3540 / What are the tax benefits for a participant of an unfunded deferred compensation agreement with an employer?

A properly constructed unfunded¹ nonqualified deferred compensation agreement can postpone payment of compensation for currently rendered services until a future date, with the intended objective of postponing the taxation of such compensation until it is actually received. Since the enactment of IRC Section 409A (generally effective as to contributions/deferrals to plans as of January 1, 2005), such an agreement, at least with respect to vested compensation, likely will create a plan that is covered by the additional tax law requirements of Section 409A, unless the plan is either specifically exempted by the statute or can claim an exception under the regulations. The IRS released proposed regulations in June 2016 that made amendments to clarify the final regulations under Section 409A (TD 9321, 72 FR 19234). This document also withdraws a specific provision of the notice of proposed rulemaking (REG-148326-05) published in the Federal Register on December 8, 2008 (73 FR 74380) regarding the calculation of amounts includible in income under Section 409A(a)(1). The provision is replaced by revised proposed regulations. These proposed regulations affect participants, beneficiaries, sponsors, and administrators of nonqualified deferred compensation plans.²

Section 409A also creates an entirely new and greatly expanded group of compensation plan types that may be covered by Section 409A under the law’s broad definition of a “nonqualified deferred compensation plan” (see the nine plan types that follow). This definition constitutes an expansion beyond what historically was considered a deferred compensation plan and now pulls in almost all executive compensation plans and some employee benefit plans.

Under Section 409A, a nonqualified deferred compensation plan is one involving a deferral of compensation that is legally binding in the present tax year and not payable until a future tax year (beyond the current tax year plus 2½ months), and is not specifically statutorily exempted or excepted by regulation.

As noted, under the current Section 409A regulations, there are nine types or categories of nonqualified deferred compensation plans, per the so-called “aggregation rule,” as follows:

(1)   Employee account balance plans (voluntary salary, bonus, commission deferral plans)

(2)   Employer account balance plans (defined contribution, “phantom stock” plans)

(3)   Employer nonaccount balance plans (defined benefit plans)

(4)   Split dollar life insurance plans (except for the two limited formats detailed in Revenue Ruling 2008-36)

(5)   Stock equity plans

(6)   Severance/separation plans

(7)   Reimbursement or fringe benefit plans

(8)   Foreign plans

(9)   Other miscellaneous plans