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Submitted by: Joe Swanson
Joe Swanson is a member a team that specializes in 401k, pension and IRA planning, and retirement income planning. The team includes CFA, CPA, MBA, CFP and CRPS designations.
Nonqualified Deferred Compensation Changes Attracting Business Owners
and Advisors Attention
It is said “the only constant in life is change.” This has certainly been the case with nonqualified
deferred compensation since the inception of nternal Revenue Code Section 409A as part of
the American Jobs Creation Act of 2004. The Act itself and subsequent guidance has provided
a new framework of rules including among other things, deferral of compensation, distribution events, payment options, and penalties for noncompliance. This Advisor Update focuses on three recent rounds of guidance that may be of special interest to advisors and their clients.
New Documentary Compliance Deadline
On October 22nd, 2007 the Internal Revenue Service (IRS) and Treasury once again extended the compliance deadline for deferred compensation plans with amounts subject to Section 409A. Notice 2007-86 extends the transitional relief set to expire at the end of 2007 until December 31st, 2008. Plan sponsors should consider operating their nonqualified deferred compensation plans consistent with the final regulations as a matter of best practice. Any exercise of discretion not consistent with the final regulations will not be considered a good faith interpretation. Although advisors have another year to meet this new “written” or documentary compliance deadline, it would be wise to take immediate steps to review and revise current plans if necessary. Remember that substantial penalties can be levied upon plan participants for non-compliance by the employer (plan sponsor). As stated in the regulations, this includes taxation of all amounts deferred, plus a 20% additional tax and interest penalty.
New W-2 Reporting Requirements
Under 409A, employers are mandated to report certain information related to deferred compensation plans. Under the Code, employers must meet two requirements. They must report the amount of compensation deferred for each plan participant and any amounts deferred that are in violation of 409A. More specifically, on a participant’s W-2 Box 12, the IRS has specified Code Y for reporting deferral amounts and Code Z for reporting taxable amounts due to a plan violation.
IRS Notice 2007-89 has suspended Code Y nonqualified deferred compensation reporting requirements for 2007, but continues to mandate the Code Z violation rules that have been in effect since 2006. If plans have been operating in good faith with Section 409A and subsequent IRS guidance, there should be no 409A violations or Code Z reporting requirements to be concerned with.
New Accounting Guidance for Financial Assets
In February, 2007 the Financial Accounting Standards Board issued FAS 159, “the Fair Value Option for Financial Assets and Financial Liabilities”. Under this new guidance, both realized and unrealized gains and losses from the investment assets are reported in current net income. As a result, the full effect (both realized and unrealized) of gains and losses in investment assets can be used to offset the effect of changes in nonqualified deferred compensation liabilities. The proper management of investment assets used to finance the nonqualified plan can substantially reduce the earnings volatility that may occur under FAS 115, the alternative to FAS 159 reporting.
Conclusion
Practitioners have witnessed more governmental guidance in nonqualified deferred compensation in the last three years than all the previous decades combined. Although, some may view these new rules as onerous or restrictive, most advisors welcome the guidance 409A has initiated. Section 409A has brought clarity by codifying the best practices for establishing and maintaining deferred compensation plans. All businesses should review their deferred compensation plans.
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Authored by the
founder of the
PaladinRegistry