Nonqualified deferred compensation agreements: tax and ERISA requirements.

In the span of a few short years, the Revenue Reconciliation Act of 1990 (RRA '90) and the Revenue Reconciliation Act of 1993 (RRA '93) raised the maximum marginal individual tax rates from 28% to 39.6%. In addition, the RRA '90's phaseout of personal and dependency exemptions and reduction of itemized deductions have effectively forced high-income taxpayers to face an additional 3% to 5% of marginal taxation. In response to these significant rate increases, higher-income taxpayers and their advisers have sought relief. One of the few remaining devices for deferring tax involves the use of nonqualified deferred compensation agreements (DCAs).

Broadly defined, a nonqualified DCA is a contract under which an employee (or independent contractor) agrees to be paid in a future year for services currently rendered to an employer.(1) Deferred compensation payments generally commence on termination of employment (e.g., retirement) or preretirement death or disability. The DCA's goal is to provide cash payments to the retiree and to defer tax on the deferred compensation to a year in which the recipient may be in a lower tax bracket. Although the employer's contractual obligation to pay the DCA benefit is typically unsecured, the obligation remains a contractual promise that must be performed by the employer in the absence of the employee's breach.

Types of DCAs

There are two broad structural categories of DCAs: elective and nonelective.

Elective DCAs: Under this form of DCA, the employee opts to defer to a future tax year receipt of some salary and bonus compensation that he would otherwise currently receive. The initiative behind the deferral comes from the employee. Generally, the deferred compensation benefit is based on the amount deferred plus an interest factor. The election to defer income should be made before the income is earned--e.g., an agreement would be entered into by Dec. 31, 1995 to defer 10% of compensation that would otherwise be earned and payable in 1996. The IRS will not issue an advance ruling when the DCA is entered into after the underlying services earning such deferred compensation have been rendered.(2)

Because the employee is initiating the deferral of compensation that would otherwise shortly be earned and received, it would be inappropriate to impose a substantial risk of forfeiture on such DCA benefits. A substantial risk of forfeiture is a vesting mechanism requiring the performance of significant future services before DCA benefits become nonforfeitable. Therefore, an elective deferral would normally be fully vested and payable in the event of preretirement termination of employment for virtually any reason. Rev. Rul. 60-31(3) allows income tax deferral regardless of the existence of a substantial risk of forfeiture.

Nonelective DCAs: It is not unusual for larger employers to provide a deferred compensation benefit, in the form of a salary continuation agreement, as a fringe benefit to key employees. In this situation, the DCA benefit is a defined benefit (often based on an average of active compensation for a stated number of preretirement years) without a stated interest factor. A nonelective DCA benefit is given as an add-on component of the compensation package to the participating employee; it does not result in a reduction in salary and bonus compensation otherwise currently payable. This is the "velvet handcuff" mechanism for retaining key employees, and usually incorporates within the DCA a substantial risk of forfeiture.(4)

ERISA Coverage and Nontax Compliance Issues

ERISA, as amended, covers all employee pension plans sponsored by an employer engaged in interstate commerce. The definition of an employee pension benefit plan in ERISA Section 3(2) is broad and encompasses any type of plan or method of providing for deferral of income and a benefit payable after retirement or termination of employment, including a DCA.(5) Compliance with the reporting and disclosure, participation, vesting and benefit accrual, funding and fiduciary responsibility requirements of Title I of ERISA is extremely burdensome, time-consuming and costly. Therefore, absent an exemption from ERISA compliance, most employers would shy away from maintenance of a DCA arrangement. ERISA Section 4(b) exempts from its compliance requirements plans maintained by state and other governmental employers and church employers. Two strategies are generally employed by nongovernmental and nonchurch employers to provide the benefits of a DCA while avoiding the most onerous of the ERISA requirements: the "excess benefit plan" and the (more common) "top-hat plan."

