Change to accrual accounting will not delay taxes on certain deferred compensation beyond 2017.

• Author: Morrison, Helen H.

In a Chief Counsel Memorandum (AM 2016-003), the IRS addressed a change in accounting method by taxpayers with grandfathered deferred compensation that must be included in income in the last tax year before 2018 under the statutory provision that enacted Sec. 457A. The IRS clarifies in AM 2016-003 that a taxpayer may not delay the income inclusion of the grandfathered deferred compensation amounts beyond 2017 by requesting a change in method of accounting from cash to accrual and then using an adjustment under the Sec. 481(a) administrative guidance to spread the income recognition to later years.

Deferred Compensation

The Tax Extenders and Alternative Minimum Tax Relief Act, RL. 110-343 (the 2008 Act), added Sec. 457A to the Internal Revenue Code. Sec. 457A applies to service providers (individuals or entities) who perform services for tax-indifferent parties (i.e., generally tax-exempt), regardless of whether the service provider uses the cash method or accrual method of accounting. Under Sec. 457A, taxpayers that provide services to a tax-indifferent party must include fees and other compensation in gross income in the later of the year when the services are performed or when the compensation is no longer subject to a substantial risk of forfeiture. If, at the time the compensation should otherwise be included in income, those amounts are not determinable (e.g., amounts due are subject to a financial performance hurdle not yet met), the compensation must be included in income when it becomes determinable, and the tax on the compensation is increased by an interest charge and an amount equal to 20% of the compensation amount.

Under Sec. 801(a) of the 2008 Act, Sec. 457A applies only to amounts deferred for services performed in 2009 or later. Section 801(d)(2) of the 2008 Act provides a transition rule for deferred amounts that are exempt from Sec. 457A solely because they are attributable to services performed before Jan. 1, 2009. (This provision commonly is known as the Sec. 457A "grandfathering" rule.) Sec. 801(d)(2) of the 2008 Act requires grandfathered amounts to be included in income in the later of (1) the last tax year beginning before 2018, or (2) the tax year in which there is no substantial risk of forfeiture of the rights to the compensation.

Service providers who are cash-method taxpayers may continue to be subject to Sec. 409A (which governs deferred compensation generally) on grandfathered amounts. Following the 2008 Act...