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Deferred compensation.

Funded Deferred Compensation (Annuities and Trusts)

111. What are the tax consequences of a funded deferred compensation agreement with an employer?

Employee Taxation

As a general rule, an employee is currently taxed on a contribution to a trust or a premium paid for an annuity contract (paid after August 1, 1969) to the extent that his interest is substantially vested when the payment is made.

An interest is substantially vested if it is (1) transferable or (2) not subject to a substantial risk of forfeiture. An interest is transferable if it can be transferred free of a substantial risk of forfeiture. See Q 113. (2)

A partner is immediately taxable on his distributive share of contributions made to a trust in which the partnership has a substantially vested interest, even if the partner's right is not substantially vested. (3)

If the employee's rights change from substantially nonvested to substantially vested, the value of his interest in the trust or the value of the annuity contract on the date of change (to the extent such value is attributable to post-August 1, 1969 contributions) must be included in his gross income for the taxable year in which the change occurs. The value on the date of change probably also constitutes "wages" for the purposes of withholding, (1) and for the purposes of FICA and FUTA, see Q 123. The value of an annuity contract is its cash surrender value. (2)

If only part of an employee's interest in a trust or an annuity contract changes from substantially nonvested to substantially vested during any taxable year, then only that corresponding part is includable in gross income for the year. (3)

An employee is not taxed on the value of a vested interest in a trust attributable to contributions made while the trust was exempt under IRC Section 501(a). (4)

Special rules apply to trusts that lose their tax qualification because of a failure to satisfy the applicable minimum participation or minimum coverage tests. (5) The IRS has taken the controversial position that these special rules apply to non-exempt trusts that were never intended to be tax qualified. As a result, the IRS would tax highly compensated employees (HCEs, see Q 359) participating in trust-funded nonqualified plans that fail the minimum participation or minimum coverage tests applicable to qualified plans (see Q 329 through Q 331), which most nonqualified plans will fail, under a special rule. See Q 112.

There is no tax liability when an employee's rights in the value of a trust or annuity (attributable to contributions or premiums paid on or before August 1, 1969) change from forfeitable to nonforfeitable. Prior to August 1, 1969, an employee was not taxed when payments were made to a nonqualified trust or as premiums to a nonqualified annuity plan if his rights at the time were forfeitable. (6) Thus, the employee did not incur tax liability when his forfeitable rights later became nonforfeitable.This old law still applies to trust and annuity values attributable to payments made on or before August 1, 1969. (7)

Where an employer amended its unfunded nonqualified deferred compensation plan to provide those participants in pay status with a choice between a lump sum payment of the present value of their future benefits or an annuity contract securing their rights to the remaining payments under the plan with a corresponding tax gross-up payment from the employer, any participant who chose the annuity contract would include in gross income the purchase price for such participant's benefits under the contract and the tax gross-up payment in the year paid (or made available, if earlier). (8)

For taxation of annuity payments to an employee, see Q 114.

Employer Taxation

The employer, whether a cash or accrual basis taxpayer, can take a deduction for a contribution or premium paid in the year in which an amount attributable thereto is includable in the employee's gross income. (9) This deduction cannot be more than the amount of the contribution; it cannot include any earnings on the contribution before they are included in the employee's income. (10) If more than one employee participates in a funded deferred compensation plan, the deduction will be allowed only if separate accounts are maintained for each employee. (11) But the employer is not allowed a deduction at any time for contributions made or premiums paid on or before August 1, 1969, if the employee's rights were forfeitable at the time. (1) Contributions or premiums paid or accrued on behalf of an independent contractor may be deducted only in the year in which amounts attributable thereto are includable in the independent contractor's gross income. (2)

With respect to contributions made after February 28, 1986, to annuity contracts held by a corporation, partnership, or trust (i.e., a nonnatural person), the "income on the contract" for the tax year of the policyholder is generally treated as ordinary income received or accrued by the contract owner during such taxable year. (3) See Q 2.

Also, corporate ownership of life insurance may result in exposure to the corporate alternative minimum tax. See Q 96.

The IRS has taken the position that a nonexempt employee's trust funded deferred compensation cannot be considered an employer-grantor trust. As a result, the employer will not be taxed on the trust's income, but it also cannot claim the trust's deductions and credits. (4) Proposed regulations have affirmed the position of the IRS. (5) See Q 112.

Funded deferred compensation may take the form of either a salary continuation or pure deferred compensation plan. See Q 115.

The fact that a trust to fund a previously unfunded deferred compensation agreement was established as part of a nontaxable (IRC Section 337) corporate liquidation did not alter its treatment as an employee trust. (6)

A nonqualified deferred compensation plan funded by a trust or annuity (other than an "excess benefit plan"--see Q 129) must provide for minimum vesting generally comparable to that required in qualified retirement plans. (7) See Q 336. But government plans and many church plans are exempt from ERISA.

The above rules do not apply to nonqualified annuities purchased by tax-exempt organizations and public schools (see Q 473 to Q 503) or to individual retirement accounts and annuities (see Q 211 to Q 239).

IRC Section 404(a)(11)

Generally, if vacation pay is paid to an employee within 2 1/2 months after the end of the applicable tax year, it is deductible for the tax year in which it is earned (vested) and is not treated as deferred compensation. (8) Employers may not deduct accrued vacation or severance pay unless it is actually received by employees. (9)

Actual receipt is defined only by what it is not: (1) a note or letter evidencing the employer's indebtedness (whether or not guaranteed by an instrument or third party); (2) a promise to provide future service or property (whether or not evidenced by written agreement); (3) an amount transferred by a loan, refundable deposit, or contingent payment; or (4) amounts set aside in a trust for an employee. (1)

The IRS provided settlement options for taxpayers who had accelerated the deduction of accrued employee benefits (primarily vacation pay, disability pay, and sick pay) secured by a letter of credit, bond, or similar financial instrument, in reliance upon Schmidt Baking Co., Inc.v. Comm. (2) (employer allowed to deduct accrued vacation liabilities because it had obtained an irrevocable letter of credit guaranteeing such obligation within 2 1/2 months of the year of deduction), which Section 404(a)(11) expressly overturned for years ending after July 22, 1998. (3) The IRS has also published guidance explaining the automatic accounting method change necessary to comply with IRC Section 404(a)(11). (4)

112. What is a "secular trust" and how is it taxed?

A secular trust is an irrevocable trust established to formally fund and secure nonqualified deferred compensation benefits, so called to distinguish it from a rabbi trust. See Q 119. Funds placed in a secular trust are not subject to the claims of the employer's creditors. Thus, unlike a rabbi trust, a secular trust can protect its participants against both the employer's future unwillingness to pay promised benefits and the employer's future inability to pay promised benefits.

Secular trusts are not as popular as rabbi trusts, in part because of questions surrounding their taxation.

Taxation of Employee

The IRS believes that IRC Section 402(b)(1) through IRC Section 402(b)(4) govern the taxation of employee-participants in an employer-funded secular trust. (5) Under the general timing rule of IRC Section 402(b)(1), contributions to a secular trust are immediately included in the income of the employee to the extent that they are substantially vested. (6) Further, in any tax year in which any part of an employee's interest in the trust changes from substantially nonvested to substantially vested, the employee will be required to include that portion in income as of the date of the change. (7)

An interest is substantially vested if it is (1) transferable or (2) not subject to a substantial risk of forfeiture. See Q 113. (8)

With respect to the taxation of distributions from an employer-funded secular trust, the IRS has previously indicated that the rules of IRC Section 72 (except IRC Section 72(e)(5)) apply. See, generally, Q 114. Under this approach, distributions would be taxable except to the extent that they represent amounts previously taxed. Consequently, it would seem that a highly compensated employee who has been taxed on his entire "vested accrued benefit" would not be taxed again upon receipt of a lump sum distribution.

The IRS has questioned the applicability of IRC Section 72 to distributions from employer-funded secular trusts to highly compensated employees (HCEs)--as defined in IRC Section 414(q), see Q 359--participating in plans that fail the minimum participation or the minimum coverage tests applicable to qualified retirement plans (which most nonqualified plans will fail), adopting the controversial position that a special rule under IRC Section 402(b)(4) should be applied to tax HCEs each year on their "vested accrued benefit" in the trust (minus amounts previously taxed). Thus, HCEs will be taxed on vested contributions and on vested earnings on those contributions. Apparently, the IRS would tax HCEs on their vested earnings even where they consist of unrealized appreciation of capital assets or nominally tax-free or tax deferred income (e.g., from municipal bonds or life insurance). Further, the IRS believes that any right to receive trust payments in compensation for these taxes will also be taxable as part of the vested accrued benefit. (1)

The IRS believes that as long as a failure to satisfy the minimum participation test or the minimum coverage test is not the only feature of the plan that keeps the secular trust from being treated as a tax-qualified trust (and it generally will not be), then any participants who are not highly compensated will be taxed under the general rules of IRC Section 402(b)(1), described above.

The 10% penalty for certain early (premature) annuity distributions under IRC Section 72(q) may apply to distributions from employer-funded secular trusts if the deferred compensation plan behind the trust is considered to be an annuity (i.e., if it provides for the payment of benefits in a series of periodic payments over a fixed period of time, or over a lifetime). (2)

Employee-funded secular trusts (where the employee establishes the trust, but the employer administers it and contributes to it) are analyzed differently. The employee generally has a choice between receiving cash--or its equivalent, e.g., an immediately surrenderable annuity or life insurance policy--currently or a cash contribution to the trust. Sometimes the employee has the choice between withdrawing contributions from the trust or leaving them in. In these situations, the IRS has generally ruled that the employee constructively received the employer-contributed cash and then assigned it to the trust. Thus, the IRS has generally held the employee to be currently taxable on employer contributions to the trust. (3)

An employee who establishes and is considered to be the owner of an employee-funded secular trust under the grantor-trust rules should not have to include the income on annuity contracts held by the trust in income each year. (4) See Q 2.

Employer's Deduction

It is the position of the IRS that an employer can take a deduction for a contribution to an employer-funded secular trust in the year in which it is includable in employee income. (5) But the rules of IRC Section 404(a)(5) limit the employer's deduction to the amount of the contribution; it can never include "earnings" on that amount between contribution and inclusion in the employee's income. (6)

An employer cannot increase its "contributions" and thus its deductions by drafting the trust agreement to require that (1) the trust distribute its earnings to the employer and (2) that the trustee retain those earnings as "re-contributions" to the trust. The IRS has indicated that it will not recognize such deemed distributions and re-contributions. (7)

If a secular trust covers more than one employee, the employer will be able to take a deduction for contributions only if the trust maintains separate accounts for the various employees. According to the IRS, the separate account rule is satisfied only if the trust document requires that the income earned on participants' accounts be allocated to their accounts. (1)

The IRS has also granted employers immediate deductions for trust contributions where participants could choose between receiving current compensation outright or having it contributed to a trust, and where trust participants could choose between withdrawing contributions from the trust or leaving them in the trust. The IRS regarded these situations as employee-funded trusts and gave the employers deductions for the payment of compensation. (2)

Taxation of Trust

The IRS believes that a secular trust can never be an employer-grantor trust. Thus, an employer-funded secular trust is a separate, taxable entity. Unless secular trust earnings are distributable or are distributed annually, the trust will be taxed on those earnings. (3)

Proposed regulations have affirmed this position. (4)

Because the IRS would generally tax HCEs each year on vested trust earnings (and would generally tax other employees on at least some trust earnings when a substantially nonvested interest becomes substantially vested), double taxation of trust earnings is a very real possibility. Funding secular trusts with life insurance may eliminate this by eliminating taxation of the trust. The IRS has not considered the use of life insurance in secular trusts, but under generally applicable tax rules, the inside build-up (or "earnings") on life insurance should not be taxed to the trust while it holds the policies. But the use of life insurance probably will not save employees from taxation on trust earnings.

It is also possible to avoid trust (and therefore double) taxation by using employee-funded secular trusts. Employee-funded trusts are generally treated as employee-grantor trusts, because the trust income is generally held solely for the employee's benefit. As a result, the trust income is generally taxed to the employee only. (5)

ERISA Implications

Use of a secular trust (at least a trust other than an employee-grantor trust) will probably cause a deferred compensation plan subject to ERISA to be funded for ERISA purposes. (6) Funded plans are generally required to meet ERISA's Title I requirements.

113. What is meant by "a substantial risk of forfeiture" under IRC Section 83?

A person's rights in property are subject to a substantial risk of forfeiture under IRC Section 83 if (1) his full enjoyment of the property is conditioned upon the future performance (or refraining from performance) of substantial services by any individual, or the occurrence of a condition related to a purpose of the transfer; and (2) the possibility of forfeiture if the condition is not satisfied is substantial. (1) Whether a risk of forfeiture is substantial depends upon the facts and circumstances. (20

Because the inquiry is so fact-based, there is little definitive guidance as to the sorts of services that will be considered substantial. But the regularity of performance and the time spent in performing the required services tend to indicate whether they are substantial. (3) Furthermore, it is not clear how far into the future an arrangement must require substantial services in order to require adequate "future performance." Nonetheless, the regulations' examples describe arrangements requiring employees to work for periods as short as one and two years as imposing substantial risks of forfeiture. (4)

For examples of service requirements that have constituted a substantial risk of forfeiture in the context of Section 457(f) plans (Q 127), see generally Letter Rulings 9642046, 9642038, 9628020, 9628011, 9627007, 9623027.

Some things are clear. Requiring that property be returned if the employee is discharged for cause or for committing a crime will not create a substantial risk of forfeiture. (5) The IRS has indicated that benefits would be taxable once a participant has met age and service requirements under an IRC Section 457 plan (see Q 125), although the benefits remained forfeitable if participants were fired for cause, and noted that forfeiture upon termination for cause was not sufficient to constitute a substantial risk of forfeiture. (6)

A covenant not to compete will not ordinarily result in a substantial risk of forfeiture unless the particular facts and circumstances indicate otherwise. (7)

Similarly, the requirement that a retiring employee render consulting services upon the request of his former employer does not result in a substantial risk of forfeiture, unless the employee is, in fact, expected to perform substantial consulting services. (8)

Imposing a sufficient condition on the full enjoyment of the property is not in itself enough to create a substantial risk of forfeiture; the possibility of forfeiture if the condition is not satisfied must be substantial. This possibility may be substantial even if there are circumstances under which failure to satisfy the condition will not result in forfeiture of the property. For example, the possibility of forfeiture is substantial where an employee would generally lose his deferred compensation upon termination of employment before completing the required services, but would not forfeit those benefits if his early termination were due to death or permanent disability. (9) The possibility that a forfeiture might not be enforced in the event of normal or early retirement before the satisfaction of the condition might not undermine the substantial risk of forfeiture. (10)

Special scrutiny will be applied in determining whether the risk of forfeiture is substantial concerning a property transfer from a corporation to a controlling shareholder-employee. In such situations, a restriction that would otherwise be considered to impose a substantial risk of forfeiture will be considered to impose such a risk only if the chance that the corporation will enforce the restriction is substantial. (1)

It is not clear whether one can effectively extend a substantial risk of forfeiture. One letter ruling has concluded that as long as the future services required of the employee were and would continue to be substantial, an agreement between the employer and the employee postponing the vesting date of restricted stock would not in itself trigger taxation of the stock. (2) But the ruling has generated controversy, particularly with respect to efforts to extend its reasoning to ineligible Section 457(f) plans (see Q 127).