* Excess benefit plans

ERISA Section 4(b)(5) defines an excess benefit plan as a DCA maintained by an employer to provide benefits for certain employees in excess of the Sec. 415 limitations for qualified plans. Whether or not the plan is funded, ERISA's participation and vesting standards do not apply. If funded, however, many other Title I requirements are applicable; thus, excess benefit plans are somewhat more technical and complicated. Excess benefit plans are also relatively rare compared to the top-hat plan addressed below. For example, DCAs structured to avoid both the Sec. 415 and 401(a)(17) limits on qualified plan benefits are not excess benefit plans.(6)

* Top-hat plans

The top-hat plan exception is the most commonly used method to avoid the ERISA rules. A DCA that is "unfunded and is maintained by an employer primarily ... for a select group of management or highly compensated employees" (HCEs) is exempted from most Title I requirements.(7) DOL Advisory Opinion 90-14A(8) states that the word "primarily" modifies the type of benefits being provided under the plan, not the participants; therefore, such a plan may not cover employees other than management or HCEs. However, a top-hat plan is subject to Title I's reporting and disclosure provisions. DOL Regs. Section 2520.104-23(a) allows for an abbreviated, one-time filing procedure for complying with these requirements within 120 days from the contractual implementation of the DCA. A copy of the DCA need not be included unless specifically requested. Failure to take advantage of this procedure will require the annual filing by the employer of Form 5500, Annual Return/Report of Employee Benefit Plan (with 100 or more participants).

While the concept of a top-hat plan being unfunded for ERISA purposes generally conforms to the concept of the plan being unfunded for tax purposes (discussed below), which employees constitute a "select group of management or HCEs" is much more vague. Although the idea is to distinguish key employees from the rank-and-file, the DOL has not formulated a definition. ERISA legislative history and DOL Advisory Opinion 90-14A indicate that the top-hat group should be limited to individuals who, by virtue of their position or compensation level, have the ability to affect or substantially influence the design and operation of the DCA. In groping for some direction, the courts(9) have equated HCEs for ERISA purposes with HCEs under Sec. 414(q), even though the preamble to the Sec. 414 regulations states that they should not be so extrapolated for ERISA purposes. Sec. 414(q) categorizes an employee as an HCE if, during the year or the preceding year, the employee met any of the following:

1. Was a 5% owner of the employer.

2. Received compensation from the employer in excess of $100,000 (for 1995).

3. Received compensation from the employer in excess of $66,000 (for 1995) and was in the toppaid group of employees for such year.

4. Was at any time an officer and received compensation greater than 50% of the amount in effect under Sec. 415(b)(1)(A) for such year ($120,000 for 1995).

Applying the Tax Law

* Actual receipt and cash equivalent doctrines

Secs. 61 and 451 require a cash-method taxpayer to include all forms of compensation in gross income in the taxable year of receipt. However, in a properly structured DCA, the employee actually receives only the employer's unsecured contractual promise to pay DCA benefits in the future. If the employee's contractual rights under the DCA could be readily assigned by the employee for money or money's worth, the value of such rights could be deemed a cash equivalent currently includible in income.(10) For this reason, a welldrafted DCA will prohibit any nongratuitous assignment of rights by the employee.

* Constructive receipt doctrine

The constructive receipt doctrine requires a taxpayer to currently include in income compensation not actually received that was under the taxpayer's unfettered dominion and control and could have been readily obtained by him without incurring substantial penalty or restriction.(11)

The IRS has attempted to invoke the constructive receipt doctrine in the context of DCAs, but has been almost uniformly unsuccessful. In Rev. Rul. 60-31, the IRS conceded that "a mere promise to pay [a DCA benefit], not represented by notes or secured in any way, is not regarded as a receipt of income within the intendment of the cash receipts and disbursement method." For this reason, the DCA should require payments to be made only out of the employer's general assets, so that the employee is not taxed until payments are received.

