What Congress Did To Deferred Compensation Arrangements New rules for timing of deferrals and distributions
By John H. Fenton
President Bush recently signed the American Jobs Creation Act of 2004, a massive tax bill that includes new rules for nonqualified deferred compensation (NQDC) plans.
NQDC plans are a popular way for employers to attract and reward key employees. In exchange for deferring compensation, an employee can avoid current taxation and receive the compensation, along with some growth, at a later date. It is not a riskless trade-off, however. To avoid current taxation, the employee must bear some risk of losing the money, either by failing to meet conditions imposed by the plan or, in the event of financial trouble for the employer, by losing it to the employers creditors. In an effort to eliminate perceived abuses, the new rules impose strict requirements for the timing of deferrals, the timing of distributions, and the funding of deferred compensation plans, and a stiff new penalty for running afoul of the requirements.
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In the past, a participant in an NQDC plan had to elect to defer income before it was payable, and as long as it was subject to a substantial risk of loss, taxation would be deferred. Now, a participant must make a deferral election before the end of the prior tax year. A first-time participant in a plan may make an election within 30 days after becoming eligible but may defer compensation only for services performed after the election.
In the past, there were few legal limitations on when a plan could allow distributions of deferred compensation. Now, a participant may receive a distribution in only 6 situations:
–separation from service;