114. How is an employee taxed on the payments he receives from a nonqualified annuity or nonexempt trust?

Annuity payments are taxable to the employee under the general rules in IRC Section 72 relating to the taxation of annuities. (3) See Q 7 (payments in annuitization phase), Q 3 (payments in accumulation phase). The employee's investment in the contract, for purposes of figuring the exclusion ratio, consists of all amounts attributable to employer contributions that were taxed to the employee and premiums paid by the employee (if any). Investment in the contract includes the value of the annuity taxed to the employee when his interest changed from nonvested to vested. (4)

Payments under a nonexempt trust are also generally taxed under the rules relating to annuities, except that distributions of trust income before the annuity starting date are subject to inclusion in income under the generally applicable "interest first" rule without regard to the "cost recovery" rule retained (for certain cases) by IRC Section 72(e)(5). (5) See Q 7, Q 3. Furthermore, a distribution from the trust before the "annuity starting date" for the periodic payments will be treated as distributed in the following order: (1) income earned on employee contributions made afterAugust 1, 1969; (2) other amounts attributable to employee contributions; (3) amounts attributable to employer contributions (made after August 1, 1969 and not previously includable in employee's gross income); (4) amounts attributable to employer contributions made on or before August 1, 1969; (5) the remaining interest in the trust attributable to employer contributions. (6) But the IRS has privately questioned whether the annuity rules of IRC Section 72 are applicable to distributions to highly compensated employees from an employer-funded nonexempt trust under a plan that fails the minimum participation or the minimum coverage tests applicable to qualified plans (see Q 327, Q 328); the taxation of such distributions is unclear. (7) See also Q 112.

If the distribution consists of an annuity contract, the entire value of the annuity, less the investment in the contract, is included in gross income. (8)

For applications of FICA and FUTA to deferred compensation payments, see Q 123.

Unfunded Deferred Compensation

General Rules

115. What are the tax benefits of an unfunded deferred compensation agreement with an employer?

A properly planned deferred compensation agreement postpones payment for currently rendered services until a future date, with the effect of postponing the taxation of such compensation until it is received. Under a typical deferred compensation agreement, an employer promises to pay an employee fixed or variable amounts for life or for a guaranteed number of years. When the deferred amount is received, the employee may be in a lower income tax bracket. See Q 122. Additionally, many employers use this type of plan to provide benefits in excess of the limitations placed on qualified plan benefits. For example, a "SERP" (Supplemental Executive Retirement Plan) is a type of plan for a selected group of executives that generally provides extra retirement benefits. An "excess benefit plan" is a special kind of supplemental plan. See Q 129.

Commentators divide nonqualified deferred compensation plans into two broad categories: pure deferred compensation plans and salary continuation plans. Both unfunded and funded deferred compensation plans may be divided into these categories. See Q 111. But because the taxation of the two types of plans is similar, the difference is mostly theoretical. In this text, the term "deferred compensation" should be understood to refer to both pure deferred compensation plans and salary continuation plans.

A "pure deferred compensation plan" involves an agreement between the employer and employee, whereby the employee defers receipt of some portion of present compensation (or a raise or bonus, or a portion thereof) in exchange for the employer's promise to pay a deferred benefit in the future. Some commentators refer to this as an "in lieu of" plan.

A "salary continuation plan" is a benefit provided by the employer in addition to all other forms of compensation--the employer promises to pay a deferred benefit, but there is no corresponding reduction in the employee's present compensation, raise, or bonus.

See Q 116 for a discussion of general principles of law applicable to private deferred compensation agreements. See Q 124 and Q 125 for an explanation of special requirements that apply to deferred compensation agreements with state and local governments and their agencies and with organizations exempt from tax under IRC Section 501. See Q 128 for deferred compensation plans covering state judges.

Private Plans

116. What requirements must be met by a private deferred compensation plan?

In General

A private deferred compensation plan is a plan entered into with any employer other than (1) a state; (2) a political subdivision of a state (e.g., a local government); (3) an agency or instrumentality of (1) or (2); or (4) an organization exempt from tax under IRC Section 501.

For the rules concerning nonqualified deferred compensation plans sponsored by government or tax-exempt employers, see Q 124 through Q 127.

Although private deferred compensation agreements are most frequently entered into with employees of corporations, they may also be entered into with employees of other business organizations and with independent contractors. (1) For example, a director's fees can be deferred through an unfunded deferred compensation agreement with the corporation. (2) But if an employer or service recipient transfers its payment obligation to a third party, efforts to defer payments from the third party may not be effective. (3)

General Rules

The employer may pay deferred amounts as additional compensation, or employees may voluntarily agree to reduce current salary. (4)

The plan must provide that participants have the status of general unsecured creditors of the employer and that the plan constitutes a mere promise by the employer to pay benefits in the future.

The plan must also state that it is the intention of the parties that it be unfunded for tax and ERISA purposes.

The plan must define the time and method for paying deferred compensation for each event (e.g., retirement) that would entitle a participant to a distribution of benefits.

If the plan refers to a trust or other informal funding mechanism, additional rules must be satisfied. See Q 118 and Q 119.

Statutory Requirements

Distributions

In the American Jobs Creation Act of 2004, Congress imposed additional requirements to avoid constructive receipt. Under IRC Section 409A, a participant may only receive a distribution of previously deferred compensation upon the occurrence of one of six events:

* separation from service;

* the date the participant becomes disabled;

* death;

* a fixed time (or pursuant to a fixed scheduled) specified in the plan at the date of the deferral;

* a change in the ownership or effective control of the corporation or assets of the corporation, to the extent provided in regulations (but an equity investment by the federal government under the Troubled Asset Relief Program (TARP) is not considered a change in ownership or control (5)); or

* the occurrence of an unforeseeable emergency. (6)

In addition, key employees (as defined in IRC Section 416(i)) of publicly traded corporations may not take distributions until six months after separation from service (or, if earlier, the date of death of the employee). (1)

Under final regulations, a change in ownership occurs when an individual or persons acting as a group acquires more than 50 percent of the total fair market value or total voting power of the corporation. Ownership under these rules is subject to attribution under IRC Section 318(a). A change in effective control occurs when an individual or persons acting as a group acquires 35 percent or more of the total voting power of the stock of the corporation within a 12-month period or where there is an adversarial change in a majority of the membership of the board of directors within a 12-month period. A change in the ownership of a substantial portion of the assets of the corporation occurs when an individual or persons acting as a group acquires assets equal to or greater than 40 percent of the total gross fair market value of the corporation. (2)

Within the meaning of IRC Section 409A(a)(2)(A), "unforeseeable emergency" means "a severe financial hardship to the participant resulting from an illness or accident of the participant, the participant's spouse, or a dependent (as defined in [IRC] section 152(a)) of the participant, loss of the participant's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant." (3)

Deferral Elections

IRC Section 409A also imposes requirements for participants making elections to defer compensation. Participants now must generally make deferral elections prior to the end of the preceding taxable year. (4) But in the first year in which a participant becomes eligible to participate in a plan, the participant may make an election within 30 days after the date of eligibility, but only with respect to services to be performed subsequent to the election. In the case of any performance-based compensation covering a period of at least 12 months, a participant must make an election no later than 6 months before the end of the covered period. (5)

Changes in Time or Form of Payment

A separate set of new election rules allows participants to elect to delay distributions or change the form of distributions from a plan as long as the plan requires the new election to be made at least 12 months in advance. In addition any election to delay a distribution must delay the distribution at least five years from the date of the new election (unless made on account of disability, death, or an unforeseeable emergency). An election related to a scheduled series of distributions made pursuant to a fixed schedule must be made at least 12 months in advance of the first such scheduled payment. (6)

Final regulations generally provide that each separately identified amount to which an employee is entitled to receive on a determinable date is a separate payment. A series of installment payments under a single plan will generally be treated as a single payment; but a plan may specify that a series of installment payments is to be treated as a series of separate payments. (7)

Acceleration of Payments

Final regulations define other circumstances under which a plan may permit the acceleration of payments:

1. to comply with a domestic relations order,

2. to comply with a conflict-of-interest divestiture requirement, (1)

3. to pay income taxes due upon a vesting event under a plan subject to IRC Section 457(f),

4. to pay the FICA or other employment taxes imposed on compensation deferred under the plan,

5. to pay any amount included in income under IRC Section 409A, or

6. to terminate a participant's interest in a plan

a. after separation from service where the payment is not greater than $10,000,

b. where all arrangements of the same type are terminated,

c. in the 12 months following a change in control event, or

d. upon a corporate dissolution or bankruptcy, or

7. to terminate a deferral election following an unforeseeable emergency. (2)

Short-Term Deferrals

A deferral of compensation does not occur when amounts are paid within 2 1/2 months after the end of the year in which the employee obtains a legally-binding right to the amounts. Under this rule, many multi-year bonus arrangements that require payments promptly after the amounts vest will not be subject to IRC Section 409A. (3)

Independent Contractors

IRC Section 409A does not generally apply to amounts deferred under an arrangement between a service recipient and an unrelated independent contractor, if, during the contractor's taxable year in which the amount is deferred, the contractor provides significant services to each of two or more service recipients that are unrelated, both to each other and to the independent contractor. A safe harbor rule provides that an independent contractor will be treated as providing significant services to more than one service recipient where not more than 70% of the total revenue of the trade or business is derived from any particular service recipient (or group of related service recipients). (4)

Reporting and Withholding

Under IRC Section 409A, employers are required to report all employee deferrals for a year on a Form W-2 or Form 1099-MISC, regardless of whether such deferred compensation is currently includable in gross income. Employers must also report amounts includable in gross income under IRC Section 409A, whether or not those amounts are treated as wages under IRC Section 3401(a). (5) The IRS temporarily waived the reporting obligations of employers for 2005, but the IRS has now provided employers guidance on their ongoing reporting obligations. (6)

Penalties

IRC Section 409A also includes substantial penalties for failing to meet the statutory requirements when deferring compensation. Any violation of the above requirements results in retroactive constructive receipt, with the deferred compensation being taxable to the participant as of the time of the intended deferral. (1) In addition to the normal income tax on the compensation, the participant must pay an additional 20% tax, as well as interest at a rate 1% higher than the normal underpayment rate. (2)

Effective Dates

The requirements of IRC Section 409A generally apply to amounts deferred after December 31, 2004. The requirements also apply to amounts deferred prior to January 1, 2005 if the plan under which the deferral is made is materially modified after October 3, 2004. There is an exception for material modifications made pursuant to IRS guidance. The IRS has deferred the date to comply with the final regulations under IRC Section 409A to January 1, 2009. (3)

A plan is materially modified if a new benefit or right is added or if a benefit or right existing as of October 3, 2004 is materially enhanced and such addition or enhancement affects amounts earned and vested before January 1, 2005. The reduction of an existing benefit is not a material modification. (40

Foreign Employers

In the Emergency Economic Stabilization Act of 2008, Congress created new IRC Section 457A to subject deferred compensation to immediate taxation where the employer is a foreign entity not subject to U.S. taxation. Under IRC Section 457A, all compensation deferred under a nonqualified deferred compensation plan of a nonqualified entity is includable in gross income when there is no substantial risk of forfeiture of the rights to such compensation. IRC Section 457A defines a substantial risk of forfeiture as applicable "only if" a person's rights are conditioned upon the future performance of substantial services. (5)

IRC Section 457A defines a nonqualified entity as "any foreign corporation"--unless substantially all of its income is "effectively connected with the conduct of a trade or business in the United States" or "subject to a comprehensive foreign income tax"--or any partnership, unless substantially all of its income is allocated to persons other than "foreign persons with respect to whom such income is not subject to a comprehensive foreign income tax" and "organizations which are exempt from tax under this title." (6) (IRC Section 457A provides a limited exception for deferred compensation payable by foreign corporations that have "effectively connected income" under IRC Section 882.) A "comprehensive foreign income tax" is the income tax of a foreign country if (1) there is an applicable comprehensive income tax treaty between that country and the United States or (2) the Secretary of the Treasury is otherwise satisfied that it is a comprehensive foreign income tax. (7)

IRC Section 457A generally applies to nonqualified deferred compensation within the same broad scope as IRC Section 409A. But IRC Section 457A explicitly does apply to all stock options and stock appreciation rights, even those issued with the option price or measurement price at fair market value. (1) IRC Section 457A also extends the 2/-month short-term deferral exemption in IRC Section 409A to 12 months, meaning that IRC Section 457A does not apply to compensation received during the taxable year following that in which the compensation is no longer subject to a substantial risk of forfeiture. (2)

If the amount of any deferred compensation taxable under IRC Section 457A is not determinable at the time it is otherwise includable under that section, it is subject to a penalty and interest when so determinable. In addition to the normal tax, the amount includable is subject to a 20% penalty tax and interest on the underpayment of taxes at the normal underpayment rate plus 1%. (3)

IRC Section 457A applies to deferred amounts attributable to services performed after December 31, 2008. Congress also directed the IRS to provide guidance within 120 days on amending plans to conform to IRC Section 457A and providing a limited period of time to do so without violating IRC Section 409A.

Constructive Receipt

Tax deferment will not be achieved if, prior to the actual receipt of payments, the employee is in constructive receipt of the income under the agreement. Income is constructively received if the employee can draw upon it at any time. But income is not constructively received if the employee's control of its receipt is subject to substantial limitations or restrictions. Some agreements contain contingencies that may cause the employee to forfeit future payments. So long as the employee's rights are forfeitable, there can be no constructive receipt. (4) But the IRS has ruled that the employee will not be in constructive receipt of income even though his rights are nonforfeitable if (1) the agreement is entered into before the compensation is earned; and (2) the employer's promise to pay is not secured in any way. (5)

The American Jobs Creation Act of 2004 created new requirements for elections to defer compensation. (6) For prior deferrals not subject to IRC Section 409A, there was some conflict between the IRS and the courts with respect to the consequences of an election to defer compensation after the earning period commences. The IRS seems to believe that a deferral election after the earning period commences will result in constructive receipt of the deferred amounts, even if made before the deferred amounts are payable. For example, in TAM 8632003, the IRS found constructive receipt where a participant in a shadow stock plan elected, just prior to surrendering his shares, to take the value of his shares in 10 installment payments rather than in one lump sum. The IRS refused to permit further deferral of amounts already earned and determinable, believing that the fact that the benefits were not yet payable at the time of the election was an insufficient restriction on the availability of the money. (7) But a plan allowing elections to defer bonus payments on or before May 31st of the year for which the deferral is to be effective did not cause constructive receipt; no express consideration of effect of election provision. (8) Contributions to a rabbi trust did not result in income to participants or beneficiaries until benefits would be paid or made available in context of plan allowing election to further defer compensation through choice of payout method after termination of services; no express consideration of effect of election provision. (1)

Courts have looked more favorably upon elections to defer compensation after the earning period commences but before the compensation was payable. For example, theTax Court considered the same plan addressed in TAM 8632003, above, and reaffirmed its position that an election to further defer compensation not yet due under the original deferred compensation agreement does not necessarily result in constructive receipt. (2) While the IRS did acquiesce in Oates and in the first Veit case, it tried to distinguish those cases and the second Veit case in TAM 8632003, above.

Special concerns are present if compensation is deferred for a controlling shareholder. If a controlling shareholder can (through his control of the corporation) effectively remove any restrictions on his immediate receipt of the money, the IRS may argue that he is in constructive receipt, because nothing really stands between him and the money. (3) It is hard to eliminate these concerns in advance, because the IRS will not issue advance rulings on the tax consequences of a controlling shareholder-employee's participation in a nonqualified deferred compensation plan. (4) But the courts may be less willing to impose constructive receipt in such situations. (5)

If a nonqualified deferred compensation plan is subject to registration as a security with the Securities and Exchange Commission (SEC), failure to register the plan may have tax implications. A participant in such a plan may be able to rescind the deferral of his compensation. Such a right to rescind could cause the participant to be in constructive receipt of the deferred amounts. Currently, though, the IRS has not resolved the nature and extent of any tax implications arising from a failure to register a plan with the SEC. Further complicating matters, the SEC has not formally clarified which nonqualified plans are subject to the registration requirement.

