Tag Archives: NDCP

Complying with nonqualified deferred compensation plan payment elections

Internal Revenue Code Section 409A contains strict rules limiting the ability of nonqualified deferred compensation plan (NDCP) participants to change their benefit commencement date (BCD) under the plan. These rules provide that, subject to certain exceptions, a change in the BCD will usually constitute an impermissible acceleration of deferral of payments under the NDCP.

In this article, Milliman’s Dominick Pizzano and White & Case’s Henrik Patel and Kenneth Barr examine how NDCP sponsors can navigate the rules to ensure their NDCP comply with Code Section 409A with respect to changes in the form of payment elections.

To quote Section 409A: An NDCP by any other name is still an NDCP

The Section 409A rules cast a very wide net when it comes to the definition of what constitutes a nonqualified deferred compensation plan (NDCP). Accordingly, employers need to regularly inventory and review their various compensation and benefits agreements in order to determine if any existing or new arrangements are structured in a manner that creates a Section 409A NDCP. This article by Milliman’s Dominick Pizzano highlights points to consider when conducting a Section 409A “to be or not to be” determination process.

This article originally appeared in the Autumn 2019 edition of Benefits Law Journal.

Pitfall questions for NDCPs attempting to successfully navigate an M&A transaction

Nonqualified deferred compensation plan (NDCP) sponsors can experience challenges during a merger and acquisition (M&A) due diligence test because of Internal Revenue Code (IRC) Section 409A compliance. However, even if all the NDCPs pass this potential problem, there are still other challenges to solve before this critical examination is completed. Two such questions are “fit” related: (1) will the NDCPs still fit within the top-hat exemption post-merger; and (2) have the NDCPs Federal Insurance Contributions Act (FICA) taxes been properly applied to the benefits? In this article, Milliman’s Dominick Pizzano and White & Case’s Henrik Patel prepare NDCP sponsors to address these two important topics and alert them to any trick questions they may pose.

M&A and nonqualified deferred compensation plans due diligence considerations

With merger and acquisition (M&A) momentum showing no signs of slowing down, companies should review their current nonqualified deferred compensation plans (NDCPs) to assess whether such plans can withstand the rigors of an M&A due diligence test, particularly with respect to compliance with Internal Revenue Code Section 409A. For companies in the midst of an M&A process, a careful examination and comparison of each of the respective companies’ NDCPs is recommended prior to closing the deal so that each side knows exactly what they will be getting into (as well as what they will be getting out of the NDCPs) when the change in control occurs. This article by Milliman’s Dominick Pizzano and White & Case’s Henrik Patel provides more perspective.

An executive survival guide for tax-exempt employers sentenced to Section 457

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

By the time executives of the corporate world-at-large experienced the first full-fledged legislative lockdown of their nonqualified deferred compensations, when the American Jobs Creation Act of 2004 instituted Internal Revenue Code (IRC) Section 409A, most of their counterparts in the tax-exempt sector had already been long used to having such benefits confined. Many years earlier, the Tax Reform Act of 1986 (TRA 86) sentenced these benefits to the custody of IRC Section 457, generally effective for taxable years beginning after December 31, 1986. The problem is that even as we approach the 30th anniversary of this sentence, Section 457 applicability and compliance still remain sources of confusion and frustration for many not-for-profit employers as they seek to provide significant executive compensation programs.

Tax-exempt employers, not employees
When not-for-profit organizations hire key decision-makers from the “for-profit” world, these organizations frequently find individuals desiring deferred compensation benefits similar to those offered by their former employers. Unfortunately, too often the tax-exempt organization complies and implements a plan that, while perfectly in compliance with the tax laws governing similar plans sponsored by corporations in the for-profit sector, does not comply with the more restrictive limitations applicable to most not-for-profit entities. If the Internal Revenue Service (IRS) discovers such a plan during an audit of the individual or the organization, the employer’s good intentions could result in extremely adverse tax consequences for the executive.

The deliberations that led to the 457 sentence
Why are tax-exempt employers subject to stricter limits than their for-profit counterparts? Because the IRS gives these organizations a pass come tax time, they cannot afford to offer the same charity to their employees. The IRS does not mind if executives of taxable entities defer as much as 100% of their compensation because, while the opportunity to tax this pay is generally deferred until the funds are distributed, the plan sponsor’s ability to take a tax deduction on such amounts is similarly delayed, thereby creating a vital trade-off that enables the U.S. Department of the Treasury to view these arrangements as tax-neutral. In contrast, tax-exempt employers have no tax deductions that can be deferred and thus no trade-off to offset the Treasury’s loss of current tax revenue incurred by their employees’ deferrals of compensation. Because tax-exempt entities as non-taxpayers are not concerned with deductibility of compensation, unless it involves unrelated trade or business income, there would be no incentive for them to limit their employees’ deferrals on their own if Section 457 did not exist.

