Bryn Mawr, Pa
For advisors who help companies fine-tune their executive and retirement plans, 2006 will be a year of both opportunity and peril. While business owners will be able to avail employees of new retirement planning options–most notably the Roth 401(k)–their nonqualified deferred compensation and defined benefits plans will also face heightened scrutiny.
This was the dual message conveyed during a presentation at The American College, held here Dec. 8 as part of the college’s annual year-end tax conference.
A chief concern of the session’s speaker, John McFadden, a Robert K. Clark chair in executive compensation and benefit planning and professor of taxation and pensions at The American College, were new regulations impacting executive pay. Businesses, he noted, have to be careful not to overstep restrictions that Internal Revenue Code Section 409 imposes on nonqualified deferred compensation. Otherwise, they’ll get hit with an immediate tax on the compensation and a 20% tax penalty.
The 409A rules, which took effect in January 2005, specify events when execs can take distributions on deferred comp (e.g., no sooner than six months after separation of service, death, disability or an unforeseeable financial emergency). And, certain exceptions notwithstanding, the code also prohibits an acceleration of benefits.
Still open to question is whether the acceleration of benefits rule precludes renegotiation of an executive’s contract. McFadden suggested the rule does, in fact, prohibit such contract renegotiations.
“We technically don’t know the answer yet,” he said. “But most practitioners who have considered this issue believe that renegotiation is now out the window. You cannot accelerate payments; nor can you extend payments unless you satisfy the rule.”
Proposed additions to 409A dating from September 2005 would, among other things, also broaden the definition of deferred compensation. Should the additions go into effect, businesses that now legitimately operate beyond 409A’s scope would either have to amend compensation packages to bring them into compliance or terminate them. Example: companies that reimburse executives for post-retirement medical expenses.
The IRS is extending 409A’s reach to still other areas, said McFadden. The Blue Book (a joint congressional committee report) on the American Jobs Creation Act of 2004, of which 409A is an outgrowth, now requires that offshore rabbi trusts and trigger provisions established prior to 2005 be terminated or made 409A-compliant. And, though the courts have ruled otherwise, the IRS has indicated that a SERP-swap–the exchange of a deferred compensation package for a life insurance policy to cover estate planning needs–also falls within 409A’s purview.
“The IRS is on the warpath,” warned McFadden. “It doesn’t accept the idea that a SERP-swap is tax-free.”
While restricting nonqualified compensation packages for top executives, the federal government is broadening them for qualified plans. Starting Jan. 1, 2006, business owners will be able to add the Roth 401(k) to their portfolio of retirement plans.