IRS Rulings

Prior to the enactment of IRC Section 409A, the IRS generally refused to issue advance rulings concerning the tax consequences of an unfunded arrangement if the arrangement failed to meet the following requirements. Some of the requirements parallel those in IRC Section 409A discussed above. (6)

Any initial election to defer compensation generally had to be made before the beginning of the period of service for which the compensation is payable, regardless of the existence of forfeiture provisions. If any election other than the initial election to defer compensation could be made after the beginning of the period of service, the plan had to set forth substantial forfeiture provisions that must remain in effect throughout the entire period of the deferral. The plan had to define the time and method for paying deferred compensation for each event (such as retirement) entitling a participant to benefits. The plan could specify the date of payment or provide that payments will begin within 30 days after a triggering event. If the plan provided for the early payment of benefits in the case of an "unforeseeable emergency," "unforeseeable emergency" had to be defined as an unanticipated emergency caused by an event beyond the control of the participant or beneficiary that would cause severe financial hardship if early withdrawal were not permitted. The plan also had to provide that any early withdrawal would be limited to the amount necessary to meet the emergency. Language similar to that in Treasury Regulations [section] [section] 1.457-2(h)(4) and 1.457-2(h)(5) could be used. The plan had to provide that participants have the status of general unsecured creditors of the employer and that the plan constitutes a mere promise by the employer to pay benefits in the future. The plan also had to state that it was the intention of the parties that it be unfunded for tax and ERISA purposes. The plan had to provide that a participant's rights to benefits could not be anticipated, alienated, sold, transferred, assigned, pledged, encumbered, attached, or garnished by the participant's or the participant's beneficiary's creditors. (1)

Transfer to Qualified Plan

A private letter ruling has held that employees who elect to cancel their interests in an unfunded nonqualified deferred compensation plan in exchange for substitute interests in a qualified plan would be taxable on the present value of their accrued benefits in the qualified plan upon the funding of those new interests, and would have to include the value of future benefits attributable to future compensation when the cash (that otherwise would have been received under the nonqualified plan) would have been includable. (2)

ERISA Requirements

Deferred compensation plans may be required to meet various requirements under ERISA, including funding and vesting requirements. See, generally, ERISA, Titles I and IV. But certain plans, including "top hat" plans (see below), "excess benefit" plans (see Q 129), and plans that provide payments to a retired partner or a deceased partner's successor in interest under IRC Section 736 are exempt from some or all of these ERISA requirements. (3)

"Top Hat" Plans

A "top hat" plan is an unfunded plan maintained primarily to provide deferred compensation for a select group of management or highly compensated employees. (4)

The determination of whether a plan is offered to a "select group" is a facts and circumstance determination. (5) Where all management employees were eligible for a plan, it was held not to meet the select group requirement. (6)

Top hat plans are subject to a different standard of review from other ERISA plans, because they are exempt from most of ERISA's substantive rules. They are subject to a de novo review unless the plan documents expressly grant deference to the plan administrator, rather than the standard of Firestone v. Bruch, (7) under which plan administrator's decisions are given deference unless found to be arbitrary and capricious. (8)

Where a Supplemental Executive Retirement Plan (SERP) (see Q 115) was found to be a top hat plan rather than an excess benefit plan (see Q 129), claim could not be brought in state court, but was subject to ERISA preemption. (9)

A top hat plan may be used as a temporary holding device for 401(k) elective deferrals (see Q 120). (1)

117. What is meant by the "economic benefit" theory?

Under the economic benefit theory, an employee is taxed when he receives something other than cash that has a determinable, present economic value.TThe danger, in the deferred compensation context, is that an arrangement for providing future benefits will be considered to provide the employee with a current economic benefit capable of valuation. Current taxation arises when assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee's sole benefit. (2)

The employer can establish a reserve for satisfying its future deferred compensation obligations while preserving the "unfunded and unsecured" nature of its promise, provided that the reserve is wholly owned by the employer and remains subject to the claims of its general creditors: "A mere promise to pay, not represented by notes or secured in any way, is not regarded as a receipt of income." (3) Unfunded plans do not confer a present, taxable economic benefit. (4) An unfunded and unsecured promise of future payment is not taxable under IRC Section 83, which codifies the economic benefit theory. (5)

It has generally been accepted that deferred compensation benefits can be backed by life insurance or annuities without creating a currently taxable economic benefit. (6)

In the Goldsmith case, (7) however, the court found that the promises of pre-retirement death and disability benefits provided the employee with a current economic benefit--current life insurance and disability insurance protection--even though the corporation was owner and beneficiary of the policy, which was subject to the claims of its general creditors. The court did not find constructive receipt of the promised future payments, but ruled that the portion of the premium attributable to life, accidental death, and disability benefits was taxable to the employee. The Goldsmith case appears to be anomalous; since it was decided, the IRS has not treated pre-retirement death or disability benefits as creating a currently taxable economic benefit. (8) Compare this treatment with that intended by Congress for deferred compensation plans under IRC Section 457. See Q 126.

118. What is the impact of the use of an informal funding or other security device in connection with a private deferred compensation plan?

A deferred compensation plan cannot be formally funded (that is, the employee cannot be given an interest in any trust or escrowed fund or in any asset, such as an annuity or life insurance contract) without adverse tax consequences. See Q 111 to Q 114. But the agreement can be informally funded without jeopardizing tax deferral. For example, an employer can set aside assets in a "rabbi" trust (Q 119) to provide funds for payment of deferred compensation obligations, as long as the employees have no interest in those assets and they remain the employer's property, subject to the claims of the employer's general creditors. (Beneficiaries of rabbi trusts take the risk of trust assets being subject to the claims of the employer's general creditors for the benefit of favorable tax treatment). (1) Rabbi trusts are very popular devices for informally funding deferred compensation.

The IRS has not considered a plan that sets aside assets in an escrow account to be "formally funded" if the assets are subject to the claims of the employer's general creditors. (2)

It has been generally accepted for some time that an employer may informally fund its obligation by setting aside a fund composed of life insurance contracts, annuities, mutual funds, securities, etc., without adverse tax consequences to the employee, so long as the fund remains the unrestricted asset of the employer and the employee has no interest in it. (3) Thus, a deferred compensation plan should not be regarded as "funded" for tax purposes merely because the employer purchases a life insurance policy or an annuity contract to ensure that funds will be available when needed. The Tax Court stretched these rules a bit in ruling that payment obligations to attorneys under a structured settlement were unfunded, even though the attorneys were annuitants under the annuities financing the obligations. (4)

Securing or distributing deferred compensation upon the employer's falling net worth or other financial events unacceptably secures the payment of the promised benefits. (5) This includes hybrid rabbi/ secular trust arrangements that distribute assets from nominal rabbi trusts to secular trusts on the occurrence of triggering events indicating the employer's financial difficulty. Under any such arrangement, otherwise deferred compensation is immediately taxable and subject to a 20% additional tax. Interest on the underpayment of taxes is due at the normal underpayment rate plus 1%. (6)

Setting aside assets in an offshore trust to directly or indirectly fund deferred compensation also unacceptably secures the payment of the promised benefits. (7) Under any such arrangement, the otherwise deferred compensation is immediately taxable and subject to a 20% additional tax. Interest on the underpayment of taxes is due at the normal underpayment rate plus 1%. (8)

Both the prohibition on financial triggers and on offshore trusts apply even to deferrals of compensation earned and vested on or before December 31, 2004 (and thus not generally subject to the requirements of IRC Section 409A). The IRS provided transition relief through December 31, 2007 for amounts otherwise subject to IRC Section 409A(b), if those assets relate to compensation deferred on or before December 31, 2004 and if those assets were set aside, transferred, or restricted on or before March 21, 2006. (9)

In addition, IRC Section 409A prohibits top executives--individuals described in IRC Section 162(m)(3) or subject to Section 16(a) of the Securities Exchange Act of 1934--from setting aside assets in a rabbi trust or other informal funding device during a "restricted period." The restricted period is any period during which the employer is in bankruptcy, during which a company's plan is in "at-risk" status, or during the six months before or after an insufficient plan termination. The restrictions apply to any transfers or reservations after August 17, 2006. If any prohibited transfer occurs, otherwise deferred compensation is immediately taxable and subject to a 20% additional tax. Interest on the underpayment of taxes is due at the normal underpayment rate plus 1%. (10)

One court has ruled that a death benefit only plan backed by corporate-owned life insurance is "funded" for ERISA purposes. (1) The decision has been criticized, but the result, if ever accepted by other courts, could have far reaching tax implications. If a plan is "funded" for ERISA purposes, it is generally required to satisfy ERISA's exclusive purpose rule and meet certain minimum vesting and funding standards. Once these requirements are met, the plan may no longer be considered "informally funded" for tax purposes, and adverse tax consequences may follow. In 1987, the same court that decided Dependahl concluded that a nonqualified deferred compensation plan informally funded with life insurance was not funded for ERISA purposes, and thus was not subject to minimum vesting and funding standards. (2) The court distinguished this case from Dependahl, in part, by noting that the Belsky agreement stated specifically that the employee's only right against the employer was that of an unsecured creditor. (3)

The DOL has issued various advisory opinions permitting the use of an employer-owned asset to finance different types of plans while the plans maintained their "unfunded" status under ERISA. (4) The DOL has stated that plan assets include any property, tangible or intangible, in which the plan has a beneficial ownership interest. (5) According to footnote three in Advisory Opinion 94-31A, the "beneficial ownership interest" analysis is not relevant in the context of excess benefit and top hat plans. (6) The DOL reasoned that its position was supported by the special nature of these plans, the participating employees' ability to affect or substantially influence the design and operation of the plan, and the rulings of the IRS surrounding the tax consequences of using rabbi trusts with these plans. What sort of plan asset analysis is relevant in that context is not clear, although the DOL does have a working premise that rabbi trusts meeting with IRS approval will not cause excess benefit or top hat plans to be funded for ERISA purposes. (7)

An insurance policy used to informally fund a plan should be held by the employer and not distributed to the employee at any time; otherwise, the employee will be taxed on the value of the contract when he receives it. (8) See also Q 80. The employer cannot deduct its premium payments, but the employer receives the death proceeds tax free. (9) But proceeds paid to a corporation may be, in part at least, includable in the corporation's income for alternative minimum tax purposes. (10) See Q 96. For tax results on surrender of the policy, see Q 266, Q 267. For accumulated earnings tax, see Q 90.

An employee is not taxable on the premiums paid by the employer or on any portion of the value of the policy or annuity, provided that the employer applies for, owns, is beneficiary of, and pays for the policy or annuity contract and uses it merely as a reserve for the employer's obligations under the deferred compensation agreement. (1) Where the employee receives basic life insurance protection and a vested right in the annual increase in the cash surrender value of the policy, the premiums will be taxable to the employee. (2)

With respect to contributions made after February 28, 1986, to annuity contracts held by a corporation, partnership, or trust (i.e., a nonnatural person), "the income on the contract" for the tax year of the policyholder is generally treated as ordinary income received or accrued by the contract owner during such taxable year. (3) See Q 2. Also, corporate ownership of life insurance may result in exposure to the corporate alternative minimum tax. See Q 96.

The IRS has privately ruled that an employee's purchase of a surety bond (with no reimbursement from his employer) as protection against nonpayment of unfunded deferred compensation benefits would not, by itself, cause deferred amounts to be includable in income prior to receipt. (4) But the IRS also warned that an employer-paid surety bond would cause current taxation. A later letter ruling has blurred somewhat the line between employee-provided and employer-provided surety bonds--the IRS has hinted, without clearly distinguishing between employee-paid and employer-paid surety bonds, that the use of a surety bond to protect deferred compensation could cause the promise to be secured, resulting in taxation under IRC Section 83 when the deferred compensation is substantially vested (that is, either not subject to a substantial risk of forfeiture or transferable to a third party free of such a risk). (5) Whether the IRS meant to question both employer-provided and employee-provided surety bonds is not clear.

The IRS has privately ruled that an employee can buy indemnification insurance to protect his deferred benefits without causing immediate taxation. This result holds even if the employer reimburses the employee for the premium payments, as long as the employer has no other involvement in the arrangement (the employee's premium payments must be treated as nondeductible personal expenses, and any premium reimbursements must be included in the employee's income). (6) The ERISA consequences of such an arrangement are not clear.

On occasion, third-party guarantees of benefit promises have received favorable treatment. For example, a parent corporation's guarantee of its subsidiary's deferred compensation obligations did not accelerate the taxation of the benefits. (7) But the conclusion that plaintiffs' promise to pay their attorney was funded and secured and subject to IRC Section 83 where they irrevocably ordered defendants' insurers to pay the plaintiffs' attorney his fees out of plaintiffs' recovery and defendants' insurers paid the attorney by purchasing annuities for him was "strengthened" by the fact that a defendant and the defendants' insurers guaranteed to make the annuity payments, should the annuity issuer default (8); the current value of protection provided by an employer-paid surety bond or other guarantee arrangement constitutes a taxable economic benefit (9); protecting deferred compensation benefits by giving employees certificates of participation secured by irrevocable standby letters of credit secured promise and triggered application of IRC Section 83 (10); and employer's purchase of irrevocable standby letter of credit beyond the reach of its general creditors to back its promise to pay accrued vacation benefits secured promise and triggered taxation under IRC Section 83. (1)

There is some controversy between the IRS and the Tax Court over whether a promise to pay will be "funded" for tax purposes if the obligation is transferred to a third party. The IRS is likely to think that the employer's promise is funded, even if the third party pays the transferred obligations out of general revenues or sets aside a fund that remains its general asset and to which the employee has no special claim. (2) The Tax Court does not seem to think that the transfer will automatically result in funding; rather, the Tax Court is more likely to examine whether any property is specially set aside by the new obligor for the employee. (3)

119. What is a "rabbi" trust and what are the income tax consequences of using such a trust to provide nonqualified deferred compensation benefits to employees?

