Nonqualified Employer Retirement Plans
Parent Corporation May Guarantee Unfunded Retirement Benefits. – The mere contractual
guarantee of a retiree's benefits under an unfunded retirement plan by an employer’s parent
company will generally not accelerate the taxation of the benefits. (Ltr. Rul. 200450032.) See
Chapter 9 of the treatise for a discussion of deferrals of compensation under unfunded
retirement plans.
Early Payments Substantially Limited under Unfunded Retirement Plans. – The American
Jobs Creation Act of 2004 imposes new limitations on premature payments under unfunded
retirement plans (other than eligible exempt organization plans). The new limitations apply to
amounts deferred after 2004. The limitations also apply to amounts deferred before 2005 if your
employer materially modifies your plan after October 3, 2004.
When deferred payments may begin. – Under the new rules, an unfunded plan may provide for
payment of benefits only after the earliest of one or more of certain dates or events. Those dates
or events include (a) a date specified at deferral, (b) a participant's separation from service, (c) a
participant's disability, (d) a participant's death, (e) a change in ownership of the employer, or (f)
an unforeseeable emergency. Nevertheless, a participant may receive earlier payments to
satisfy divorce court orders, comply with federal conflict of interest rules, pay social security
taxes on deferrals of compensation, and certain other unusual events.
Some additional deferrals permitted. – An unfunded plan may allow a participant to make an
election to further delay payments or change their form. However, the election may not take
effect for at least 12 months. The election must also delay the payments for a period of at least
five additional years – unless the payments relate to the participant's death, disability, or
unforeseeable emergency. If the election involves a specified date for payment, the participant
must make the election at least 12 months before the specified date
Potentially harsh taxes, penalties, and interest. – Most employers will have modified plans to
conform to the new requirements. If not, though, or if a plan actually makes payments that do not
conform, a participant may become subject to substantial taxes, penalties, and interest (on the
tax deferred). The participant must include in gross income all of his or her deferred
compensation under the plan that is not subject to a substantial risk of forfeiture and not
previously taxed. For this purpose, proposed regulations provide that deferred amounts are not
subject to a substantial risk of forfeiture that lapses during the year of a failure to conform,
whether lapsing before or after the failure.
The proposed regulations also narrowly define “previously taxed” amounts excludable from
gross income upon a 409A failure. For example, deferred compensation is not “previously
taxed” unless the participant actually reported it on a prior year tax return or amended return, or
the IRS or a court required its inclusion in gross income. Thus, deferred compensation not
actually included in gross income in a prior year does not escape taxation even if the statute of
limitations has run on the prior year. In addition, payments of deferred amounts to a participant
during the tax year of a failure to conform are not “previously taxed” amounts, whether or not paid
before or after the failure.
Upon a failure to conform, the participant must also pay a 20 percent penalty tax on the taxable
amounts, and must pay interest on the hypothetical taxes the participant would have incurred in
prior years without the deferral. Proposed regulations provide that, for purposes of computing
prior year hypothetical taxes, investment losses and payments of deferred compensation in all
prior years first reduce compensation for the earliest such prior year or years.
Finally, the proposed regulations allow a participant to take a deduction for the excess of (1)
unpaid deferred compensation previously included in gross income due to failures to conform
over (2) the amount the retiree receives as final payment from the plan. However, the deduction
is available only if the participant’s rights to any other payments under the plan are then wholly
worthless.
Certain property set aside for deferred payments. – A participant may also be liable for
substantial taxes, penalties, and interest if the participant's employer owns or transfers property
outside the United States that is set aside for payment of the participant's deferred
compensation – unless the property is in a foreign country where the participant earned the
compensation. The taxes, penalties, and interest may also apply if the plan restricts property to
payment of a participant's benefits upon future deterioration of the employer’s financial health –
or if property is actually so restricted.
For a more complete discussion of the new requirements, see Chapter 9 of the treatise.
(American Jobs Creation Act of 2004, Pub. L. No. 108-537; I.R.C. § 409A; Prop. Reg. § 1.409A-4;
Notice 2005-1, 2005-2 I.R.B. __.)
No Private Letter Rulings on Nonqualified Plan Issues. – Unfortunately, the IRS has
announced it will not issue private letter rulings on issues involving the statutory restrictions
applicable to nonqualified retirement plans (i.e., on section 409A issues). (Rev. Proc. 2009-3,
2009-1 I.R.B. 107.) See Chapter 9 of the treatise for a complete discussion of section 409A.