There are distinct keys to avoiding application of the constructive receipt doctrine; the most important, previously discussed, is for the parties to enter into the DCA prior to the earning of the deferred income. Additionally, the employee should not be able to unilaterally manipulate the timing of the DCA payments. However, in certain exigent circumstances, such as an employer cashflow problem, deferred income due to be paid may again be deferred without constructive receipt.(12) Second, the DCA must be a boan fide manifestation of the parties' intent. At the inception of the DCA, both parties must intend to conform to the DCA's contractual terms and conditions.(13)

* Economic benefit doctrine

The economic benefit doctrine provides an additional means by which the IRS can tax currently a DCA. Under this doctrine, the value of property transferred by the employer to fund a DCA would be currently taxable to the employee to the extent money or property transferred was legally set aside from the claims of the employer's creditors (e.g., under a trust or escrow arrangement) for the benefit of the employee, even if the benefited employee had no current actual or constructive access to such assets. Taxation under Sec. 402(b)(1) and Regs. Sec. 1.83-3(a) stems from the fact that the benefited employee is receiving a vested and secured economic benefit from the arrangement.

However, a number of "informal funding" techniques have developed that do not invoke the economic benefit doctrine; the employer's obligation is financed through life insurance or annuity contracts. The policy must be the sole property of the employer and constitute a general asset subject to claims of the employer's creditors.(14) Gold-smith(15) indicates that caution is in order if an employer-owned life insurance policy informally funds a plan that will provide death benefits to the employee in the full amount of the insurance, especially if the employee is a controlling share-holder of a corporate employer.

Another informal funding device is the "rabbi trust,"(16) under which an employer makes contributions to a trust to provide for deferred compensation payments. Although the contributions are generally irrevocable, the trust agreement must provide that assets placed in trust remain subject to claims of the employer's general creditors if the employer becomes insolvent or files for bankruptcy. If the trust agreement does not give the employee vested ownership rights in trust assets prior to receiving the DCA payments, the employee is taxed only when such payments are received. Additionally, the DOL will not consider a DCA to be funded solely because it is maintained in conjunction with a rabbi trust.(17) Rev. Proc. 92-64(18) provides model rabbi trust language.

An employer may establish a deferred compensation account to track the accumulation of benefits and to earmark assets to fund its obligations; such set-aside accounts must remain subject to the claims of the employer's general creditors.(19) Additionally, an employee may designate a nonbinding preference regarding the investment of employer assets used to finance DCAs; the employee must remain an unsecured creditor of the employer.(20)

Significantly, an unsecured third-party contractual guarantee of benefits payable under a DCA has been found not to result in a currently taxable economic benefit to the benefitted employee (e.g., the guarantee by a parent of a subsidiary employer's deferred compensation promise, or by a team owner of the employer-team's promise to pay a ballplayer's deferred compensation).(21) Thus, the backup guarantee assures ultimate payment of the DCA benefits, but this economic benefit is not currently taxed.

The IRS National Office has ruled that an employee can buy indemnification insurance to protect his deferred compensation benefits in the event of employer default without invoking current taxation, even if the employer were to reimburse the employee for the premiums paid on the indemnity contract.(22) Such reimbursements, of course, would be includible in the employee's income.

* Employer's deduction

The employer's ability to deduct payments of DCA benefits is governed under Sec. 404(a)(5) and Prop. Regs. Sec. 1.83-6(a)(1). The deduction is permitted subject to the Sec. 162 reasonable compensation limits in the tax year in which the employee recognizes DCA income. Sec. 404(d) provides that the deductibility rule is the same for payments to independent contractors as for employees.

* Formally funded DCAs

A funded DCA is one in which an employer sets aside funds (e.g., in a nonqualified trust or escrow arrangement) to meet its obligation to pay deferred compensation in the future. Such funds are either beyond the reach of the employer's general creditors or the employee has an interest in the funds that has priority over those of the employer's general creditors.