A rabbi trust is a vehicle for accumulating assets to support unfunded deferred compensation obligations. Established by the employer with an independent trustee, a rabbi trust is designed to (1) provide employees with some assurance that their promised benefits will be paid while (2) preserving the tax deferral that is at the heart of unfunded deferred compensation plans. To accomplish these ends, a rabbi trust is generally irrevocable. But--and this is the key characteristic of a rabbi trust--a rabbi trust provides that its assets remain subject to the claims of the employer's general creditors in the event of the employer's insolvency or bankruptcy. (4) These trusts are called "rabbi" trusts because the first such trust approved by the IRS was set up for a rabbi. (5)

Securing or distributing deferred compensation upon the employer's falling net worth or other financial events unacceptably secures the payment of the promised benefits. (6) This includes hybrid rabbi/ secular trust arrangements that distribute assets from nominal rabbi trusts to secular trusts on the occurrence of triggering events indicating the employer's financial difficulty. Under any such arrangement, otherwise deferred compensation is immediately taxable and subject to a 20% additional tax. Interest on the underpayment of taxes is due at the normal underpayment rate plus 1%. (7)

Setting aside assets in an offshore trust to directly or indirectly fund deferred compensation also unacceptably secures the payment of the promised benefits. (8) Under any such arrangement, the otherwise deferred compensation is immediately taxable and subject to a 20% additional tax. Interest on the underpayment of taxes is due at the normal underpayment rate plus 1%. (9)

Both the prohibition on financial triggers and on offshore trusts apply even to deferrals of compensation earned and vested on or before December 31, 2004 (and thus not generally subject to the requirements of IRC Section 409A). The IRS has provided transition relief through December 31, 2007 for amounts otherwise subject to IRC Section 409A(b), if those assets relate to compensation deferred on or before December 31, 2004 and if those assets were set aside, transferred, or restricted on or before March 21, 2006. (10)

The combination of security, albeit imperfect--a rabbi trust can protect an employee against the employer's future unwillingness to pay promised benefits, but it cannot protect an employee against the employer's future inability to pay--and tax deferral offered by a rabbi trust has made them very popular. In fact, the rabbi trust is so popular that the IRS released a model rabbi trust instrument to aid taxpayers and to expedite the processing of requests for advance rulings on these arrangements. The IRS model trust is intended to serve as a safe harbor for employers. Used properly, the model trust will not, by itself, cause employees to be in constructive receipt of income or to incur an economic benefit. Of course, whether an unfunded deferred compensation plan using the model rabbi trust effectively defers taxation will depend upon whether the underlying plan effectively defers compensation. The IRS will continue to issue advance rulings on the tax treatment of (1) unfunded deferred compensation plans that do not use a trust and (2) unfunded deferred compensation plans that use the model trust. But the IRS will no longer, except in rare and unusual circumstances, issue advance rulings on unfunded deferred compensation arrangements that use a trust other than the model trust. (1)

The model trust language contains all provisions necessary for operation of the trust except provisions describing the trustee's investment powers. The parties involved must provide language describing the investment powers of the trustee, and those powers must include some investment discretion. Proper use of the model trust requires that its language be adopted verbatim, except where substitute language is expressly permitted. Although it is somewhat puzzling in light of the claim by the IRS that it will not rule on plans that do not use the model trust, the employer may add additional text to the model trust language, as long as such text is "not inconsistent with" the model trust language. (2)

The rights of plan participants to trust assets must be merely the rights of unsecured creditors. Participants' rights cannot be alienable or assignable. The assets of the trust must remain subject to the claims of the employer's general creditors in the event of insolvency or bankruptcy. (3)

In at least one older letter ruling, the IRS found that the use of a third-party guarantee as an additional security measure did not undermine the tax-effectiveness of a rabbi trust. (4)

The board of directors and the highest ranking officer of the employer must be required to notify the trustee of the employer's insolvency or bankruptcy, and the trustee must be required to cease benefit payments upon the company's insolvency or bankruptcy. (5)

If the model trust is used properly, it should not cause a plan to lose its status as "unfunded." In other words, contributions to a rabbi trust should not cause immediate taxation to employees; employees should not have income until the deferred benefits are received or otherwise made available. (6) Contributions to a rabbi trust for the benefit of a corporation's directors have been treated similarly. (7) Likewise, contributions to a rabbi trust should not be considered "wages" subject to income tax withholding until benefits are actually or constructively received. (8)

A proper rabbi trust should not be considered an IRC Section 402(b) nonexempt employees' trust. Contributions to a proper rabbi trust should not be subject to IRC Section 83. (1)

The employer should receive no deduction for amounts contributed to the trust, but should receive a deduction when benefit payments are includable in the employee's income. See Q 121. In pre-model trust days, the employer was generally considered the owner of the trust under IRC Section 677 and was required to include the income, deductions, and credits generated by the trust in computing the employer's taxable income. (2)

The IRS will generally issue advance rulings on the grantor trust status of trusts following the model trust. (3) Such model trust rulings seem entirely consistent with past rulings. (4) In pre-model trust rulings, the IRS generally conditioned favorable tax treatment upon the satisfaction of two additional requirements: (1) that creation of the trust did not cause the plan to be other than unfunded for ERISA purposes; and (2) that trust provisions requiring that the trust's assets be available to satisfy the claims of general creditors in the event of insolvency or bankruptcy were enforceable under state and federal law. (5) The same conditions have been imposed in model trust rulings. (6)

The concern of the IRS with respect to the ERISA issue seems to be that if the use of a rabbi trust causes the underlying plan to be other than unfunded for ERISA purposes, then the plan would generally be subject to Title I of ERISA, and the application of Title I provisions, such as the exclusive purpose rule and the vesting and funding requirements, would cause the plan to be funded for tax purposes and require the accelerated taxation of contributions to the rabbi trust. The DOL's position seems to be that at least rabbi trusts maintained in connection with excess benefit or top hat plans will not cause the underlying plans to be funded for ERISA purposes. (7) At least one court has noted that the use of a rabbi trust will not cause a top hat plan to lose its ERISA exemption as long as (1) the trust assets remain subject to the claims of the employer's creditors in the event of insolvency; and (2) the participants' interests are inalienable and unassignable. (8) Nonetheless, rulings on plans using the model trust are supposed to state that the IRS expresses no opinion on the ERISA consequences of using a rabbi trust. (9)

In past private letter rulings, the IRS has allowed the use of a rabbi trust in conjunction with a deferred compensation plan that permits hardship withdrawals, ruling that the hardship withdrawal provision will not cause amounts deferred to be taxable before they are paid or made available. In these letter rulings, "hardship" is generally defined as an unforeseeable financial emergency caused by events beyond the participant's control. The amount that can be withdrawn is generally limited to that amount needed to satisfy the emergency need. (10) IRS guidelines for giving advanced rulings on unfunded deferred compensation plans expressly permit the use of certain hardship withdrawal provisions. (11) See Q 116.Thus, it would seem that a rabbi trust conforming to the model trust could be used in conjunction with a deferred compensation plan permitting an acceptable hardship withdrawal. (1) While an appropriate hardship withdrawal provision should not trigger taxation before deferred amounts are paid or made available, such a provision may trigger constructive receipt at the time when a qualifying emergency arises. (2)

The trustee may be given the power to invest in the employer's securities. If the trustee is given that power, the trust must (1) be revocable or (2) include a provision that the employer can substitute assets of equal value for any assets held by the trust. (3) Where presumably model trusts separately serving a parent and affiliates could invest in the parent's stock, it was ruled that (1) dividends paid on the parent's stock held by the parent's trusts would not be includable in the parent's income in the year paid, (2) no gain or loss would be recognized by the parent upon transfer of its stock from its trusts to its participants or their beneficiaries, and (3) no gain or loss would be recognized by the affiliates upon the direct transfer of the parent's stock to the affiliates' participants or their beneficiaries if that stock was transferred directly by the parent to the participants or beneficiaries and neither the affiliates nor their trusts were the legal or beneficial owners of parent's stock. (4) Regulations under IRC Section 1032 (see Q 89) generally permit nonrecognition treatment for transfers of stock from an issuing corporation to an acquiring corporation, if the acquiring corporation immediately disposes of such stock. A transfer of a parent corporation's stock to a rabbi trust for the benefit of a subsidiary's employee would not qualify for this nonrecognition treatment, because the stock is not immediately distributed to the participant. The IRS has announced that nonrecognition treatment is available for such transfers, albeit under a different theory. The IRS will treat the parent corporation, rather than the subsidiary corporation, as the grantor and owner of the rabbi trust, so long as the trust provides that (1) stock not transferred to the subsidiary's employees reverts to the parent and (2) the parent's creditors can reach the stock. (5) The IRS has indicated that it will rule on model rabbi trusts that have been modified to comply with this notice.

The trust must provide that, if life insurance is held by the trust, the trustee will have no power to (1) name any entity other than the trust as beneficiary, (2) assign the policy to any entity other than a successor trustee, or (3) to loan to any entity the proceeds of any borrowing against the policy (but an optional provision permits the loan of such borrowings to the employer). (6)

Taxpayers that adopt the model trust and wish to obtain an advance ruling on the underlying deferred compensation plan must not only follow the standard guidelines for obtaining a ruling on an unfunded deferred compensation plan (see Q 116) but must also follow other guidelines unique to plans using a trust. First, the plan must provide that the trust and any assets held by it will conform to the terms of the model trust. Second, taxpayers must generally include a representation that the plan is not inconsistent with the terms of the trust with the letter ruling request. Third, the language of the trust must generally conform with the model text, and taxpayers must generally include a representation that the trust conforms to the model trust language (including the order in which the provisions appear) and that the trust does not contain any inconsistent language (in substituted portions or elsewhere) that conflicts with the model trust language. Provisions may be renumbered if appropriate, any bracketed model trust language may be omitted, and blanks may be filled in. Fourth, the request for a letter ruling generally must include a copy of the trust document on which all substituted or added language is clearly marked and on which the required investment authority text is indicated. Fifth, the request for a ruling must generally contain a representation that the trust is a valid trust under state law, and that all of the material terms and provisions of the trust, including the creditors' rights clause, are enforceable under the appropriate state laws. Finally, the trustee must generally be an independent third party that may be granted corporate trustee powers under state law, such as a bank trust department or a similar party. (1)

The IRS has issued several private letter rulings addressing the deductibility of interest paid on life insurance policy loans after the policies are transferred to a rabbi trust. See Q 262.

120. Can a private nonqualified deferred compensation plan serve as a temporary holding device for 401(k) elective deferrals?

Yes, according to a 1995 private letter ruling approving a particular nonqualified/401(k) "wraparound" or "pour-over" plan. (2) Since that time, more rulings approving the use of wrap around plans have been issued.3 Note that wrap-around plans have been primarily used to maximize elective deferrals under both an IRC Section 401(k) plan and a nonqualified plan. Thus, such an arrangement may be unnecessary due to the manner in which the actual deferral percentage test for 401(k) plans is now administered (see Q 411). Some plans will elect to use the current year testing method, however, and for these plans a wrap-around plan will continue to provide planning opportunities.

In addition, under final regulations, a wrap-around plan will not violate IRC Section 409A if it meets certain requirements. In particular, such a linkage may not result in a decrease in deferrals in the nonqualified arrangement in excess of the deferral limits under IRC Section 402(g). (4) For existing arrangements, the IRS offered transition relief through December 31, 2007. For these plans, elections as to the timing and form of payment under the nonqualified plan that are controlled by the qualified plan are permitted through December 31, 2007. Elections must be made in accordance with the terms of the nonqualified plan as of October 3, 2004. (5)

Background. An employer seeking to maximize highly compensated employees' (HCEs) elective deferrals to its 401(k) plan established an unfunded, nonqualified salary reduction plan to temporarily hold elective deferrals until the maximum amount of 401(k) elective deferrals could be determined. Employees could defer compensation into the proposed nonqualified plan by entering into salary reduction agreements by December 31st of the prior year. These employees would then receive "matching" contributions under the nonqualified plan equal to their matching contributions under the 401(k) plan. The employer would determine the maximum amount of elective contributions that the HCEs could make to the 401(k) plan for the current year as soon as practicable each year, but no later than January 31st of the next year. The lesser of the maximum allowable amount or the amount actually deferred under the nonqualified plan would be distributed in cash to the HCEs by March 15 th of the following year unless they irrevocably elected to have such amounts contributed as elective deferrals to the 401(k) plan at the same time they elected to defer compensation into the nonqualified plan. Where such election was made, the "elective deferrals" and the appropriate "matching" contributions made under the nonqualified plan would be contributed directly to the 401(k) plan. However, earnings under the nonqualified plan would not be contributed to the 401(k) plan. Presumably, any balance in the nonqualified plan would remain in the nonqualified plan.

Ruling. The IRS ruled that amounts initially held in the nonqualified plan would be treated as made to the 401(k) plan in the year of deferral under the nonqualified plan, and would be excluded from income under IRC Section 402(e)(3). Amounts distributed to an employee that he did not elect to contribute to the 401(k) plan would be taxable in the year the compensation was earned.

Apparently, the key to the success of this arrangement was the requirement that the election to transfer amounts to the 401(k) plan had to be made at the same time as the election to initially defer compensation into the nonqualified plan, before the beginning of the year in which the compensation was earned. The IRS had earlier approved, and then revoked its approval, of a similar arrangement where the election to transfer amounts to a 401(k) plan could be made after the initial election to defer compensation into the nonqualified plan and after the close of the year in which the amounts were earned. (1) Apparently, the IRS was concerned that this latter arrangement raised the specter of constructive receipt. See Q 116.

Another private letter ruling approved a similar arrangement utilizing a rabbi trust (see Q 119) in connection with the nonqualified plan. (2)

One ruling (involving a top hat plan, see Q 116) specifically indicated that amounts must be transferred from the nonqualified plan to the 401(k) plan no later than March 15th. (3)

In general,a 401(k) plan will be disqualified if any employer-provided benefit (other than matching contributions) is contingent upon the employee's elective deferrals under the 401(k) plan. See Q 398. But the 401(k) regulations provide that participation in a nonqualified deferred compensation plan is treated as contingent only to the extent that the employee may receive additional deferred compensation under the nonqualified deferred compensation plan based upon whether he makes elective deferrals under the 401(k) plan. These regulations explicitly state that a provision under a nonqualified deferred compensation plan requiring an employee to have made the maximum permissible elective deferral under the 401(k) plan is not treated as contingent. (Deferrals under a nonqualified plan permitting deferral up to 15% of compensation if participants have made maximum allowable 401(k) elective deferrals were not impermissibly conditioned upon elective deferrals). (4)

121. When are deferred amounts deductible by the employer?

Generally, the employer can take a deduction for deferred compensation only when it is includable in the employee's income, regardless of whether the employer is on a cash or accrual basis of accounting. (5) Likewise, deduction of amounts deferred for an independent contractor can be taken only when they are includable in the independent contractor's gross income. (6)

The IRS confirmed that payments made under an executive compensation plan within 2 1/2 months of the end of the year in which employees vest do not constitute deferred compensation and thus may be deducted in the year in which employees vest, rather than the year in which the employees actually receive the payments. (7) See also the discussion under the heading "Employer Taxation" in Q 111.

Previously, there was some controversy over the proper timing of an accrual basis employer's deduction for amounts credited as "interest" to employee accounts under a nonqualified deferred compensation plan. The weight of authority currently holds that IRC Section 404(a)(5) governs the deduction for such amounts, which must be postponed until such amounts are includable in employee income. Amounts representing "interest" cannot be currently deducted by an accrual basis employer under IRC Section 163. (8)

To be deductible, deferred compensation payments must represent reasonable compensation for the employee's services when added to current compensation. What is reasonable is a question of fact in each case. One of the factors considered in determining the reasonableness of compensation is whether amounts paid are intended to compensate for past, under-compensated services. See Q 109. Thus, deferred compensation for past services may be deductible, even if the total of such compensation and other compensation for the current year is in excess of reasonable compensation for services performed in the current year, as long as that total, plus all compensation paid to the employee in prior years, is reasonable for all of the services performed through the current year. (1)

Little difficulty with reasonableness of compensation should be encountered with respect to non-shareholder or minority shareholder employees. A finding of unreasonableness in the case of a controlling shareholder is more likely. (Benefits paid to surviving spouse of controlling shareholder of a closely held corporation were not reasonable compensation where (1) the controlling shareholder had not been under-compensated in previous years, (2) the controlling shareholder's compensation exceeded the amounts paid by comparable companies, (3) the payments were not part of a pattern of benefits provided to employees, and (4) there was an absence of dividends.) (2) Deferred compensation payments were held to be reasonable where the controlling shareholder was inadequately paid during his life and the surviving spouse, to whom payments were made, did not inherit controlling stock ownership. (3)

Publicly-held corporations generally are not permitted to deduct compensation in excess of $1 million per tax year to certain top-level employees. (4) See Q 109.