Deferral of Recurring Part-Year Compensation. – If certain conditions are satisfied, an
employee’s recurring part-year compensation will not be subject to the rules governing
nonqualified deferred compensation. Most employees affected by this provision will be teachers
employed for a 9 to 10 month service period, but paid over a 12-month period. To qualify, an
employee must receive the compensation by the end of the 13th month following the beginning
of the employee’s service period. The service period must be a period of less than 12 months
and the arrangement must be likely to continue in future years. Finally, the arrangement cannot
defer more than a specified amount from year to year ($16,500 for 2009). (I.R.C. § 457(f); Reg. §
1.409A-2(a)(14); Notice 2008-62, 2008-2 C.B. 130; Notice 2008-102, 2008-2 C.B. 1106.) See
Chapters 9 and 10 of the treatise for discussions of nonqualified deferred compensation.
Taxes, Penalties, and Interest upon Failure to Conform to Section 409A – A participant in a
nonqualified plan may suffer harsh consequences if the terms of the plan fail to satisfy the
requirements of Code section 409A, or if the plan fails to operate in conformity with those
requirements. The participant must include in gross income all deferred compensation under
the plan not subject to a substantial risk of forfeiture and not previously taxed. For this purpose,
deferred amounts are not subject to a substantial risk of forfeiture if it lapses during the year of a
409A failure, whether it lapses before or after the failure.
Further, deferred compensation is not “previously taxed” unless the participant actually reported
it on a prior year return, or the IRS or a court required its inclusion in gross income. If not, the
deferred compensation does not escape taxation even if the statute of limitations has run on the
prior year. In addition, deferred amounts paid to a participant during the year of a 409A failure
are not “previously taxed” amounts, whether or not paid before or after the failure.
Upon a 409A failure, the participant must also pay a 20 percent penalty tax on the taxable
amounts, and must pay interest on the hypothetical taxes the participant would have incurred in
prior years. For purposes of computing prior year hypothetical taxes, investment losses and
payments of deferred compensation in all prior years first reduce compensation for the earliest
such prior year or years. (I.R.C. § 409A(a)(1), (d)(5); Prop. Reg. § 1.409A-4(a), (d).) See
Chapters 9 and 10 of the treatise for discussions of nonqualified deferred compensation.
Deferred Compensation Payable by Certain Foreign Entities. – Nonqualified deferred
compensation payable by certain largely untaxed foreign corporations or partnerships for
services performed after 2008 receives generally unfavorable treatment. Such compensation is
generally taxable to the recipient when the compensation is no longer subject to a substantial
risk of forfeiture. If the amount of the compensation is not determinable until a still later date, it is
taxable at that later date, together with applicable interest and penalties. (I.R.C. § 457A; Notice
2009-8, 2009-4 I.R.B. 347.) See Chapters 9 and 10 of the treatise for discussions of
nonqualified deferred compensation.
TARP Executive Pay Accelerations or Deferrals under Section 409A. – The Emergency
Economic Stabilization Act of 2008 provided for certain adjustments to the compensation of
executives of financial institutions receiving funds under the Troubled Asset Relief Program
(TARP). Some such adjustments may require accelerations of the payment of deferred
compensation, or require a delay in the payment of short-term deferrals beyond the usual 2½-
month period. If so, the acceleration or delay generally does not constitute a violation of section
409A governing unfunded nonqualified plans. (Notice 2009-92, 2009-52 I.R.B. 964.) See
Chapter 9 of the treatise for the taxation of distributions from unfunded nonqualified plans.
Relief for Section 409A Operational Failures. – The IRS has provided plan participants with
some relief for operational failures to comply with section 409A. If certain conditions are
satisfied, a plan and its participants may be able to obtain such relief by:
1. Correcting certain operational failures during a participant’s tax year that includes the failure
and, for some participants, during the subsequent tax year.
2. Limiting the amount includible in income for certain operational failures that involve only
limited amounts
3. Limiting the amount includible in income for certain operational failures regardless of
whether the failure involves only limited amounts, but subject to further required actions to
correct the failure.
4. Obtaining special transition relief for certain operational failures occurring before January 1,
2008.
(Notice 2008-113, 2008-2 C.B. 1305.) See Chapter 9 of the treatise for the taxation of
distributions from unfunded nonqualified plans).
