Executive employees of U.S. companies, and executives in the U.S. of companies with U.S. operations, often are parties to employment agreements that are intended to provide assurances against unanticipated changes in circumstances (such as a change in control of the employer), and participate in arrangements that are intended to provide retirement or similar benefits which will be taxable only at the time the payments or benefits are actually received. 

In 2004, the U.S. Internal Revenue Code was amended by the addition of a new Section 409A establishing a number of rules that limit the ways in which "nonqualified deferred compensation" arrangements can be structured.  Failure to comply with these rules can result in the executive being taxed before any payments are actually received, and subjected not only to ordinary tax liability on the value of their benefits, but subject to an additional 20% tax (e.g., raising the effective U.S. income tax rate on that income from 35% to 55%). 

While many executives in the U.S. understand by now that their participation in their employer's "Nonqualified Executive Deferral Plan" or in the "Supplemental Executive Retirement Plan" has become subject to some changes in the U.S. tax rules, there may not be the same level of awareness that other arrangements that were never thought to be "deferred compensation plans" may nonetheless be subject to these new rules (and the potential penalty tax that applies to plans that are noncompliant). 

Listed below are just some of the types of arrangements (some are obvious and some are not) that may be considered to provide nonqualified deferred compensation benefits that should be reviewed for compliance with the new Section 409A of the U.S. Internal Revenue Code and the regulations and other guidance that is or may be issued by the Internal Revenue Service in the future:

ï           "Top-hat" executive retirement plans (sometimes referred to as "supplemental executive retirement plans" or "SERPs").

ï           Executive deferral plans (sometimes mirroring a 401(k) plan, but permitting larger deferrals than are permitted in a "qualified plan" such as a 401(k)).

ï           Employment agreements that provide for payments on death, disability or termination of employment.

ï           Severance benefit plans (particularly problematic are plans for top executives of public companies, and severance plans that are linked to a "change of control" of the employer).

ï           Equity based compensation plans.  Stock options can be considered a form of  nonqualified deferred compensation, particularly if the option is granted at less than fair market value of the underlying stock determined as of the date of grant.  Phantom stock plans, "restricted stock units" (as distinct from normal "restricted stock" grants), stock appreciation rights and other phantom equity arrangements can all be considered to be forms of nonqualified deferred compensation plans 

ï           Split-dollar arrangements that involve payments from the employer to the key employee at a future date or a future transfer of property (e.g., as where a life insurance policy is to be "rolled out" to the employee at some future date, or where other future payments of "compensation" may be made to an employee to continue an existing split-dollar arrangement) may be considered to be a form of nonqualified deferred compensation. 

Any arrangements that are described above, or that may provide similar benefits should be reviewed and discussed with tax counsel, and particularly with tax counsel that is experienced with executive compensation and benefits. 

^*Partner, Wolf, Block, Schorr and Solis-Cohen LLP
Chair, Employee Benefits Practice

Mr. Fusfeld is a Partner of the firm, where he has worked as an attorney since 1986. His practice is primarily in the area of employee benefits and taxation, including executive compensation and deferred compensation (both qualified and non-qualified).  In his practice, Mr. Fusfeld is involved in all levels of ERISA and non-ERISA employee plan design, drafting and implementation. His experience in the area of executive compensation includes extensive experience in the areas of deferred compensation arrangements, stock-based and performance-based executive compensation programs and issues of special concern to publicly traded companies.

e-mail: wfusfeld@wolfblock.com
phone: 215-977-2604