This type of arrangement intentionally invokes the economic benefit doctrine. The employee recognizes compensation income (to the extent of the value of the contributions) in the first tax year in which his interest in the fund becomes substantially vested under Sec. 83 (i.e., not subject to a substantial risk of forfeiture, or transferable free of such risk).(23) As in the case of an unfunded DCA, the deduction is allowable in the year in which the employee recognizes DCA income. Since the employee's taxable event is accelerated, so is the timing of the employer's deduction.

Funded DCAs are often referred to as "secular" trust arrangements. In many cases, the employee is willing to incur current taxation to obtain the enhanced security such a trust arrangement provides. Additionally, an employer may be more willing to set up this type of funded DCA, because its deductions for plan contributions are accelerated. However, severe ERISA problems may result. A DCA (other than an excess benefit plan) formally funded by a trust or other funding vehicle has to comply with minimum vesting and other burdensome Title I ERISA requirements.

Social Security Taxation

Under Secs. 3121(v)(2) and 3306(r)(2), nonqualified deferred compensation will be subject to FICA on the later of (1) performance of the underlying services or (2) lack of substantial risk of forfeiture of the right to receive the compensation (as defined in Sec. 83(c)(1)).(24) As was previously discussed, a substantial risk of forfeiture on elective deferrals generally would be nonexistent or short-lived, while a substantial risk of forfeiture is typical for nonelective DCAs. Generally, in both cases, inclusion of deferred compensation in FICA wages is required prior to the inclusion of the income for Federal tax purposes. In the case of an elective DCA, in which there typically is no substantial risk of forfeiture, the amount electively deferred will be incrementally included in the FICA wage base in the year earned and deferred. In the case of a nonelective DCA, there will generally be a large, lump-sum inclusion in FICA wages in the year the substantial risk of forfeiture lapses (typically, at retirement) and the deferred compensation benefit vests and becomes nonforfeitable.

In practice, this may not be a significant issue, because high-income taxpayers will already exceed the general maximum taxable wage base ($61,200 for 1995) on their current compensation. However, RRA '93 Section 13207(a)(2)'s elimination of the cap on the 2.9% combined employer and employee medicare portion of FICA will result in additional medicare taxation as the vested deferred compensation benefit falls into the FICA wage base.

Once deferred compensation has been taken into account as wages for FICA and FUTA purposes, neither it nor any income attributable to it will thereafter be treated as wages for FICA and FUTA purposes.(25)

For purposes of the Social Security "excess earnings" test (which reduces benefits for wages earned between the ages of 65 and 70), deferred compensation payments, like any postretirement "pension" benefit, are deemed earned preretirement. Therefore, under Social Security Act Section 203(e)(5)(c),(26) DCA payments are not deemed earned between the ages of 65 and 70, so that Social Security payments are not reduced under the excess earnings test.

DCAs of Tax-Exempt Employers

Unfunded DCAs of tax-exempt employers are subject to the rules applicable to similar state and local government plans under Sec. 457.(27) Sec. 457 imposes numerous restrictions, so that care must be taken in the drawing up of such plans. As in other types of DCAs, the employee's interest in the deferred compensation benefits must be unsecured. Consequently, the employee has only the employer's unsecured contractual promise to pay deferred compensation benefits in the future.

Sec. 457(b)(2) provides that the maximum amount that may be tax deferred under such plan for each plan year generally may not exceed the lesser of $7,500 or 33 1/3% of the participant's compensation. Any attempt to defer more compensation each year for the benefited employee will generally trigger current income tax to the employee, even if the actual or constructive receipt or economic benefit doctrine would not so require.(28)

Benefits and Burdens of DCAs

* Advantages

Recent changes in Federal law (e.g., qualified annuities, penalties on premature distributions, and higher discrimination and participation requirements) have restricted not only the benefits of a qualified plan, but plan administration as well. RRA '93 Section 13212(a)(1)(A)'s limit of qualified plan compensation under Sec. 401(a)(17) to $150,000 is the latest, and one of the more extreme, detriments to qualified plan maintenance. This and other requirements may make qualified pension and profit-sharing plans less appealing to executives and increase reliance on DCAs. Although DCAs have traditionally played a secondary role in providing compensation and retirement benefits to executives, their importance may grow in the future as the qualified plan rules become more complex and restrictive.