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Parent Corporation May Guarantee Unfunded Retirement Benefits. – The mere contractual
guarantee of a retiree's benefits under an unfunded retirement plan by an employer’s parent
company will generally not accelerate the taxation of the benefits. (Ltr. Rul. 200450032.) See
Chapter 9 of the treatise for a discussion of deferrals of compensation under unfunded
retirement plans.
Early Payments Substantially Limited under Unfunded Retirement Plans. – The American
Jobs Creation Act of 2004 imposes new limitations on premature payments under unfunded
retirement plans (other than eligible exempt organization plans). The new limitations apply to
amounts deferred after 2004. The limitations also apply to amounts deferred before 2005 if your
employer materially modifies your plan after October 3, 2004.
When deferred payments may begin. – Under the new rules, an unfunded plan may provide for
payment of benefits only after the earliest of one or more of certain dates or events. Those dates
or events include (a) a date specified at deferral, (b) a participant's separation from service, (c) a
participant's disability, (d) a participant's death, (e) a change in ownership of the employer, or (f)
an unforeseeable emergency. Nevertheless, a participant may receive earlier payments to
satisfy divorce court orders, comply with federal conflict of interest rules, pay social security
taxes on deferrals of compensation, and certain other unusual events.
Some additional deferrals permitted. – An unfunded plan may allow a participant to make an
election to further delay payments or change their form. However, the election may not take
effect for at least 12 months. The election must also delay the payments for a period of at least
five additional years – unless the payments relate to the participant's death, disability, or
unforeseeable emergency. If the election involves a specified date for payment, the participant
must make the election at least 12 months before the specified date
Potentially harsh taxes, penalties, and interest. – Most employers will have modified plans to
conform to the new requirements. If not, though, or if a plan actually makes payments that do not
conform, a participant may become subject to substantial taxes, penalties, and interest (on the
tax deferred). The participant must include in gross income all of his or her deferred
compensation under the plan that is not subject to a substantial risk of forfeiture and not
previously taxed. For this purpose, proposed regulations provide that deferred amounts are not
subject to a substantial risk of forfeiture that lapses during the year of a failure to conform,
whether lapsing before or after the failure.
The proposed regulations also narrowly define “previously taxed” amounts excludable from
gross income upon a 409A failure. For example, deferred compensation is not “previously
taxed” unless the participant actually reported it on a prior year tax return or amended return, or
the IRS or a court required its inclusion in gross income. Thus, deferred compensation not
actually included in gross income in a prior year does not escape taxation even if the statute of
limitations has run on the prior year. In addition, payments of deferred amounts to a participant
during the tax year of a failure to conform are not “previously taxed” amounts, whether or not paid
before or after the failure.
Upon a failure to conform, the participant must also pay a 20 percent penalty tax on the taxable
amounts, and must pay interest on the hypothetical taxes the participant would have incurred in
prior years without the deferral. Proposed regulations provide that, for purposes of computing
prior year hypothetical taxes, investment losses and payments of deferred compensation in all
prior years first reduce compensation for the earliest such prior year or years.
Finally, the proposed regulations allow a participant to take a deduction for the excess of (1)
unpaid deferred compensation previously included in gross income due to failures to conform
over (2) the amount the retiree receives as final payment from the plan. However, the deduction
is available only if the participant’s rights to any other payments under the plan are then wholly
worthless.
Certain property set aside for deferred payments. – A participant may also be liable for
substantial taxes, penalties, and interest if the participant's employer owns or transfers property
outside the United States that is set aside for payment of the participant's deferred
compensation – unless the property is in a foreign country where the participant earned the
compensation. The taxes, penalties, and interest may also apply if the plan restricts property to
payment of a participant's benefits upon future deterioration of the employer’s financial health –
or if property is actually so restricted.
For a more complete discussion of the new requirements, see Chapter 9 of the treatise.
(American Jobs Creation Act of 2004, Pub. L. No. 108-537; I.R.C. § 409A; Prop. Reg. § 1.409A-4;
Notice 2005-1, 2005-2 I.R.B. __.)
No Private Letter Rulings on Nonqualified Plan Issues. – Unfortunately, the IRS has
announced it will not issue private letter rulings on issues involving the statutory restrictions
applicable to nonqualified retirement plans (i.e., on section 409A issues). (Rev. Proc. 2009-3,
2009-1 I.R.B. 107.) See Chapter 9 of the treatise for a complete discussion of section 409A.