Golden parachute rules may limit the amount of the deduction for deferred compensation payments contingent upon a change in ownership or control of a corporation or made under an agreement that violates a generally enforced securities law or regulation. See Q 110. (5)

122. How are deferred compensation payments taxed when they are received by the employee or beneficiary?

When payments are actually or constructively received, they are taxed as ordinary income. Deferred compensation payments are "wages" subject to regular income tax withholding (and not the special withholding rules that apply to pensions, etc.) when actually or constructively received. (6)

Deferred compensation that is subject to constructive receipt and taxation under IRC Section 409A is subject to a 20% additional tax. See Q 116 and Q 118. Interest on the underpayment of taxes retroactively imposed is due at the normal underpayment rate plus 1%. (7)

If the amount of any deferred compensation taxable under IRC Section 457A is not determinable at the time it is otherwise includable under that section, it is subject to a penalty and interest when so determinable. See Q 116. In addition to the normal tax, the amount includable is subject to a 20% penalty tax and interest on the underpayment of taxes at the normal underpayment rate plus 1%. (8)

Where an unfunded plan paid deferred compensation benefits in the form of a commercial single premium annuity at the termination of employment, a private ruling concluded that the value of the contract would be includable in the recipient's income at the time of distribution, in accordance with the rules of IRC Section 83. (1)

Payments made to a beneficiary are "income in respect of a decedent," and, as such, are taxed as they would have been to the employee. It is not clear whether the same withholding rules apply. For treatment of death benefits under deferred compensation agreements, see Q 135.

Benefits assigned by an employee to an ex-spouse in a divorce agreement will be taxed to the employee, rather than to the ex-spouse. There is no framework for the assignment of nonqualified deferred compensation--other than eligible Section 457 plans (see Q 125)--similar to the framework for the assignment of qualified plan benefits through a qualified domestic relations order (QDRO). (2)

123. Are contributions to and postretirement payments from a deferred compensation plan subject to FICA and FUTA taxes?

There are two timing rules for the treatment of deferred compensation amounts under the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA)-the "general timing rule" and the "special timing rule." The general timing rule provides that amounts taxable as wages are generally taxed when paid or "constructively received" (see Q 116). The special timing rule applies to amounts deferred by an employee under a traditional deferred compensation plan of an employer covered by FICA. The special timing rule applies to salary reduction plans and supplemental plans, funded plans and unfunded plans, private plans and (eligible or ineligible) Section 457 plans. It does not apply to "excess (golden) parachute payments."

An employee's "amount deferred" is considered to be "wages" for FICA purposes at the later of the date when (1) the services are performed or (2) the employee's rights to such amount are no longer subject to a "substantial risk of forfeiture" (see Q 113). (3)

Similar rules apply for FUTA (federal unemployment tax) purposes, although the taxable wage base for FUTA purposes is smaller ($7,000). (4)

Where an amount deferred cannot be readily calculated by the last day of the year, employers may choose between two alternative methods: the estimated method and the lag method.

Under the estimated method, the employer treats a reasonably estimated amount as wages paid on the last day of the calendar year. If the employer underestimates, it may treat the shortfall as wages in the first year or in the first quarter of the next year (the second year). If the employer overestimates, it may claim a refund or credit.

Under the lag method, the employer may calculate the end-of-year amount deferred on any date in the first quarter of the next calendar year. The amount deferred will be treated as wages paid and received on that date, and the amount deferred that would otherwise have been taken into account on the last day of the year must be increased by income through the date on which the amount is taken into account. (1)

Plans Excluded

The following plans and benefits are not considered deferred compensation for FICA and FUTA purposes:

(1) Stock options, stock appreciation rights, and other stock value rights, but not phantom stock plans or other arrangements under which an employee is awarded the right to receive a fixed payment equal to the value of a specified number of shares of employer stock;

(2) Some restricted property received in connection with the performance of services;

(3) Compensatory time, disability pay, severance pay, and death benefits;

(4) Certain benefits provided in connection with impending termination, including window benefits;

(5) Excess (golden) parachute payments;

(6) Benefits established 12 months before an employee's termination, if there was an indication that benefits were provided in contemplation of termination;

(7) Benefits established after termination of employment; and

(8) Compensation paid for current services. (2)

Account Balance Plan versus Nonaccount Balance Plan

The manner of determining the amount deferred for a given period depends upon whether the deferred compensation plan is an account balance plan or a nonaccount balance plan.

Account Balance Plan

A plan is an account balance plan only if, under its terms, (1) a principal amount is credited to an employee's individual account; (2) the income attributable to each principal amount is credited or debited to the individual account; and (3) the benefits payable to the employee are based solely on the balance credited to his individual account. (3)

If the plan is an account balance plan, the amount deferred for a period equals the principal amount credited to the employee's account for the period, increased or decreased by any income or loss attributable thereto through the date when the principal amount must be taken into account as wages for FICA and FUTA purposes.

The regulations explain that "income attributable to the amount taken into account" means any amount that, under the terms of the plan, is credited on behalf of an employee and attributable to an amount previously taken into account, but only if the income is based on a rate of return that does not exceed either (1) the actual rate of return on a predetermined actual investment; or (2) a reasonable rate of interest, if no predetermined actual investment has been specified.

Nonaccount Balance Plan

If the plan is a nonaccount balance plan, the amount deferred for a given period equals the present value of the additional future payment or payments to which the employee has obtained a legally binding right under the plan during that period. The present value must be determined as of the date when the amount deferred must be taken into account as wages, using actuarial assumptions and methods that are reasonable as of that date. (1)

With respect to these defined-benefit-type plans, the IRS has ruled privately that when a deferred compensation plan promises to pay a fixed amount in the future, the "amount deferred" is the present value of the expected benefits at the time when the benefits are considered wages for FICA purposes. The discount (that is, the income attributable to the amount deferred) is not treated as wages in that or any later year. (2) Thus, if the deferred compensation payments under such a plan vest (become nonforfeitable) upon retirement, then the present value of the expected payments will be treated as wages for FICA purposes in the year of retirement.

An employer may treat a portion of a nonaccount balance plan as a separate account balance plan if that portion satisfies the definition of an account balance plan and the amount payable under that portion is determined independently of the amount payable under the other portion of the plan. (3)

The "income attributable to the amount taken into account" means the increase, due solely to the passage of time, in the present value of the future payments to which the employee has obtained a legally binding right, the present value of which constituted the amount taken into account, but only if determined using reasonable actuarial methods. (4)

The final regulations provide that an amount deferred under a nonaccount balance plan need not be taken into account as wages under the special timing rule until the earliest date on which the amount deferred is reasonably ascertainable.

An amount deferred is reasonably ascertainable when there are no actuarial (or other assumptions) needed to determine the amount deferred other than interest, mortality, or cost-of-living assumptions. (5) For example, the IRS ruled that a participant's benefits under an IRC Section 457 plan (see Q 125) would not be subject to FICA tax simply because the plan's age and service requirements had been met, because benefits were not 'reasonably ascertainable' at that time. Similarly, the benefits would not be subject to income tax withholding at that time, because they are not treated as constructively received until actually received for income tax withholding. (6)

No amount deferred under a deferred compensation plan may be taken into account as FICA or FUTA wages before the plan is established. (7)

Nonduplication Rule

A nonduplication rule designed to prevent double taxation provides that once an amount is treated as wages, it (and any income attributable to it) will not be treated as wages for FICA or FUTA purposes in any later year. (8) A deferred amount is treated as taken into account for FICA and FUTA purposes when it is included in computing the amount of wages, but only to the extent that any additional tax for the year resulting from the inclusion is actually paid before the expiration of the period of limitation for the year. A failure to so take a deferred amount into account subjects it (and any income attributable thereto) to inclusion when actually or constructively paid. (1)

Self-Employed Individuals and Corporate Directors

Self-employed individuals pay social security taxes through self-employment (SECA) taxes rather than FICA taxes. Deferred compensation of self-employed individuals is usually counted for SECA tax purposes when it is includable in income for income tax purposes. (2) So, deferred compensation of self-employed individuals is generally counted for SECA purposes when paid, or, if earlier, when it is constructively received. (3)

Likewise, corporate directors who defer their fees generally count those fees for SECA purposes when paid or constructively received. (4) See Q 116.

For a discussion of the SECA taxation of deferred commission payments to self-employed life insurance agents, see Q 803.

Earnings Base Subject to Tax

OASDI Portion

The wage base for the old age, survivors, and disability insurance (OASDI) portion of the FICA tax and the taxable earnings base for the OASDI portion of the SECA tax are both $106,800 for 2010. The amount was also $106,800 for 2009.

Medicare Hospital Insurance Portion

There is no taxable wage base cap for the Medicare hospital insurance portion of the FICA tax, so all deferred compensation counted as wages for FICA purposes is subject to at least the hospital portion of the FICA tax. (5) Nor is there an earnings base cap for the hospital insurance portion of the SECA tax. (6)

Section 457 Plans (Government and Tax-Exempt Employers)

124. Are the tax benefits of a nonqualified deferred compensation plan available through an agreement with a state or local government or other tax-exempt employer?

Yes. Receipt and taxation of compensation for services performed for a state or local government may be deferred under a Section 457 plan. For this purpose, a state or local government includes a state, a political subdivision of a state, or any agency or instrumentality of either of them. A plan of a tax-exempt rural electric cooperative and its tax-exempt affiliates is included under these same rules. Deferred compensation plans covering state judges may not be governed under these rules. See Q 128. While the Code does not appear to provide for tax-exempt employers and governmental entities to maintain SIMPLE IRA plans (see Q 243), the IRS has stated that they may do so. (7) (SIMPLE IRA plans of tax-exempt employers and governmental entities are not subject to the limits of IRC Section 457).

IRC Section 457 also generally applies to deferred compensation agreements entered into with nongovernmental organizations exempt from tax under IRC Section 501 (for the most part, nonprofit organizations serving some public or charitable purpose). Amounts deferred under agreements with such tax-exempt organizations (other than tax-exempt rural electric cooperatives) in taxable years prior to December 31, 1986 do not fall within the rules applicable to Section 457 plans (see "Grandfather Rule," below).

Neither a church (as defined in IRC Section 3121(w)(3)(A)), nor a church-controlled organization (as defined in IRC Section 3121(w)(3)(B)), nor the Federal government or any agency or instrumentality thereof is an eligible employer for purposes of IRC Section 457. (1)

In Notice 2005-58, (2) the IRS reversed a decision from a 2004 private letter ruling (3) that a federally chartered credit union was not an eligible employer under IRC Section 457 because it was a federal instrumentality under IRC Section 501(c)(1). Pending the release of further guidance, a federal credit union that has consistently claimed the status of a non-governmental tax-exempt organization for employee benefit plan purposes may establish and maintain an "eligible" plan under IRC Section 457.

An "eligible" Section 457 plan is one that meets the annual deferral limits and other requirements of IRC Section 457. (4) See Q 125. Plans that do not meet these limits are referred to as "ineligible" plans. (5) See Q 127.

Plans Not Subject to IRC Section 457

In general, bona fide vacation leave, sick leave, compensatory time, severance pay (including certain voluntary early retirement incentive plans), disability pay, and death benefit plans are not considered to be plans providing for the deferral of compensation and, thus, are not subject to IRC Section 457. (6) The IRS has issued interim guidance for certain broad-based, nonelective severance pay plans of a state or local government in existence before 1999 with respect to the timing of reporting payments. (7)

Length of service awards accruing to bona fide volunteers (or their beneficiaries) due to "qualified services" after December 31, 1996 are also excluded from coverage. (8) "Qualified services," for this purpose, means fire fighting and prevention services, emergency medical services, and ambulance services. (9) This exclusion does not apply when the accrued aggregate amount of the award in any year of service exceeds $3,000. (10)

IRC Section 457 also does not apply to nonelective deferred compensation attributable to services not performed as an employee. Deferred compensation is treated as nonelective for this purpose if all individuals with the same relationship to the employer are covered under the same plan, with no individual variations or options under the plan. (11)

Grandfather Rule

Amounts deferred under plans of nongovernmental tax-exempt organizations for taxable years beginning after December 31, 1986 are not subject to IRC Section 457 if made pursuant to an agreement that (1) was in writing on August 16, 1986 and (2) provides for yearly deferrals of a fixed amount or an amount determined by a fixed formula. (1) This grandfather provision is available only to those individuals covered under the plan on August 16, 1986. (2)

Any modification to the written plan that directly or indirectly alters the fixed amount or the fixed formula will subject the plan to the limitations of IRC Section 457. (3) But apparently modifications that reduce benefits will not. (4)

Where promised retirement benefits provided (as a matter of practice) solely through a grandfathered nonqualified plan were offset by benefits from a qualified plan without altering the fixed formula determining the total of promised benefits, the grandfathered status of the nonqualified plan was not affected. (5) Likewise, an amendment to allow for the diversification into different mutual funds for the deemed investment of a participant's account and not limiting such participant to his original mutual fund investment options was found not to modify the basic formula and not to affect the grandfather status of the plan. (6)

Where, in the context of a parent-subsidiary structure established before August 16, 1986, a participant in the subsidiary's plan became an employee of the parent and was paid by the parent but retained his positions and responsibilities with, but not his compensation from, the subsidiary, a proposal to amend the subsidiary's plan to cover the participant's employment with the parent was found not to modify the plan's fixed formula and not to affect the grandfathered status of the plan. (7)

The IRS has indicated that amendments providing for selection of investment alternatives and an election to receive an annual cash payment did not adversely affect the plan's grandfathered status under the Tax Reform Act of 1986.8

125. What requirements must a Section 457 plan meet?

A deferred compensation plan under IRC Section 457 must meet certain requirements, set forth below. There is no prohibition against discrimination among these requirements. A Section 457 plan that is not administered in accordance with these requirements will be treated as "ineligible," (9) see Q 127. Plans paying solely length of service awards to bona fide volunteers or their beneficiaries on account of such volunteers' qualified services are exempt from these requirements. (10)

It should be noted that the Economic Growth and Tax Relief ReconciliationAct of2001 (EGTRRA 2001) made many changes in the rules applicable to Section 457 plans. In addition, final regulations were issued in 2003 and are generally effective for taxable years beginning after December 31, 2001. (11)

Permissible Participants

Only individuals may participate, but they may be either employees or independent contractors. Partnerships and corporations cannot be participants. (12) Where local government employees were hired by a water company as part of privatization, they could no longer participate in the local government's Section 457 plan. (1)

It should be noted that nongovernmental tax-exempt employers must structure their plans to take advantage of an ERISA exemption (e.g., by allowing only a select group of management or highly compensated employees to participate). Otherwise, the plan would be subject to the exclusive purpose and funding requirements of Title I of ERISA, and a nongovernmental tax-exempt Section 457 plan cannot, by definition, meet those requirements. (2)

Timing of Deferred Compensation Agreement

Generally, compensation may be deferred for any calendar month, but only if a deferral agreement has been entered into before the beginning of that month. (3) But a Section 457 plan may permit a newly hired employee to enter into an agreement before his first day of employment, under which deferrals will be made for the first month in which he is employed. Nonelective employer contributions are treated as being made under an agreement entered into before the first day of the calendar month. (4)

A Section 457 plan may permit deferrals pursuant to an automatic election, under which a fixed percentage of an employee's compensation is deferred unless he affirmatively elects to receive it in cash. (5)

Availability of Amounts Payable

A Section 457 plan generally cannot provide that amounts will be made available before (1) the calendar year in which the participant attains age 70V2, (2) the date when the participant has a severance from employment (see below), or (3) the date when the participant is faced with "an unforeseeable emergency" (see below). (6)

A participant in an eligible nongovernmental, tax-exempt Section 457 plan may make a one-time election, after amounts are available and before commencement of distributions, to defer commencement of distributions. (7) See Q 127.

