Deferred Compensation:Pros & Cons
- 1. DEFERRED COMPENSATION PROS & CONS GAIN CONTROL berrydunn.com
- 2. DEFERRED COMPENSATION: THE PROS & CONS Just what is deferred compensation? • Service provider has a legally binding right during the current taxable year to compensation that is (or may be) payable in a future taxable year GAIN CONTROL
- 3. DEFERRED COMPENSATION: THE PROS & CONS Qualified Plan vs. Non-qualified deferred compensation • Qualified Plan deferred compensation − 401(k) and 403(b) deferrals Yes − 401(k) and 403(b) employer contributions? Hmmm . . . − Defined Benefit Plan Hmmm . . . • Non-qualified deferred compensation (NQDC) − Stock appreciation rights Yes − Supplemental executive retirement plan Yes − Incentive stock option (ISO) No GAIN CONTROL
- 4. DEFERRED COMPENSATION: THE PROS & CONS Qualified vs. Non-qualified deferred compensation • The single major tax difference: − Qualified deferred compensation − Income tax is deferred by participant − Employer takes current wage expense deduction − Non-qualified deferred compensation − Income tax is deferred by participant − Employer deduction is deferred (until income recognition) GAIN CONTROL
- 5. DEFERRED COMPENSATION: THE PROS & CONS Qualified vs. Non-qualified deferred compensation • Who can implement non-qualified deferred compensation? − Any entity − Corporations (C or S) − Partnerships − LLCs − Whether for-profit or not-for-profit − Large or small GAIN CONTROL
- 6. DEFERRED COMPENSATION: THE PROS & CONS Pros of Non-qualified deferred compensation • Tax code qualified retirement plan rules do NOT apply − No minimum participation rules − No non-discrimination rules − No minimum vesting rules − No distribution rules – for the most part (409A!) • ERISA rules generally do NOT apply Must file Statement to procure 5500 exemption (often forgotten) GAIN CONTROL
- 7. DEFERRED COMPENSATION: THE PROS & CONS Pros of Non-qualified deferred compensation • Employer can generally pick and choose whom to cover Select group of HCEs or Management • Generally, no minimums or maximums on amounts deferred • Plans can provide for EE deferrals and/or ER contributions • A potential way to provide a “piece of the action” – synthetic equity − Stock Appreciation Rights (SARs) − Phantom Stock • Potential FICA savings (early inclusion rule) • Great flexibility GAIN CONTROL
- 8. DEFERRED COMPENSATION: THE PROS & CONS Cons of Non-qualified deferred compensation • It’s still “compensation”! − Ordinary income tax rates − FICA applies • Assets are subject to creditors until distributed (plan must be “unfunded”) • No ability to roll distributions over to an IRA or similar vehicle GAIN CONTROL
- 9. DEFERRED COMPENSATION: THE PROS & CONS Cons of Non-qualified deferred compensation • Employer must defer tax deduction • Liability on Employer’s balance sheet • Can present a future cash drain if not properly planned for • Section 409A! GAIN CONTROL
- 10. DEFERRED COMPENSATION: THE PROS & CONS Cons of Non-qualified deferred compensation • How does Section 409A change the landscape? − Introduces formalities that MUST be followed − Draconian penalties for failures − Code Section and Regulations are exceedingly complex − No Employers are exempted (large, small, for-profit, non- profit) BUT – Work with a good advisor and all should be fine. GAIN CONTROL
- 11. DEFERRED COMPENSATION: THE PROS & CONS Cons of Non-qualified deferred compensation • A major Problem specific only to non-profit entities: Substantial Risk of Forfeiture • This alone is a killer for many non-profits • So what are non-profits doing? GAIN CONTROL
- 12. DEFERRED COMPENSATION: THE PROS & CONS Non-qualified Deferred Compensation • Being used more than ever • Synthetic equity is very popular • Section 409A is not proving to be a deterrent (nor should it) • There is lots of room for creativity • Any entity can make use of NQDC • Watch out for ‘hidden’ deferred compensation • Don’t let the tax tail wag the dog! GAIN CONTROL