Secondary advantages include the following:

Supplement to a qualified plan: A DCA can provide benefits in excess of the qualified plan limits under Secs. 401(a)(17) and 415. Thus, a DCA can be used to layer and provide benefits in excess of those under a qualified plan.

Tax savings: The participant may be in a lower tax bracket when he retires and the payments from the DCA become available. Consequently, the DCA can be a useful tool to defer income, particularly when adding a factor for a market rate of interest.

Recruiting and keeping executives: A DCA can be used to recruit a new executive by helping to make up lost nonvested qualified benefits due to the change in employers. As mentioned earlier, a nonelective DCA also works as a "velvet handcuff" to make it very expensive for key employees to leave.

Early retirement inducement: A DCA can be useful in implementing an early retirement program, especially when the employer wants to select which employees may choose an early retirement option. The employer is precluded from freely doing this under a qualified plan.

Sheltered accumulation of income and cash flow management: If the employer is willing to add an inflation or interest factor for the deferred compensation, the employee can often accumulate greater income by deferring compensation. This type of arrangement can also help a company with temporary cash flow problems maintain or recruit executives.

* Disadvantages

Conversely, the tax adviser must be intimately aware of the possible disadvantages of a DCA. The following queries should be made:

Can a qualified pension or profit-sharing plan do a better job? The two major problems with a typical DCA--lack of security for the employee and deferral of the deduction for the employer--are avoided in the case of a qualified plan. The major complaints with qualified plans are the burdensome ERISA compliance requirements--primarily, reporting, disclosure, minimum participation and vesting. Often, however, in the case of a family business, key and long-term employees tend to be family members and friends. In such case, broad participation and vesting of benefits becomes less of an employer burden and more of a legitimate tax shelter. If such a company does not have a qualified retirement plan in place, the possibility of establishing one should be fully explored before implementing a DCA.

Is the employer a professional corporation that will finance the DCA obligation through company-owned life insurance? When a controlling shareholder-employee of a professional corporation is encouraged to enter into a DCA with his company and have the company finance its obligation through a cash value company-owned life insurance (COLI) policy or other informal funding vehicle, there can be problems. Life insurance has a myriad of uses in business succession and tax planning, but its use is limited in the case of a professional corporation. The corporation, as a Sec. 448(d)(2) personal service corporation, is taxed under Sec. 11(b)(2) at a flat 35% corporate rate on its undistributed income used to fund the DCA, including income retained to pay premiums on the COLI (payments that are nondeductible). This rate may equal or exceed the rate that would have been paid by the employee if such income were paid out to him currently. Moreover, the employee continues to be subject to future business vagaries and the risk that the corporation will be unable to fulfill its contractual obligations under the DCA (e.g., future malpractice suits, future disgruntled successor owners). If there is a real need for life insurance protection, it should be paid for directly by the employee; the corporation could provide additional current compensation to the employee to cover the premium cost. The employee will be the outright owner of the life insurance contract, as opposed to the possessor of a mere contractual right to receive payments under the DCA.

Will the deferred income be taxed at a lower rate than if it is received currently? The logic that often motivates an elective DCA is the desire to defer tax from high- to low-bracket years. Many tax advisers routinely advised against elective deferral of compensation from 1987 to 1990 due to the then historically low maximum income tax rates. Now that the marginal rates have been significantly increased, a DCA again makes sense.

