Tax Article - The New Nonqualified Deferred Compensation Law
The American Jobs Creation Act of 2004, which President Bush signed into law on October 22, 2004, contains provisions that could restrict the use of many types of deferred compensation. As a result of the law change, if certain operational or design failures occur in a nonqualified deferred compensation plan, the deferred amounts, including compensation deferred under the plan in prior years, could be subject to:
- Immediate regular income tax,
- A 20 % penalty, and
- An interest charge on the tax liability that would have been incurred if the deferred amounts had been taxed initially.
Under the new law, the description of what constitutes a deferred compensation arrangement is quite broad. A nonqualified deferred compensation plan means any plan that provides for deferral of compensation except a qualified employer plan or a bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. A "plan" includes any agreement or arrangement, including an agreement or arrangement that includes just one person.
Examples of deferred compensation plans are:
- Bonuses deferred beyond 2 1/2 months after year end,
- Phantom stock plans,
- Stock appreciation plans,
- Non-qualified stock options (where the exercise price was less than grant date fair market value),
- Supplemental executive retirement plans,
- Other similar deferred plans or arrangements
The new rules require these plans to meet certain distribution and election requirements. Many plans comply with these requirements already and will not need to be modified. Plans that are in effect after October 3, 2004 and not materially modified may still operate in accordance with their old terms for any deferrals before January 1, 2005.
Many questions concerning the new law remain unanswered. The IRS is required to provide guidance on these matters within 60 days of the law’s enactment. . Employers and other service recipients may want to undertake a thorough review of all compensation arrangements that could result in the deferred payment of compensation to employees and other persons. In addition, employers should review their executive employment and consulting agreements to determine whether such agreements provide for the deferral of compensation.
We will update you as further guidance becomes available. Please contact us to review any deferred compensation plan you think you might have. These new rules can be complex and uncertain.
Find out how our expertise in deferred compensation can add value to your business. Email us or call us at 1 (888) 875-9770.
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