The early distribution penalty applicable to qualified retirement plans generally does not apply to distributions from a Section 457 plan, except to the extent that the distribution is attributable to rollovers from a qualified retirement plan or a Section 403(b) plan, for which Section 457 plans are required to separately account (see discussion under "Rollovers," below). (8)

Severance from Employment

A severance from employment occurs when a participant ceases to be employed by the employer sponsoring the plan. (9) An employee will not experience a severance from employment merely because any portion of his benefit is transferred (other than by a rollover or elective transfer) from his former employer's plan to the plan of his new employer. (10)

Under the regulations, an independent contractor is considered to have separated from service upon an expiration of all contracts under which services are performed, if such expiration is considered a good faith and complete termination of the contractual relationship. Good faith is lacking where a renewal of the contractual relationship or the independent contractor becoming an employee is anticipated. (1)

Unforeseeable Emergency

An unforeseeable emergency must be defined in the plan as a severe financial hardship of participants or beneficiaries resulting from illnesses or accidents of the participants or beneficiaries or of their spouses or dependents, the loss of the participants' or beneficiaries' property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond their control. Examples in the regulations include the imminent foreclosure of or eviction from a primary residence or the need to pay for medical or funeral expenses. Whether an event is an unforeseeable emergency will depend upon the relevant facts and circumstances of each case. But a distribution on account of an unforeseeable emergency may not be made where the emergency may be relieved through reimbursement or compensation from insurance or otherwise, by liquidation of a participant's assets if liquidation in itself would not cause severe financial hardship, or cessation of deferrals under the plan. In addition, the distribution must be limited to the amount reasonably necessary to satisfy the emergency need (including amounts necessary to pay taxes or penalties reasonably expected to result from the distribution). (2)

Distributions made at any time on or after August 25, 2005 and before January 1, 2007 by an individual whose principal place of abode on August 28, 2005 was located in the Hurricane Katrina disaster area and who sustained an economic loss by reason of Hurricane Katrina are treated as permissible distributions under IRC Section 457(d)(1)(A). Total distributions under this provision may not exceed $100,000. (3)

A court did find a severe financial hardship where the participant's spouse gave birth to a severely ill child and had to cease working in order to care for such child. (4)

Loans

Any amount received as a loan from an eligible nongovernmental Section 457 plan is treated as a distribution in violation of the distribution requirements. (5) But a facts and circumstances standard is applied to amounts received as loans from an eligible governmental Section 457 plan to determine whether the loan is bona fide and for the exclusive purpose of benefitting participants and beneficiaries. Factors considered include whether the loan has a fixed repayment schedule, a reasonable rate of interest, and repayment safeguards. (6) Such loans are taxed under the rules of IRC Section 72(p) (see Q 433). (7)

Domestic Relations Orders

The qualified domestic relations order (QDRO) rules applicable to qualified plans (see Q 352) also apply to eligible Section 457 plans, so that the IRC Section 457(d) distribution rules are not violated if an eligible Section 457 plan makes a distribution to an alternate payee pursuant to a QDRO. (8)

Required Minimum Distributions

WRERA 2008 provides that RMDs from governmental Section 457 defined contribution plans for calendar year 2009 are waived. Also, the five year rule is determined without regard to 2009.

For distributions after December 31, 2001, an eligible Section 457 plan is generally subject only to the same required minimum distribution rules as apply to qualified retirement plans. (1) These rules generally require a plan to begin distribution of an employee's interest no later than his required beginning date. (2) For a detailed discussion of the rules that apply to qualified retirement plans, see Q 342 through Q 349.

"Required beginning date" generally means April 1 of the calendar year following the later of (1) the year in which the employee attains age 70V2 or (2) the year in which he retires. (3) A special rule applies to a "5% owner" (as defined in IRC Section 416, see Q 360), for whom required beginning date means April 1 of the calendar year following the year in which he attains age 70 1/2. (4) Although this rule technically applies to Section 457 plans maintained by tax-exempt employers (and not to governmental or church plans), as a practical matter, tax-exempt employers are as unlikely as governments and churches to have 5% owners. A Section 457 plan may provide that the required beginning date for all employees is April 1 of the calendar year following the calendar year in which the employee attains age 70 1/2. (5)

Penalty. An excise tax of 50% of the amount by which the required minimum distribution for the year exceeds the amount actually distributed is imposed on the payee. (6) See also Q 350.

Treatment of Plan Assets

Governmental plans. An eligible Section 457 plan of a governmental employer must hold all plan assets and income thereon in a trust, custodial account, or annuity contract for the exclusive benefit of participants and their beneficiaries. This account is exempt from tax under IRC Section 501(a). (7)

Nongovernmental tax-exempt plans. A Section 457 plan of a nongovernmental tax-exempt employer must provide that amounts deferred, all property purchased with those amounts, and the income thereon remain the property of the employer sponsoring the plan, and subject to the claims of its general creditors. (8) The participants may not have a secured interest in property held under such a Section 457 plan. A rabbi trust (see Q 119) may be established without causing such a Section 457 plan to violate this requirement. (9)

Deferral Limits

A Section 457 plan must provide that the annual deferral amount may not exceed the lesser of (1) 100% of includable compensation or (2) the applicable dollar limit. The dollar limit is $16,500 in 2010. (10) The limit was also $16,500 in 2009. In tax years beginning after 2006, cost-of-living adjustments are made in $500 increments. (1) "Annual deferral" is defined to include not only elective salary deferral contributions, but also non-elective employer contributions. (2) The annual deferral amount does not include any rollover amounts received by the plan on behalf of the participant. (3)

Any amount deferred in excess of the Section 457 plan's deferral limits is considered an excess deferral. Likewise, where an individual participates in more than one Section 457 plan, amounts deferred not in excess of the applicable plan's deferral limits, but that nevertheless exceed the individual participant's deferral limit are also considered excess deferrals. (4) Amounts that exceed a governmental Section 457 plan's deferral limits must be distributed to the participant, along with allocable net income, as soon as administratively practicable after the plan determines that the amount constitutes an excess deferral. (5) If a nongovernmental tax-exempt Section 457 plan's deferral limits are exceeded, the plan will be treated as an ineligible plan. (6) For these purposes, all plans in which the individual participates as a result of his relationship with a single employer are treated as a single plan. (7) Where excess deferrals have arisen out of a failure to satisfy the individual deferral limitation, a Section 457 plan may provide that the excess deferral will be distributed as soon as administratively practicable after the plan determines that the amount constitutes an excess deferral. If the Section 457 plan does not distribute the excess deferral, it will not lose its status as an eligible plan, but the participant must include the excess amount in income for the later of (1) the taxable year in which it was deferred or (2) the first taxable year in which there is no longer a substantial risk of forfeiture. (8)

The contribution limits under IRC Section 457 are not coordinated with the IRC Section 402(g) limits on elective deferrals under IRC Section 401(k) plans and IRC Section 403(b) plans. (9)

Example. In 2010, an employee works for a not-for-profit organization sponsoring a Section 457 plan, and "moonlights" as a sales representative for a business sponsoring a 401(k) plan. The employee can defer up to $16,500 under the Section 457 plan and up to $16,500 under the 401(k) plan (prior to 2002, the employee was limited to the maximum deferral amount under the Section 457 plan).

These limitations do not apply to qualified governmental excess benefit arrangements under IRC Section 415(m)(3). (10)

Some employers have avoided the deferral limitations by deliberately failing to satisfy the trust requirements under IRC Section 457(g) - so that the IRS would rule the plan to be an ineligible plan (see Q 127)--while maintaining a substantial risk of forfeiture (Q 113) in order to avoid current taxation. (11)

Compensation. "Includable compensation" has the meaning given to "participant's compensation" by IRC Section 415(c)(3). See Q 334. Includable compensation is determined without regard to community property laws. Compensation is taken into account at its present value in the plan year in which it is deferred (or, if the compensation deferred is subject to a substantial risk of forfeiture, at its present value in the plan year in which such risk is first eliminated). (12)

"Catch-up" Provisions

IRC Section 457 Catch-up Rules. An eligible Section 457 plan can provide for catch-up contributions in one or more of a participant's last three taxable years ending before he attains normal retirement age under the plan. For those years, in addition to the normal limits, a participant may defer a catchup amount equal to the portions of normal deferral limits unused in prior taxable years for which the participant was eligible to participate in the plan. (1) During those years, the limit on deferrals is increased to the lesser of (1) twice the amount of the regularly applicable dollar limit (2 X $16,500 in 2010); or (2) the underutilized limitation. (2) Note that the IRC Section 457 catch-up rules cannot be used for the year in which the participant attains Normal Retirement Age. (3) The underutilized limitation is the sum of (1) the otherwise applicable limit for the year; plus (2) the amount by which the applicable limit in preceding years exceeded the participant's actual deferral for those years. (4) For purposes of determining the underutilized limitation for pre-2002 years, participants remain subject to the rules in effect for those prior years (e.g., includable compensation is reduced by all pre-tax contributions and the previous coordination rules apply.). (5) A participant cannot elect to have the IRC Section 457 catch-up rules apply more than once, even if he failed to use it in all three years before he reached retirement age, and even if he rejoined the plan or participated in another plan after retirement.

For purposes of the IRC Section 457 catch-up rules, the Section 457 plan must generally specify the plan's normal retirement age. Under the regulations, a Section 457 plan may define normal retirement age as any age on or after the earlier of (1) age 65 or (2) the age when participants may retire and receive immediate retirement benefits (without actuarial or other reduction) under the basic defined benefit plan of the government or tax-exempt entity, but in any event, no later than age 70 1/2. A special rule provides that Section 457 plans may permit participants to designate a normal retirement age within these ages instead of designating a normal retirement age. A participant may not have more than one normal retirement age under different plans sponsored by the employer sponsoring the Section 457 plan for purposes of the IRC Section 457 catch-up rules. Plans that include among their participants qualified police or firefighters may designate an earlier normal retirement age for such qualified police and firefighters. (6)

Age 50 Catch-up Rules. An additional catch-up rule applies for eligible Section 457 plans of governmental employers. (7) Additional contributions are allowed for participants who have attained age 50 by the end of the taxable year. (8) (See also Q 400.) All eligible IRC Section 457 governmental plans of an employer are treated as a single plan. (9) The additional amount is the lesser of (1) the applicable dollar amount; or (2) the participant's compensation, reduced by the amount of any other elective deferrals that the participant made for that year. (10)

The applicable dollar amount for eligible IRC Section 457 governmental plans is $5,500 in 2010. (11) The applicable dollar amount was also $5,500 for 2009. The $5,500 limit is indexed for inflation in $500 increments for years beginning after 2006. (12) An individual participating in more than one plan is subject to one annual dollar limit for all catch-up contributions during the taxable year. (1) Catch-up contributions by participants age 50 or over, made under the provisions of IRC Section 414(v), are not subject to any otherwise-applicable limitation of IRC Section 457(b)(2) (determined without regard to IRC Section 457(b)(3)). (2) See Q 400 for additional details on the requirements for the new catch-up contributions.

During the last three years before a participant reaches Normal Retirement Age, the age 50 catch-up rules do not apply if a higher catch-up amount would be permitted under the IRC Section 457 catch-up rules referenced above. Thus, an individual who is eligible for additional deferrals under both the age 50 catch-up and the IRC Section 457 catch-up rules is entitled to the greater of (1) the applicable dollar limit in effect for the plan year plus the age 50 catch-up contribution amount, disregarding the IRC Section 457 catch-up rules or (2) the applicable dollar limit in effect for the plan year plus the contribution amount under the IRC Section 457 catch-up rules, disregarding the age 50 catch-up rules. (3)

Small Distributions and Transfers

If a participant's total distribution is $5,000 or less, the participant may elect to receive such amount (or the Section 457 plan may provide for an involuntary cashout of such amount) if (1) no amount has been deferred by the participant during the 2-year period ending on the date of distribution; and (2) there has been no prior distribution under this provision. (4)

Participants are permitted to make tax-free transfers between eligible Section 457 plans as long as the amounts transferred are not actually or constructively received prior to the transfer. (5) But according to the regulations, plan-to-plan transfers must meet certain requirements and are permitted only from one governmental plan to another, or from one nongovernmental tax-exempt plan to another, not between a governmental plan and a nongovernmental tax-exempt plan. In addition, no direct transfer may be made from a governmental plan to a qualified retirement plan except in the context of a service credit purchase, discussed below. A tax-exempt plan may not directly transfer assets to a qualified retirement plan, and a qualified retirement plan may not directly transfer assets to either a governmental plan or a nongovernmental tax-exempt plan. (6)

Employees that deferred amounts to a Section 457 plan in which they were ineligible to participate cannot transfer such amounts, under IRC Section 457(e)(10), to a Section 457 plan in which they are eligible to participate. (7)

Rollovers

Distributions may be rolled over to and from eligible Section 457 plans of governmental employers under rules similar to those for qualified retirement plans and tax-sheltered annuities. (8) If an eligible Section 457 plan of a governmental employer receives a rollover from a qualified retirement plan or a TSA, it must separately account for such rollover amounts thereafter. (9)

The following rules applicable to rollovers from qualified retirement plans (see Q 455) are also applicable to rollovers to and from eligible Section 457 plans of governmental employers: (1) maximum amount of rollover; (2) 60-day limitation; (3) definition of eligible rollover distribution; (4) sales of distributed property; (5) frozen deposits; (6) surviving spouse rollovers; and (for distributions after December 31, 2006) (7) non-spouse beneficiary rollovers. (1) The direct rollover rules, automatic rollover option, and withholding rules applicable to qualified retirement plans (see Q 457) also apply. (2)

Transfers between eligible Section 457 plans remain the only option for eligible Section 457 plans of nongovernmental tax-exempt organizations. (3)

Service Credit Purchase

In many states, participants may use "permissive service credits" to increase their retirement benefits under the state's defined benefit retirement plan(s). For this purpose, permissive service credit means credit for a period of service that a plan recognizes only if the employee contributes an amount, determined by the plan, that does not exceed the amount necessary to fund the benefit attributable to such period of service. Such contributions must be voluntary and made in addition to regular employee contributions, and are generally subject to the limits of IRC Section 415. (4)

Participants may exclude from income amounts directly transferred (i.e., from trustee to trustee) from a Section 457 plan of a governmental employer to a governmental defined benefit plan in order to purchase permissive service credits. Likewise, a participant may use such directly transferred amounts to repay contributions or earnings that were previously refunded because of a forfeiture of service credit, under either the transferee plan or another Section 457 plan maintained by a governmental employer in the same state. (5)

IRS Rulings

The IRS will issue advance rulings on the tax consequences of unfunded deferred compensation plans only if certain conditions are met (see the discussion under "IRS Rulings" in Q 116); it is not clear whether or to what extent these conditions apply to Section 457 plans. It is clear, though, that the IRS will not issue an advance ruling on the tax consequences of a Section 457 plan to independent contractors, unless all such independent contractors are identified. (6)

For the taxation of amounts deferred under a Section 457 plan, see Q 127.

126. Is the cost of current life insurance protection under a Section 457 plan taxable to participants? Are death benefits under a Section 457 plan excludable from gross income?

If life insurance is purchased with amounts deferred under a Section 457 plan, the cost of current life insurance protection is not taxed to the participant, as long as the employer (1) retains all the incidents of ownership in the policy; (2) is the sole beneficiary under the policy; and (3) is under no obligation to transfer the policy or pass through the proceeds of the policy. (7) See Q 124.