Applicability of Section 457: Not all tax-exempts are treated equally

Free from Section 457: No separation of Church and the Feds: Originally sentenced to Section 457 by TRA 86 with the other tax-exempts, NDCPs maintained by churches and qualified church-controlled organizations (QCCOs) were paroled in 1988, when the Technical and Miscellaneous Revenue Act exempted this congregation of plans from the application of Section 457 (however, a nursing home or hospital that is associated with a church, but which is not itself a church or a QCCO, would be covered by Section 457 if it is a tax-exempt entity). The only other NDCPs granted Section 457 immunity are those established by the federal government or any agency or instrumentality thereof; although this should not be too surprising given that the creation of these rules as well as determining who must comply with them is, after all, a federal function.

Those sentenced to Section 457: The states, cities, towns, and the rest of the tax-exempts: If an employer is an entity that is a state or local government or a tax-exempt entity other than those described in the preceding paragraph, any NDCP it establishes must comply with Section 457. Plans of states and local governments have been subject to Section 457 from its creation in 1978; however, because the rules governing these arrangements are more similar to those covering qualified plans (e.g., all employees—not just executives—participate, and plan assets must be held in a separate trust for the exclusive benefit of participants), the remainder of this blog will focus on the rules applicable to the nongovernmental tax-exempts sentenced to 457.

What are the terms of a Section 457 sentence?
While a 457 sentence is mandatory, in the sense that it is levied based on the employer’s status, tax-exempt employers do have considerable discretion over the manner in which they choose to serve this sentence: a 457(b) plan (aka an eligible 457 plan), a 457(f) plan (aka an ineligible plan), or concurrently using both. The following chart reveals their major differences:

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The DB/NDCP funding conundrum

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

A particularly perplexing piece of the Pension Protection Act of 2006 (PPA) is Internal Revenue Code section 409A(b)(3), which creates a mandatory funding (i.e., a cash contribution) connection between a plan sponsor’s tax-qualified defined benefit (DB) plan and any nonqualified deferred compensation plan (NDCP) it maintains. Sponsors are prohibited from “funding” an NDCP for certain highly paid employees if circumstances arise that either actually or potentially jeopardize their DB plans’ funding status. The puzzle lies neither with the purpose of this rule nor its desired effect. True to PPA’s overall goal of protecting qualified DB plans, the prohibition put some teeth into the message that DB plan funding must take priority over dedicating corporate assets to NDCPs. Consequently, sponsors must continue to look closely at their DB plan funding before leaping into funding any NDCPs.

While the statute’s intent seems clear enough, the dilemma is in the details or, in some cases, the lack thereof. As currently written, and still absent any clarifying guidance, the statute raises a host of questions, including:

• Which employees are actually affected by the funding restraints?
• What does “fund” mean in this context?
• How does the law affect a sponsor’s ability to pay NDCP benefits?
• What are the ramifications for deferral-only plans?

When do restrictions apply?
NDCP restrictions apply during the appropriately named “restricted period,” which goes into effect:

• When the “employer” is a debtor in a federal or state bankruptcy proceeding. (Note: Throughout this article, “employer” means the NDCP sponsor and any other employers in the same control group.)

• Six months before or after the date that an underfunded DB plan of the employer is formally terminated and approved by the Internal Revenue Service (IRS) and/or Pension Benefit Guaranty Corporation (PBGC).

• During any period when an employer’s DB plan is “at-risk,” which generally means the plan has more than 500 participants and the assets of the plan represent less than 80% of the value of the benefits earned under the plan.

Are all NDCP participants affected by the funding restraints?
The funding restraints of the NDCP only apply if an individual is identified as an “applicable covered employee” of the employer. This term includes not only presently “covered employees” of the employer but also captures any employees who were “covered employees” of the employer at the time of those employees’ termination of employment. The term “covered employee” has a two-pronged definition:

1. The principal executive officer (or an individual acting in that capacity during the last completed fiscal year) or an employee whose total compensation is required to be reported to shareholders under the Securities Exchange Act of 1934 by reason of the employee being among the three highest compensated officers for the taxable year (not counting the principal executive officer), as described in tax code section 162(m)(3) and clarified by IRS Notice 2007-49.

2. An officer, director, or shareholder who owns 10% or more of a publicly traded company’s equity (i.e., an individual subject to the requirements of section 16(a) of the Securities Exchange Act of 1934).

While the application of these definitions to NDCP sponsors that are publicly traded is clear-cut, the extent, if any, of their applicability to private companies is the subject of debate. Some analysts have argued that private companies are completely exempt. Their rationale is that such companies generally would not be subject to the Securities Exchange Act of 1934, which would by definition exclude them from coverage under prong 2 of the above definition. In prong 1, they argue that the reference is to section 162(m)(3), which is part of section 162(m) and deals with the $1 million deduction limit for publicly traded companies. Accordingly, they ask, “How can this definition apply to private companies if it is from a code section governing publicly held entities?”

Getting a legal opinion before relying on that interpretation is advisable. If prong 1 applies to private companies, it may only apply on a limited basis, given that they have no employees “whose total compensation is required to be reported to shareholders under the Securities Exchange Act of 1934 by reason of the employee being among the three highest compensated officers.” Thus, in a private company, if anyone is affected, it would only be the principal executive officer. The IRS has not confirmed or denied a total exemption for private companies and no timetable for clarifying guidance has been announced, so the conservative approach for such companies (absent the above-referenced legal opinion) may be to treat the principal executive officer as an “applicable covered employee.”

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