Current Issues in Non-qualified Deferred Compensation
| Publication year | 1985 |
| Pages | 1606 |
1985, September, Pg. 1606. Current Issues in Non-Qualified Deferred Compensation
Non-qualified deferred compensation plans ("NQDCPs")(fn1) have long provided important planning alternatives for the compensation of corporate executives. Their use and importance has dramatically increased during the last three years, as successive new tax acts have eroded the attractiveness of qualified plans.
NQDCPs initially have a deceptive appearance of simplicity. Although the plans seem simple when compared with the intricacies of qualified plans, they contain numerous pitfalls for those who deal with them infrequently. For example, NQDCPs confront several major tax issues, including the constructive receipt doctrine; ERISA compliance; reasonable compensation to the employee; and "golden parachute" provisions for key employees.(fn2) Furthermore, securities considerations and protection from creditor claims pose significant non-tax hurdles.(fn3)
This article discusses three issues of current significance in the consideration of NQDCPs: (1) deferring receipt of current compensation; (2) golden parachute provisions for key employees; and (3) securing deferred compensation.
The fundamental principle, as first set out in a published Revenue Ruling, is that income must be deferred prior to the time it is earned.(fn4) A subsequent Revenue Procedure narrowed the issue by requiring that "such election must be made before the beginning of the period of service for which the compensation is payable...."(fn5) There are two exceptions to this rule: (1) executives can elect to defer future income within thirty days after the corporate adoption of a plan; and (2) executives can make an election within thirty days of becoming eligible to participate in the plan.
Deferral elections generally apply to two types of compensation: regular salary and lump sum bonus/incentive compensation. The formal position of the Internal Revenue Service ("Service") states the same rule for both salary and bonus deferrals---the election must be made prior to the start of the year during which the compensation will be earned.(fn6) Informally, the Service distinguishes between the two situations.
Salary deferral rulings follow the formally stated Service position. Thus, for a corporation using the calendar year as its fiscal year, an election to defer calendar year 1986 salary, or any part thereof, will have to be made on or before December 31, 1985. An exception is that the "year" of salary payment can be designed to be either the corporate fiscal year or the calendar year for the individual taxpayer.(fn7)
Bonus deferrals present a different and more difficult case. Conceptually, the "defer prior to earning" requirement does not apply as cleanly to bonuses as to salary because:
1) Payment occurs in a year other than when earned;
2) The amount is often unknown or uncertain;
3) The award is frequently based on personal or intangible...
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