Will the benefit to be derived from the DCA be offset by a loss of other qualified retirement income? If an employer is also maintaining a qualified plan, an employee should not electively defer compensation in a DCA if it would result in a reduction in employer contributions to the qualified plan. Since qualified plan contributions are typically based on a percentage of currently taxable compensation, reduction of that taxable compensation through an elective DCA may reduce contributions to the qualified plan for the benefit of that employee.

Is the employer a good security risk? As was emphasized earlier, tax deferral can be obtained only if the DCA is unfunded. The employee has no security for the payment of DCA benefits beyond the financial ability of the employer to make good on its contractual promise. Even in the case of a "quasi-funded" arrangement, such as the rabbi trust, receipt of DCA benefits is totally a function of the ongoing solvency of the employer.

Conclusion

With the advent of significantly higher individual marginal income rates after the RRA '90 and RRA '93, taxpayers and their advisers have become more interested in nonqualified DCAs as a vehicle for deferring otherwise currently taxable compensation income. If the DCA is properly drafted and structured, the benefited employee or independent contractor may defer income taxation until actual receipt of benefits. Also, if attention is paid to a few relatively simple ERISA steps, annual Form 5500 reporting and other troublesome Title I requirements may be completely avoided. These tax and nontax benefits are generally available to DCAs, even though the exact form of such arrangements may be quite varied and flexible in meeting a variety of employer and employee needs and desires. With such variety, flexibility and tax and nontax benefits available through DCAs, the tax and business adviser must be thoroughly familiar with these arrangements in meeting the needs of a highly compensated clientele.

(1)See generally, Rev. Rul. 60-31, 60-1 CB 174, modified by Rev. Ruls. 64-279, 1964-2 CB 121, and 70-435, 1970-2 CB 100; Rev. Proc. 71-19, 1971-1 CB 698.

(2)Rev. Proc. 71-19, id.; Rev. Rul. 60-31, id. Department of Labor (DOL) Opinion Letter 90-14A (5/8/90) provides that electively funded DCAs are not subject to DOL Regs. Section 2510.3-102, which requires that participant contributions to an Employee Retirement Income Security Act of 1974 (ERISA) pension or welfare plan be held under a formal trust arrangement.

(3)Rev. Rul. 60-31, note 1.

(4)See Regs. Sec. 1.83-3(c)(4); note 28.

(5)A line of cases, as well as conflicting DOL Opinion Letters, hold that an individually negotiated and unfunded DCA, as opposed to a true plan provided to a class of employees, is not an ERISA pension plan. See Lackey v. Whithall Co., 704 F Supp 201 (DC Kans. 1988) (individual but similar plans were not ERISA plans); McQueen v. Salida Coca Cola Bottling Co., 652 F Supp 1471 (DC Colo. 1987) (DCA that was to pay employee monthly income at age 65 or on death or disability was not an ERISA plan where there was no trust, fiduciary or provision to amend); DOL Opinion Letters 76-79 (5/25/76) and 76-110 (9/28/76); compare DOL Opinion Letter 79-115 (10/29/79).

(6)See Petkus v. Chicago Rawhide Manufacturing Co., 763 F Supp 357 (N.D. Ill. 1991).

(7)See ERISA Sections 201(2) (participation and vesting), 301(a)(3) (funding) and 401(a)(1) (fiduciary responsibility).

(8)Note 2.

(9)See, e.g., Plazzo v. Nationwide Insurance Co., 697 F Supp 1437 (N.D. Ohio 1988), rev'd on another issue, 892 F2d 79 (6th Cir. 1989).

(10)See Frank Cowden, Sr., 289 F2d 20 (5th Cir. 1961)(7 AFTR2d 1160, 61-1 USTC [paragraph]9382).

(11)Regs. Sec. 1.451-2(a). See also Rev. Ruls. 80-300, 1980-2 CB 165, and 68-482, 1968-2 CB 186.

(12)Howard Veit, 8 TC 809 (1947) and 8 TCM 919 (1949); see also George C. Martin, 96 TC 814 (1991) (DCA participant may be able to elect between a lump-sum or installment payout shortly before benefits become payable without being in constructive receipt).