Deferral of Recurring Part-Year Compensation. – If certain conditions are satisfied, an
employee’s recurring part-year compensation will not be subject to the rules governing
nonqualified deferred compensation. Most employees affected by this provision will be teachers
employed for a 9 to 10 month service period, but paid over a 12-month period. To qualify, an
employee must receive the compensation by the end of the 13th month following the beginning
of the employee’s service period. The service period must be a period of less than 12 months
and the arrangement must be likely to continue in future years. Finally, the arrangement cannot
defer more than a specified amount from year to year ($16,500 for 2009). (I.R.C. § 457(f); Reg. §
1.409A-2(a)(14); Notice 2008-62, 2008-2 C.B. 130; Notice 2008-102, 2008-2 C.B. 1106.) See
Chapters 9 and 10 of the treatise for discussions of nonqualified deferred compensation.
Taxes, Penalties, and Interest upon Failure to Conform to Section 409A – A participant in a
nonqualified plan may suffer harsh consequences if the terms of the plan fail to satisfy the
requirements of Code section 409A, or if the plan fails to operate in conformity with those
requirements. The participant must include in gross income all deferred compensation under
the plan not subject to a substantial risk of forfeiture and not previously taxed. For this purpose,
deferred amounts are not subject to a substantial risk of forfeiture if it lapses during the year of a
409A failure, whether it lapses before or after the failure.
Further, deferred compensation is not “previously taxed” unless the participant actually reported
it on a prior year return, or the IRS or a court required its inclusion in gross income. If not, the
deferred compensation does not escape taxation even if the statute of limitations has run on the
prior year. In addition, deferred amounts paid to a participant during the year of a 409A failure
are not “previously taxed” amounts, whether or not paid before or after the failure.
Upon a 409A failure, the participant must also pay a 20 percent penalty tax on the taxable
amounts, and must pay interest on the hypothetical taxes the participant would have incurred in
prior years. For purposes of computing prior year hypothetical taxes, investment losses and
payments of deferred compensation in all prior years first reduce compensation for the earliest
such prior year or years. (I.R.C. § 409A(a)(1), (d)(5); Prop. Reg. § 1.409A-4(a), (d).) See
Chapters 9 and 10 of the treatise for discussions of nonqualified deferred compensation.
Deferred Compensation Payable by Certain Foreign Entities. – Nonqualified deferred
compensation payable by certain largely untaxed foreign corporations or partnerships for
services performed after 2008 receives generally unfavorable treatment. Such compensation is
generally taxable to the recipient when the compensation is no longer subject to a substantial
risk of forfeiture. If the amount of the compensation is not determinable until a still later date, it is
taxable at that later date, together with applicable interest and penalties. (I.R.C. § 457A; Notice
2009-8, 2009-4 I.R.B. 347.) See Chapters 9 and 10 of the treatise for discussions of
nonqualified deferred compensation.
TARP Executive Pay Accelerations or Deferrals under Section 409A. – The Emergency
Economic Stabilization Act of 2008 provided for certain adjustments to the compensation of
executives of financial institutions receiving funds under the Troubled Asset Relief Program
(TARP). Some such adjustments may require accelerations of the payment of deferred
compensation, or require a delay in the payment of short-term deferrals beyond the usual 2½-
month period. If so, the acceleration or delay generally does not constitute a violation of section
409A governing unfunded nonqualified plans. (Notice 2009-92, 2009-52 I.R.B. 964.) See
Chapter 9 of the treatise for the taxation of distributions from unfunded nonqualified plans.
Relief for Section 409A Operational Failures. – The IRS has provided plan participants with
some relief for operational failures to comply with section 409A. If certain conditions are
satisfied, a plan and its participants may be able to obtain such relief by:
1. Correcting certain operational failures during a participant’s tax year that includes the failure
and, for some participants, during the subsequent tax year.
2. Limiting the amount includible in income for certain operational failures that involve only
limited amounts
3. Limiting the amount includible in income for certain operational failures regardless of
whether the failure involves only limited amounts, but subject to further required actions to
correct the failure.
4. Obtaining special transition relief for certain operational failures occurring before January 1,
2008.
(Notice 2008-113, 2008-2 C.B. 1305.) See Chapter 9 of the treatise for the taxation of
distributions from unfunded nonqualified plans).
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| Copyright © 2005-2010 by Vorris J. Blankenship All Rights Reserved |
The author intends that this website provide accurate and authoritative information on the subject matter
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
Key Tax Developments Affecting Retirees
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