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Non-Qualified Deferred Compensation Legislation Likely To Pass This Year

It looks like the nonqualified deferred compensation legislation is likely to pass this year after all.  The FSC/ETI bill H.R. 4520 currently under consideration in the House/Senate conference includes the common nonqualified deferred compensation provisions from the bills previously approved by the House and the Senate.  Yesterday a “Chairman’s Mark” was issued which will be under consideration today.  The Chairman’s Mark includes the following changes and revised elements of prior proposals:

Onerous Senate Bill Features Omitted.  Significantly, the proposal does not contain the following features that had been included in the Senate-approved version of the legislation: restrictions on the types of investments available to plan participants, rules prohibiting deferral of stock option gains, and golden parachute excise tax treatment.

Effective Date.  The proposal would generally apply to amounts deferred after December 31, 2004.  The new rules would also apply to amounts deferred before January 1, 2005, under plans that are materially modified after October 3, 2004 (other than if the material modifications are pursuant to Treasury guidance permitting (1) termination of plan participation or elections or (2) plans to conform to the new rules).

General Rule.  Under the proposal, amounts deferred under an nonqualified deferral plan are generally taxable if the plan fails to meet the new rules or if the plan is not operated in accordance with those rules.  In the event of such a failure, all compensation deferred under the plan for the current or prior taxable years is taxable (to the extent not subject to a substantial risk of forfeiture).  Unlike previous versions of the proposal, the proposal would limit this taxability rule to individual participants with respect to whom a failure relates (i.e., not to the entire plan).  If compensation is required to be included in income because of such a failure, the tax would be increased by an interest factor (relating back to the year of original deferral) and by 20-percent of the includible compensation.

Distributions.  As in prior versions, nonqualified deferral plan distributions could be made no earlier than separation from service, the date a participant becomes disabled, death, a specified time (or fixed schedule) specified at the date of deferral, upon a change of ownership of the corporation or a substantial portion of its assets (to the extent specified by the Treasury Department), or the occurrence of an unforeseeable emergency.  For certain key employees, distributions on separation from service would have to be delayed an additional 6 months.

Benefits Cannot Be Accelerated.  Except as provided in regulations, a nonqualified plan may not permit the acceleration of benefits.

Deferral Elections.  In general, compensation for services performed during a taxable year may be deferred at the participant’s election only if the election to defer is made before the end of the preceding taxable year (or at such other time as the as provided in regulations).  In the first year of eligibility, an election can be made with 30 days after a participant becomes eligible to participate (but only with respect to services performed after the election).  In a new rule, for performance-based compensation based on services performed over a period of at least 12 months, the election could be made up to 6 months before the end of the service period.

Changes in the Time and Form of Distribution.  For plans permitting a subsequent election to delay a payment or to change the form of a payment, the election may not take effect for at least 12 months after it is made, generally the first payment must be delayed at least 5 years, and the election may not be made less than 12 months prior to the date of the first scheduled payment.

Offshore Trusts.  Amounts set aside in offshore trusts to pay deferred compensation would generally be taxed when set aside.

Employer’s Financial Health.  Deferred compensation would generally be taxable if the plan restricts funds to the payment of benefits upon the event of a change in the employer’s financial health.

Treasury Guidance.  The Treasury would be expected to provide certain guidance by regulations, including, within 60 days of enactment, guidance allowing, for a limited period, the modification of plans (1) to permit plan participants to terminate participation or to cancel an outstanding deferral election or (2) to conform to the new rules.

No COLI Provisions. H.R. 4520 and the “Chairman’s Mark” do not include the provisions previously approved on corporate-owned life insurance (COLI).  However, efforts are being made by the insurance industry to have the previously agreed to COLI provisions included in this bill.

This client alert is a publication of Loeb & Loeb LLP and is intended to provide information on recent legal developments. This client alert does not create or continue an attorney client relationship nor should it be construed as legal advice or an opinion on specific situations. We will continue to monitor and keep you informed of further developments regarding this legislation. If you have further questions, please contact Marla Aspinwall at 310.282.2377.

Circular 230 Disclosure: To assure compliance with Treasury Department rules governing tax practice, we inform you that any advice (including in any attachment) (1) was not written and is not intended to be used, and cannot be used, for the purpose of avoiding any federal tax penalty that may be imposed on the taxpayer, and (2) may not be used in connection with promoting, marketing or recommending to another person any transaction or matter addressed herein.