent election to postpone payment could not be made for at least five years from the original payment due date, except in the event of death, disability or an unforeseeable emergency.

    (d) No other acceleration of the time of payment of deferred amounts would be permitted, whether voluntary or at the employer's sole discretion. This would eliminate the common "haircut" provisions that allow executives to take early voluntary withdrawals in exchange forfeiting a portion (typically 10%) of their benefits.

    (e) No distribution could be made prior to (i) separation from service, subject to a six-month delay for certain "key employees" of public companies (one year delay for Section 16 officers under the Senate bill), (ii) a specified time or under a fixed schedule, specified under the plan as of the date of deferral, (iii) disability or death, (iv) a change in control, or (v) the occurrence of an unforeseeable emergency.

    (f) Under the Senate bill, the deferred compensation plan would have to restrict deemed investment options to those available under the employer's tax-qualified defined contribution plan;

    (g) Gains from stock option exercises, restricted stock awards and restricted share units could not be effectively deferred.

    Effective Dates

    The effective dates in AJC and the Senate bill differ and will need to be reconciled by Congress. Under AJC, the new tax law requirements for deferred compensation would apply to amounts deferred after June 3, 2004, except for amounts deferred before January 1, 2005 under an irrevocable election or binding arrangement made before June 3, 2004. The Senate bill would only apply to amounts deferred after December 31, 2004.