Deferred compensation alternatives to sec. 457(f).

• Author: Zarzar, Robert
• Position: Large tax-exempt organizations

Large tax-exempt organizations (such as universities and hospitals) must address complex administrative and financial problems, triggering a need for top executive talent. The ability to offer an attractive total compensation package, including a deferred compensation plan, is a valuable recruiting tool for both for-profit and nonprofit organizations. However, for-profit organizations generally have substantially greater flexibility in offering deferred compensation plans to employees, in large part because of the Sec. 457 limits on tax-exempt organizations.

Sec. 457 provides rules for two types of nonqualified deferred compensation plans--an "eligible" plan under Sec. 457(b) and an "ineligible" plan under Sec. 457(f). Under an eligible Sec. 457(b) plan, an employee may elect to defer a portion of compensation; the plan functions much like a Sec. 403(b) or 401(k) plan, in that deferred amounts and the earnings thereon are not subject to Federal income tax until distribution. Like Sec. 401(a) qualified plans and Sec. 403(b) plans, Sec. 457(b) plans are subject to limits under the Code and generally cannot provide significant deferred compensation value to executives. Notwithstanding these limits, recent tax legislation removes the coordination requirement (with Secs. 403(b) and 401(k)) under Sec. 457(c), thus providing better opportunities for deferral under a Sec. 457(b) plan.

Certain employees of tax-exempt organizations may be able to receive deferred compensation under an ineligible Sec. 457(f) plan. However, benefits under such a plan must be subject to a "substantial risk of forfeiture" to avoid taxation at deferral. Typically, vesting in a deferred compensation amount is conditioned on future performance of substantial services for the employer. This condition creates a "catch-22" situation for an executive. On the one hand, the executive will not realize a meaningful benefit from tax deferral unless he can defer tax for a reasonably long period of time; on the other hand, the longer the deferral period, the greater the risk that the executive may forfeit his right to the compensation altogether by terminating employment before the vesting date. There are, however, potential alternatives for deferral of compensation by executives that may fall outside of Sec. 457(f).

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