(13)Morris Zeltzerman, 34 TC 73 (1960), aff'd, 283 F2d 514 (1st Cir. 1960).

(14)Rev. Rul. 72-25, 1972-1 CB 127.

(15)Douglas M. Goldsmith, 586 F2d 810 (Ct. Cl. 1978)(42 AFTR2d 78-6203, 78-2 USTC [paragraph]9804); this decision has been criticized by commentators and has not been followed by any other court.

(16)The first of this type of trust was established for a rabbi, hence the name. See IRS Letter Ruling 8113107 (12/31/80); see also Thomson and Wittenbach, "Rabbi Trusts," 26 The Tax Adviser 171 (Mar. 1995).

(17)GCM 39230 (1/20/84); IRS Letter Rulings 9242007 (7/16/92), 9214035 (12/30/91) and 9210013 (12/5/91); DOL Opinion Letters 89-22A (9/21/89) and 91-16A (4/5/91); DOL Letter to IRS dated Dec. 13, 1985.

(18)Rev. Proc. 92-64, 1992-2 CB 422.

(19)IRS Letter Rulings 8607029 (11/15/85) and 9030035 (4/30/90).

(20)IRS Letter Ruling 8648011 (4/23/86).

(21)IRS Letter Rulings 8906022 (11/10/88) (guarantee by parent company's parent) and 8741078 (7/17/87) (guarantee by parent); M. Douglas Berry, 593 F Supp 80 (M.D. N.C. 1984)(54 AFTR2d 84-5722, 84-2 USTC [paragraph]9646) (shareholder guarantee).

(22)IRS Letter Ruling (TAM) 9344038 (8/2/93).

(23)Sec. 402(b)(1); Regs. Secs. 1.402(b)-1(a) and 1.83-3(b).

(24)H. Rep. No. 98-47, 98th Cong., 1st Sess. 147 (1983); see Regs. Sec. 1.83-3(c). Notice 94-96, IRB 1994-46, 10, states that the IRS intends to publish proposed regulations on the FICA taxation of nonqualified deferred compensation.

(25)Sec. 3121(v)(2)(B); IRS Letter Ruling (TAM) 9050006 (9/6/90).

(26)42 U.S.C. Section 403(f)(5)(C).

(27)For DCAs maintained by exempt employers, Sec. 457 is generally effective for tax years beginning after 1986; under Tax Reform Act of 1986 Section 1107(c)(3)(B), grandfathered DCAs escape Sec. 457 treatment if they were established and written before Aug. 17, 1986. See Mann, "Nonprofit Supplemental Pension Plans After 1993," 26 The Tax Adviser 37 (Jan. 1995).

(28)Because of the Sec. 457 limits on deferrals, the tax adviser will likely be asked for ways to circumvent that section. One technique is to contractually impose a substantial risk of forfeiture on benefits, thus deferring tax until the risk lapses. If the plan does not meet Sec. 457's requirements, amounts deferred each year will be immediately taxable to the employee under Sec. 457(f)(1) to the extent they are not subject to a substantial risk of forfeiture. The authors have been informally advised by the IRS National Office that substantial risk of forfeiture for Sec. 457 purposes has the same meaning as under Sec. 83. Regs. Sec. 1.83-3(c)(2) offers a number of examples of substantial risk of forfeiture in a postretirement setting. As previously mentioned, the clearest example of substantial risk of forfeiture is the loss of all benefits on premature termination of employment for reasons other than death or permanent disability. Rev. Rul. 75-448, 1975-2 CB 55; IRS Letter Rulings 9010080 (12/15/89) and 9030025 (4/27/90); Edward L. Burnetta, O.D., P.A., 68 TC 387 (1977) (the fact that benefits are lost if the employee commits a crime does not create a substantial risk of forfeiture).