If a Section 457 plan provides a death benefit, any such death benefit will not qualify for exclusion from gross income as life insurance proceeds under IRC Section 101(a). (1) Instead it is to be treated under the deferred compensation rules. (2)

127. How are the participants in an eligible Section 457 plan taxed? In an ineligible plan?

Eligible Governmental Section 457 Plan

Amounts deferred under an eligible governmental Section 457 plan, and any income attributable to such amounts, are includable in the participant's gross income for the taxable year in which they are paid to the participant (or beneficiary). (3)

Unless a taxpayer elects otherwise, any amount of a qualified Hurricane Katrina distribution required to be included in gross income shall be so included ratably over the 3-year taxable period beginning with such year. Qualified Hurricane Katrina distributions are distributions not exceeding $100,000 in the aggregate from qualified retirement plans, individual retirement plans, Section 403(b) tax-sheltered annuities, or eligible governmental Section 457 plans made at any time on or after August 25, 2005 and before January 1, 2007 by an individual whose principal place of abode on August 28, 2005 was located in the Hurricane Katrina disaster area and who sustained an economic loss by reason of Hurricane Katrina. (4)

Eligible Nongovernmental Tax-Exempt Section 457 Plan

Distributions of amounts deferred under eligible Section 457 plans sponsored by nongovernmental tax-exempt organizations are includable in the participant's gross income for the taxable year in which they are made available to the participant (or beneficiary), without regard to whether they have actually been distributed. (5) Such amounts are not considered to be available simply because the participant or beneficiary is permitted to direct the investment of amounts deferred under the plan. (6)

Amounts are generally considered made available and, hence, includable in income as of the earliest date on which the plan permits distributions to be made on or after severance of employment, but not later than the date on which the required minimum distribution rules of IRC Section 401(a)(9) would require commencement of distributions. (7) Plans may provide a period during which participants are permitted to elect to defer the payment of all or a portion of amounts deferred until a fixed or determinable date in the future. This election period must expire before the first time when any amounts deferred are considered made available to the participant. (8) If the participant fails to make this election, the amounts deferred would generally be includable in income when made available as discussed above. Plans may, however, provide for a "default payment schedule" to be used if no election is made, in which case amounts deferred are includable in income for the year in which such amounts are first made available under the default payment schedule. (9) In addition, a plan may provide for a second, one-time election to further defer payment of amounts deferred beyond the initial distribution deferral. Participants may not, however, elect to accelerate commencement of such distributions. Amounts deferred are not treated as available merely because the participant may elect this second deferral. Participants may be permitted to make this second deferral election even if they (1) have previously received a distribution on account of an unforeseeable emergency; (2) have previously received a cash-out distribution of an amount of $5,000 or less; (3) have previously made (or revoked) other elections regarding deferral or mode of payment; or (4) are subject to a default payment schedule deferring the commencement of benefit distribution. (1)

A plan may provide participants with an opportunity to elect among methods ofpayment, provided such election is made before the amounts deferred are to be distributed according to the participant's (or beneficiary's) initial or additional distribution deferral election. If the participant does not make an election regarding the mode of payment, the amounts deferred are included in his gross income when they become available pursuant to either his initial or additional election, unless such amounts are subject to, and includable in income according to, a default payment schedule. (2)

In addition, amounts are not considered made available to a participant or beneficiary solely because a participant or beneficiary may elect to receive a distribution (1) on account of an unforeseeable emergency; or (2) or a cash-out distribution of $5,000 or less. (3)

The use of a rabbi trust in connection with an eligible nongovernmental tax-exempt Section 457 plan should not affect the tax treatment of participants or their beneficiaries. (4)

Ineligible Section 457 Plan

As a general rule, compensation deferred under an ineligible Section 457 plan is includable in gross income in the first taxable year during which it is not subject to a "substantial risk of forfeiture." (5) See Q 113.Where no substantial risk of forfeiture exists in the initial year of deferral, all compensation deferred under the plan must be included in the participant's gross income for that year.

A participant's right to deferred compensation under an ineligible Section 457 plan is subject to a substantial risk of forfeiture if it is conditioned on the future performance of substantial services by any individual. (6) Distributions from an ineligible plan are taxed according to the annuity rules. (7) Property (including an insurance contract or annuity) distributed from an ineligible plan is includable in gross income at its fair market value. (8) Once the annuity contract has been distributed, payments or withdrawals from that contract may be subject to the "interest first" rule. See Q 3, Q 251.

Prior to the issuance of regulations, it was not entirely clear when earnings on compensation deferred under an ineligible plan would be includable in gross income. The regulations provide that if amounts deferred are subject to a substantial risk of forfeiture, then the amount includable in gross income for the first taxable year in which there is no substantial risk of forfeiture includes earnings up to the date of the lapse. Earnings accruing after the date of the lapse are not includable in gross income until paid or otherwise made available, provided that the participant's (or beneficiary's) interest in any assets of the employer is not senior to that of the employer's general creditors. (9)

These rules pertaining to the tax treatment of ineligible Section 457 plans do not extend to (1) any plan qualified under IRC Section 401, IRC Section 403, or IRC Section 415(m); (2) that portion of any plan which consists of a nonexempt trust to which IRC Section 402(b) applies; and (3) any transfer of property to which IRC Section 83 applies. (1) The regulations clarify that these provisions do not apply if the IRC Section 83 transfer occurs before the lapse of a substantial risk of forfeiture applicable to amounts deferred under an ineligible plan. If, on the other hand, the IRC Section 83 transfer occurs after the lapse of a substantial risk of forfeiture, the provisions do apply. If such property is includable in income under IRC Section 457(f) upon the lapse of a substantial risk of forfeiture, then when the property is later made available to the participant, the amount includable is the excess of the value of the property when made available, over the amount previously included in income upon the lapse. (2) This section does not apply to an option that (1) has no readily ascertainable fair market value (as defined in IRC Section 83(e)(3)); and (2) was granted on or before May 8, 2002. (3)

If a plan ceases to be an eligible governmental plan, amounts subsequently deferred by participants will be includable in income when deferred, or, if later, when the amounts deferred cease to be subject to a substantial risk of forfeiture. Amounts deferred before the date on which the plan ceases to be an eligible governmental plan, and any earnings thereon, will be treated as if the plan continues to be an eligible governmental plan and, thus, will not be includable in income until paid to the participant or beneficiary. (4)

Rulings on Ineligible Plans

The creation of a rabbi trust in connection with an ineligible Section 457 plan does not affect the tax treatment of amounts deferred thereunder. (5)

The right to designate "deemed" investments in an ineligible Section 457 plan will not result in current taxation under the constructive receipt doctrine (see Q 116), the economic benefit doctrine (see Q 117), or on account of a transfer of property under IRC Section 83. (6)

A Section 457 plan established to provide additional benefits for an employee on an extended leave of absence was an ineligible plan, because it was unfunded and no trust was established (as would otherwise be required by IRC Section 457(g)), and because a settlement agreement called for deferrals in excess of the IRC Section 457(b) maximum amount. The IRS found that a plan provision requiring service of the participant (then age 44) until age 50 was a substantial risk of forfeiture. (7)

Reporting and Withholding

Annual Reporting. Deferrals under an eligible Section 457 plan (and earnings thereon) are not subject to withholding when deferred, but they must be reported annually on the participant's Form W-2 (according to the Form W-2 instructions). (8)

Income Tax Withholding. Payments from Section 457 plans are wages subject to regular income tax withholding, not under the withholding rules that apply to pensions. (9)

Employers are generally liable for withholding from Section 457 plan distributions. If a trustee (or custodian or insurance carrier treated as a trustee) of a governmental plan makes distributions from such plan's trust or custodial account, then that person is responsible for withholding income tax and reporting the distributions. (1)

FICA and FUTA. Amounts deferred under both eligible and ineligible 457 plans are generally subject to social security taxes under the Federal Insurance Contributions Act (FICA) and federal unemployment taxes under the Federal Unemployment Tax Act (FUTA) at the later of (1) the date when the services are performed; or (2) the date when the employee's right to such amounts is no longer subject to a substantial risk of forfeiture (see Q 113). (2) For more detail on the application of FICA and FUTA taxes to deferred compensation, see Q 123.

Service performed in the employ of a state or political subdivision thereof is exempt from FUTA, and may also be exempt from FICA. (3)

Length of service awards from an eligible employer accruing to bona fide volunteers (or their beneficiaries) due to "qualified services" after December 31, 1996, which are exempted from the Section 457 plan requirements (see Q 124, Q 125) and maintained by an eligible employer are not considered "wages" for FICA purposes. (4)

Plans for State Judges

128. What rules apply to nonqualified deferred compensation plans covering state judges?

A nonqualified deferred compensation plan covering state judges is taxed under the rules applicable to funded and unfunded nonqualified deferred compensation plans if (1) the plan has been continuously in existence since December 31, 1978; (2) the plan requires all eligible judges to participate and contribute the same fixed percentage of their basic or regular compensation; (3) the plan provides no judge with an option as to contributions or benefits, which, if exercised, would affect the amount of his includable compensation; (4) retirement benefits under the plan are a percentage of the compensation of judges holding similar positions in the state; and (5) benefits paid to any participant in any year do not exceed the limitation of IRC Section 415(b) (see Q 335). (5)

Excess Benefit Plans

129. What is an excess benefit plan? How is it taxed?

ERISA Section 3(36) defines an "excess benefit" plan as a nonqualified plan maintained by an employer solely for the purpose of providing benefits for certain employees in excess of the limitations on contributions and benefits imposed by IRC Section 415 (see Q 335). ERISA Section 3(36) has never been amended to include the limitations on compensation imposed by IRC Section 401(a)(17) ($245,000 in 2010). If an excess benefit plan cannot restore these benefits, its usefulness is limited. One case seems to indicate that an excess benefit plan can replace benefits limited by IRC Section 401(a)(17), provided that the plan was never amended to take the 401(a)(17) limits into account.6 On the other hand, a Supplemental Executive Retirement Plan (SERP) (see Q 115) intended as an excess benefit plan was held to be a top hat plan (see Q 116) because it was not specifically limited to restoring benefits lost under IRC Section 415. (7)

An excess benefit plan can be funded or unfunded. If it is unfunded, an excess benefit plan need not comply with any of ERISA's requirements. Even if it is funded, an excess benefit plan is exempt from ERISA's minimum participation, vesting, funding, and plan termination insurance provisions. (1)

In contrast to the special treatment afforded by ERISA, excess benefit plans remain subject to the tax rules applicable to deferred compensation plans. See, generally, Q 111. The employer's deduction is deferred until amounts are includable in the employee's gross income, and the employee is generally taxed upon payments when they are received. See Q 111, Q 121.

"Qualified governmental excess benefit arrangements" are excess benefit plans maintained by state and local governmental employers. The requirements for such plans are set forth in IRC Section 415(m). (2) For a discussion of the interaction between IRC Section 415(m) and IRC Section 457, see Q 125.

Employee Stock Options

130. What are employee stock options and how are they taxed?

An employee stock option gives an employee the right to buy a certain number of shares in the employer's corporation at a fixed price within a specified period of time. The price at which the option is offered is called the "grant" price and is usually at or below the stock's current market value. It is assumed that the stock will increase in value, allowing the employee to profit by the difference. Should the stock price decrease below the grant price, the option is "underwater" and the employee simply does not "exercise" the option to purchase the stock; he is not at risk for out-of-pocket losses.

There are two principal kinds of stock option programs, each with unique rules and tax consequences: "qualified" or "incentive stock options" (ISOs), sometimes also referred to as "statutory stock options," and non-qualified stock options (NQSOs), sometimes also referred to as "nonstatutory stock options." But some executive plans, use performance-based options, which provide that the option holder will not realize any value from the option unless specified conditions are met, such as the share price exceeding a certain value above the grant price, or the company outperforming the industry. Performance-based plans can require special plan accounting.

ISOs

For a stock option to qualify as an ISO (and thus receive special tax treatment under IRC Section 421(a)), it must meet the requirements of IRC Section 422 when granted and at all times from the grant until its exercise. The key requirements are that an ISO have an exercise price not less than the fair market value of the stock at the time of the grant, expire within no more than 10 years, and be generally nontransferable and exercisable only by the grantee. (3)

Tax Implications for Employee

An employee receiving an ISO realizes no income upon its receipt or exercise. (4) Instead, the employee is taxed when he disposes of the stock acquired with the ISO.

Disposition generally means any sale, exchange, gift, or transfer of legal title of stock. It does not include a transfer from a decedent to his estate, a transfer by a bequest or inheritance, or any transfer of ISO stock between spouses or incident to a divorce. (5)

The tax treatment of the disposition of ISO stock depends upon whether it was disposed of within the statutory holding period for ISO stock. The ISO statutory holding period is the later of two years from the date of the grant or one year from the date when the shares were transferred to the employee upon exercise. (1)

If the employee disposes of the stock within the holding period, he first recognizes ordinary income, measured by the difference between the option price and the fair market value of the stock at the time of exercise, and second, capital gain measured by the difference between the fair market value of the stock at exercise and the proceeds of the sale. (2) When an employee disposes of ISO stock after the holding period, all of the gain is capital gain, measured by the difference between the option price and the sale proceeds. (3)

Although the exercise of an ISO does not result in an immediate taxable event, any deferred gain is includable as an adjustment in calculating the Alternative Minimum Tax (AMT). See Q 829.

Tax Implications For Employer

An employer granting an ISO is not entitled to a deduction with respect to the option upon its grant or its exercise. (4) The amount received by the employer as the exercise price will be considered the amount received by the employer for the transfer of the ISO stock. (5) If the employee disposes of the stock prior to the end of the requisite holding period, the employer may generally take a deduction for the amount that the employee recognized as ordinary income in the same year in which the employee recognizes the income. (6)

Reporting and Withholding

The employer has no obligation to pay FICA or FUTA taxes, or to withhold federal income taxes when an option is granted. Pending further guidance from the IRS, employers are also not obligated to pay or withhold FICA and FUTA taxes upon the exercise of ISOs. (7) The IRS has announced that any rule imposing FICA or FUTA upon the exercise of ISOs will not take effect before January 1st following the second anniversary of the announcement.

IRC Section 6039 requires employers to provide a written statement to each employee regarding any exercise of an ISO and, beginning for transfers occurring in 2009 or later, to file a similar information return with the IRS by January 31 of the year following the transfer. (8) Under proposed regulations, the information return must identify the parties and provide the following information:

* the date the option was granted,

* the exercise price per share,

* the date the option was exercised,

* the fair market value of a share on the date of exercise, and

* the number of shares transferred pursuant to the exercise.

NQSOs

An NQSO is generally an option to purchase employer stock that does not satisfy the legal requirements of an ISO.

Tax Implications for Employee

The tax implications of an NQSO are governed by IRC Section 83. Generally, an employee is not taxed on an NQSO at grant unless it has a readily ascertainable fair market value and is not subject to a substantial risk of forfeiture. (1) Options generally do not have a readily ascertainable fair market value unless they are publicly traded. (2) If an NQSO does not have a readily ascertainable fair market value at grant, it is taxed at the time of exercise. (3) If an NQSO with a readily ascertainable fair market value is subject to a substantial risk of forfeiture, it is taxed when the risk of forfeiture lapses. When taxed, the employee will recognize the excess of the market value of shares receivable over the grant price as ordinary income subject to FICA, FUTA, and federal income tax. (4)

Within 30 days of the grant of an NQSO subject to a substantial risk of forfeiture, an employee may elect under IRC Section 83(b) to be taxed currently on the fair market value of the option. Any appreciation after the election is taxable as a capital gain. If the NQSO is ultimately forfeited, no deduction is allowed for that forfeiture. (5)

Tax Implications for Employer

The employer has a corresponding deduction (in the same amount and at the same time) as the ordinary income recognized by the employee. (6) In general, compensation paid in the form of stock options normally triggers the receipt of wages for the purpose of employment tax and withholding provisions in the amount of the income generated under IRC Section 83(a). (7)

Deferred Compensation

NQSOs exercisable at less than the fair market value at the date of grant will be subject to the rules governing deferred compensation plans under IRC Section 409A. See Q 116.Where the exercise price can never be less than the fair market value of the underlying stock at the date of grant, and where there is no other feature for the deferral of compensation, a stock option will not constitute deferred compensation subject to IRC Section 409A. (8) Plans could generally substitute non-discounted stock options and stock appreciation rights for discounted options and rights until December 31, 2007. (9) See Q 116 for exceptions.

