Even with the economic downturns, heightened Internal Revenue Service (IRS) scrutiny, and ever-increasing compliance complexity that have marked the last decade, nonqualified deferred compensation plans (NDCPs) remain popular and highly effective executive benefit plans. In addition to providing executives with tax-deferred benefits in excess of their qualified plan benefits, these plans also can be structured to serve a wide range of corporate agendas (e.g., golden handcuffs, recruitment, performance incentives, etc.).
However, what could and should be a “win-win” proposition for employers and executives alike can quickly degenerate into a “lose-lose” bet if the players cannot keep track of the compliance cards that cover their plan’s hand. Whether plan sponsors are opening with the initial draw of the design, drafting and communication of NDCPs, or dealing with the ongoing administration of their existing plans, they must ensure that these compliance cards do not get lost in the shuffle. The compliance stakes are very high for both the employers and executives.
For example, employers need to be concerned about violations of Section 409A because the penalties for such violations are significant, and are imposed directly on the executive who receives the deferred compensation. While employers are not directly subject to penalties for these violations, they may decide or have agreed to pay any 409A tax penalties incurred by their employees. Furthermore, employers may face associated tax reporting and withholding penalties.
Based on our experience with these plans, we have identified the following 12 traps as the areas to which plan sponsors need to pay particular attention:
1. 409A plan recognition
2. Plan document requirement
3. “Top-Hat” group determination
4. 409A grandfathering
5. Application of FICA taxation
6. Timing of deferral elections
7. 401(k) contingent benefit rule
8. Timing of distributions
9. Forms of distributions
10. NDCP/defined benefit (DB) plan funding connection
11. Plan termination rules
12. Separate rules for tax-exempt organizations
Throughout 2016, we will be examining one of these issues each month. Whether you deal with NDCPs from the human resources or administrative perspective, these posts will alert you to some of the most common, most problematic, and potentially costliest errors that plan sponsors and/or participants make in these plans. Rather than delve into a highly technical review of the intricacies of the applicable regulations, the above listed 12 traps will be explored, intending to provide guidance regarding not only what to watch out for but also what proactive steps should be taken to avoid these traps.