Non-Qualified Deferred Compensation
By Joe Rankin & Bruce Delbecq
Employee Benefits Alert, November 2005
Requirement
The 2004 American Jobs Creation Act placed restrictions on deferred compensation plans that are now in effect. These rules generally apply to any plan or arrangement that defers the payment of compensation more than 2½ months after the end of the year in which it’s earned.
Description
The new rules focus on executive style deferred compensation plans but also encompass certain severance, bonus, and employment contract payments that will be paid in a year after the amounts are earned.
Generally, arrangements will have to be in writing, and the timing and form of payment will have to be specified at the time of deferral. Acceleration or postponement of the payment timing can only be done in certain limited circumstances. Employee elective deferrals must be made before the beginning of the tax year to which the election relates, except the election for certain performance-based compensation that may be postponed until six months before the end of the performance period.
Certain special rules apply to equity arrangements, such as stock options and stock appreciation rights, change in control provisions, and for arrangements related to employees performing services outside their home country.
Based on the new rules, tax strategies such as deferring bonus payments into a subsequent year may have unintended and negative consequences on deferred compensation arrangements.
Action
Every deferred compensation arrangement should be reviewed for compliance with the new rules before December 31, 2005. Since certain elections and options expire at the end of 2005, design and administration decisions will have to be made before new non-qualified deferred compensation plan awards or accruals are granted, and most plan documents will have to be amended before the end of 2006.