Under a prior ruling, stock options could be "converted" to a deferred compensation plan free of tax under limited circumstances. Where employees could choose to retain or surrender both ISOs and NQSOs in exchange for an initial deferral amount under a nonqualified deferred compensation plan, the IRS indicated that neither the opportunity to surrender the options, nor their actual surrender, would create taxable income for participants under either the constructive receipt or economic benefit doctrines. (10) For a discussion of the theories of constructive receipt and economic benefit, see Q 116 and Q 117, respectively.

Reporting and Withholding

The employer has no obligation to pay employment taxes or to withhold federal income taxes upon the grant of NQSOs. Upon exercise, the employer must treat the excess of the market value of shares received over the grant price as wages subject to FICA, FUTA, and federal income tax withholding in the pay period in which the income arises. The employer has no obligation to withhold or pay federal income or employment taxes upon the sale of shares purchased by option.

Employers are to use code "V" in box 12 on FormW-2 to identify the amount of compensation to be included in an employee's wages in connection with the exercise of an employer-provided NQSO. Completion of codeV is addressed in the instructions for FormsW-2 andW-3. Employers must report the excess of the fair market value of the stock received upon exercise of the option over the amount paid for that stock on Form W-2 in boxes 1, 3 (up to the social security wage base), 5, and 12 (using code V) when an employee (or former employee) exercises his options. (1)

Department of Labor Issues

Generally speaking, an ISO is not subject to ERISA's reporting requirements and a summary plan description need not be distributed to participants. But the employer must furnish a statement to the employee on or before January 31st of the year following the year in which he exercises the ISO, stating details about the options granted. (2)

131. What is restricted stock?

A restricted stock award is an outright grant of shares by a company to an individual, usually an employee, without any payment by the recipient (or for only a nominal payment). Generally, the shares of stock are subject to a contractual provision under which the granting company has the right (but not the obligation) to repurchase or reacquire the shares from the recipient upon the occurrence of a specified event (e.g., termination of employment). This right of repurchase or reacquisition expires after a specified period of time, either all at once or in increments (for example, a grant of 1,000 shares with 200 shares vesting annually over a five-year period). The expiration of this right is referred to as "vesting." During the period that the shares of stock may be repurchased or reacquired, the recipient is prohibited from selling (or otherwise transferring) the shares. This is why the shares are called "restricted stock." Although the passage of time typically serves as the primary restriction for such stock, vesting may depend on restrictions other than time (e.g., satisfying corporate performance goals, such as reaching a specified level of profitability.)

For the tax treatment of restricted stock (including the taxability of dividends on restricted stock), see Q 132.

132. How is restricted stock taxed? How are dividends on restricted stock taxed?

The tax implications of restricted stock are governed by IRC Section 83. In general, restricted stock does not constitute taxable income to the employee at the time it is granted (unless it is "substantially vested," see below, upon grant). An employee who receives restricted stock must include the fair market value of that stock in his income in the year the stock becomes "substantially vested." The amount the employee paid for the restricted stock, if any, must be subtracted from this amount. Restricted stock becomes substantially vested in the year in which (1) the stock becomes transferable or (2) the stock is no longer subject to a substantial risk of forfeiture. (3)

Within 30 days of receiving the restricted stock, an employee may elect under IRC Section 83(b) to be taxed on the fair market value of the stock currently rather than the year the stock becomes substantially vested. Any appreciation after the election is taxable as a capital gain. But if the restricted stock is ultimately forfeited, no deduction is allowed for that forfeiture. (1)

Where restricted stock that is substantially vested is subjected to new restrictions that cause it to be come substantially nonvested, the stock is not subject to IRC Section 83(b) in the absence of an exchange of stock. But where substantially vested stock is exchanged for substantially nonvested stock, the new restricted stock is subject to IRC Section 83(b). (2)

The employer has a corresponding deduction, in the same amount and at the same time, as the ordinary income recognized by the employee.3 In general, compensation paid in the form of restricted stock normally triggers the receipt of wages for the purpose of employment tax and withholding provisions in the amount of the income generated under IRC Section 83(a). (4)

Dividends received on restricted stock are extra compensation to the employee. The employer includes these payments on the employee's FormW-2.With respect to dividends received on restricted stock that the employee choses to include in his income in the year transferred, such dividends are treated the same as any other dividends. The employee should receive a Form 1099-DIV showing these dividends. These dividends should not be included in the employee's wages on his income tax return; instead, the employee should report them as dividends.

Planning Point: Employers should use great care in making any modifications to existing deferred compensation arrangements in order to avoid unexpected application of IRC Section 409A. According to the final regulations, a material modification may be a formal plan amendment or may occur simply by virtue of an employer's exercise of discretion in the plan participant's favor.

Planning Point: The American Jobs Creation Act of 2004 has called into question many prior decisions and rulings in the deferred compensation arena. Employers and employees should exercise caution in structuring deferred compensation plans, especially using rabbi trusts and other informal funding mechanisms.

(1.) IRC Sec. 280G(b)(4); Treas. Reg. [section] 1.280G-1, Q&A 40-44.

(2.) See IRC Secs. 402(b)(1), 403(c), 83(a); Treas. Regs. [section] [section] 1.402(b)-1(a)(1), 1.403(c)-1(a), 1.83-1(a)(1), 1.83-3(b), 1.83-3(d).

(3.) U.S. v. Basye, 410 U.S. 441 (1973).

(1.) See Temp. Treas. Reg. [section] 35.3405-1T, A-18; Let. Rul. 9417013.

(2.) See IRC Secs. 402(b)(1), 403(c), 83(a); Treas. Regs. [section] [section] 1.402(b)-1(b), 1.403(c)-1(b).

(3.) Treas. Regs. [section] [section] 1.402(b)-1(b)(4), 1.403(c)-1(b)(3).

(4.) Treas. Reg. [section] 1.402(b)-1(b)(1).

(5.) See IRC Sec. 402(b)(4).

(6.) See IRC Secs. 402(b) and 403(b), prior to amendment by P.L. 91-172 (TRA '69).

(7.) Treas. Regs. [section] [section] 1.402(b)-1(d), 1.403(c)-1(d).

(8.) Let. Rul. 9713006.

(9.) IRC Sec. 404(a)(5); Treas. Regs.[section] [section] 1.404(a)-1(c).

(10.) See Treas. Reg. [section] 1.404(a)-12(b)(1).

(11.) Treas. Reg.[section] 1.404(a)-12(b)(3).

(1.) Treas. Reg. [section] 1.404(a)-12(c).

(2.) IRC Sec. 404(d); Temp. Treas. Reg. [section] 1.404(d)-1T.

(3.) IRC Sec. 72(u). See also H.R. Rep. 99-426 (TRA '86), reprinted in 1986-3 CB (vol. 2) 703, 704; the General Explanation of TRA '86, at 658.

(4.) See, e.g., Let. Rul. 9302017.

(5.) Prop. Treas. Reg. [section] 1.671-1(g).

(6.) Teget v. U.S., 552 F.2d 236, 77-1 USTC [paragraph] 9315 (8th Cir. 1977).

(7.) See ERISA Sec. 201.

(8.) Temp. Treas. Reg. [section] 1.404(b)-1T, A-2.

(9.) IRC Sec. 404(a)(11).

(1.) See IRSRRA '98, Sec. 7001, H.R. Conf. Rep. No. 105-599.

(2.) 107 TC 271 (1996).

(3.) See Rev. Proc. 99-26, 1999-1 CB 1244.

(4.) See Notice 99-16, 1999-1 CB 501.

(5.) See Let. Ruls. 9502030, 9302017, 9212024, 9212019, 9207010, 9206009.

(6.) Treas. Reg. [section] 1.402(b)-1(a)(1).

(7.) See IRC Sec. 402(b)(1); Treas. Regs. [section] [section] 1.402(b)-1(b)(1), 1.402(b)-1(b)(4).

(8.) See Treas. Regs. [section] [section] 1.402(b)-1(a)(1), 1.83-3(b).

(1.) See Let. Ruls. 9502030, 9417013, 9302017, 9212024, 9212019, 9207010.

(2.) See Let. Ruls. 9502030, 9212024, 9212019.

(3.) See Let. Ruls. 9548015, 9548014. See also Let. Rul. 9450004 (employee who could keep or contribute cash to trust was currently taxable on amounts contributed, although keeping cash would jeopardize future contributions and benefits).

(4.) See Let. Ruls. 9322011, 9316018.

(5.) See Let. Ruls. 9502030, 9417013, 9302017, 9212024, 9212019.

(6.) See Treas. Reg. [section] 1.404(a)-12(b)(1); Let. Ruls. 9502030, 9417013, 9302017, 9212024, 9212019.

(7.) See Let. Rul. 9302017.

(1.) Treas. Reg. [section] 1.404(a)-12(b)(3); Let. Ruls. 9502030, 9302017, 9212024.

(2.) See Let. Ruls. 9548015, 9548014. See also Let. Rul. 9450004 (employer allowed immediate deduction where employee could keep or contribute cash to employee-funded trust).

(3.) See Let. Ruls. 9502030, 9417013, 9302017, 9212024.

(4.) Prop. Treas. Reg. [section] 1.671-1(g) (employer not treated as an owner of any portion of a domestic, nonexempt employees' trust under IRC Section 402(b) if part of a deferred compensation plan, regardless of whether the employer has power of interest described in IRC Section 673 through IRC Section 677).

(5.) See Let. Ruls. 9548015, 9548014, 9450004. Compare Let. Rul. 9620005 (group of secular trusts, each with a separate employee grantor, pooled investment resources together to form a master trust, will be taxed as a partnership, thereby avoiding double taxation applicable to corporations).

(6.) See, e.g., Dependahl v. Falstaff Brewing Corp., 653 F.2d 1208 (8th Cir. 1981) (plan is funded when employee can look to property separate from employer's ordinary assets for satisfaction of benefit obligations), affg in part 491 F. Supp. 1188 (E.D. Mo. 1980), cert. denied, 454 U.S. 968 (1981) and 454 U.S. 1084 (1981).

(1.) IRC Sec. 83(c)(1); Treas. Reg. [section] 1.83-3(c)(1).

(2.) Treas. Reg. [section] 1.83-3(c)(1).

(3.) Treas. Reg. [section] 1.83-3(c)(2).

(4.) See Treas. Reg. [section] 1.83-3(c)(4), Ex. 1 and Ex. 3.

(5.) Treas. Reg. [section] 1.83-3(c)(2).

(6.) TAM 199902032.

(7.) Treas. Reg. [section] 1.83-3(c)(2); see also Let. Ruls. 9548015, 9548014.

(8.) Treas. Reg. [section] 1.83-3(c)(2).

(9.) See Rev. Rul. 75-448, 1975-2 CB 55.

(10.) See Let. Rul. 9431021; but compare Let. Rul. 9215019 (where employer could accelerate vesting of employee's benefits under an IRC Section 457 plan anytime on or after three years of service under the plan, employee's benefits would not appear to be subject to a substantial risk of forfeiture after three years; existence of such risk is a question of fact).

(1.) See Treas. Reg. [section] 1.83-3(c)(3). Compare Ludden v. Comm., 68 TC 826 (1977) (possibility of forfeiture did not amount to a substantial risk of forfeiture because there was too little chance that the shareholder-employees would cause themselves to be fired), affd on other grounds, 620 F.2d 700, 45 AFTR 2d 80-1068 (9th Cir. 1980).

(2.) Let. Rul. 9431021.

(3.) IRC Sec. 403(c).

(4.) Let. Rul. 7728042.

(5.) IRC Sec. 402(b)(2).

(6.) Treas. Reg. [section] 1.402(b)-1(c)(2).

(7.) See Let. Ruls. 9502030, 9417013.

(8.) Treas. Reg. [section] 1.402(b)-1(c)(1).

(1.) See, e.g., Rev. Rul. 60-31, 1960-1 CB 174, as modified by Rev. Rul. 70-435, 1970-2 CB 100.

(2.) Rev. Rul. 71-419, 1971-2 CB 220.

(3.) See Rev. Rul. 69-50, 1969-1 CB 140, as amplified in Rev. Rul. 77-420, 1977-2 CB 172 (deferral of physicians' payments from Blue Shield type organization ineffective); TAM 9336001 (deferral of plaintiffs' attorney's fees under structured settlement with defendants' liability insurers ineffective); contra Childs v. Comm., 103 TC 634 (1994), affd, 89 F.3d 856 (11th Cir. 1996) (deferral of plaintiffs' attorneys' fees under structured settlement with defendant's liability insurers effective).

(4.) See Rev. Rul. 69-650, 1969-2 CB 106.

(5.) Notice 2009-49, 2009-25 IRB 1093.

(6.) IRC Sec. 409A(a)(2)(A); Treas. Reg. [section] 1.409A-3.

(1.) IRC Sec. 409A(a)(2)(B)(i).

(2.) Treas. Reg. [section] 1.409A-3(i)(5).

(3.) Treas. Reg. [section] 1.409A-3(i)(3).

(4.) IRC Sec. 409A(a)(4)(B)(i).

(5.) IRC Sec. 409A(a)(4)(B); Treas. Reg. [section] 1.409A-2.

(6.) IRC Sec. 409A(a)(4)(C); Treas. Reg. [section] 1.409A-2(b).

(7.) Treas. Reg. [section] 1.409A-2(b)(2).

(1.) See IRC Section 1043.

(2.) Treas. Reg. [section] 1.409A-3(a).

(3.) Treas. Reg. [section] 1.409A-1(b)(4).

(4.) Treas. Reg. [section] 1.409A-1(f)(2).

(5.) IRC Secs. 6041, 6051.

(6.) Notice 2006-100, 2006-51 IRB 1109.

(1.) IRC Sec. 409A(a)(1)(A)(i).

(2.) IRC Sec. 409A(a)(1)(B).

(3.) Notice 2007-86, 2007-46 IRB 990; Notice 2006-79, 2006-43 IRB 763.

(4.) Treas. Reg. [section] 1.409A-6(a)(4).

(5.) IRC Sec. 457A(d)(1)(A).

(6.) IRC Sec. 457A(b).

(7.) IRC Sec. 457A(d)(2).

(1.) IRC Sec. 457A(d)(3)(A).

(2.) IRC Sec. 457A(d)(3)(B).

(3.) IRC Sec. 457A(c).

(4.) See Treas. Regs. [section] [section] 1.451-1, 1.451-2.

(5.) Rev. Rul. 60-31, 1960-1 CB 174, as modified by Rev. Rul. 70-435, 1970-2 CB 100.

(6.) IRC Sec. 409A(a)(4).

(7.) See also Let. Rul. 9336001 (election to defer must be made before earning compensation to avoid constructive receipt); Rev. Proc. 71-19, 1971-1 CB 698, as amplified by Rev. Proc. 92-65, 1992-2 CB 428.

(8.) See Let. Rul. 9506008.

(1.) See also Let. Rul. 9525031.

(2.) See Martin v. Comm., 96 TC 814 (1991). See also Childs v. Comm., 103 TC 634 (1994), aff'd, 89 F.3d 856 (11th Cir. 1996); Oates v. Comm., 18 TC 570 (1952), aff'd, 207 F.2d 711 (7th Cir. 1953), acq., 1960-1 CB 5; Veit v. Comm., 8 TCM 919 (1949); Veit v. Comm., 8 TC 809 (1947), acq., 1947-2 CB 4.

(3.) See, e.g., TAM 8828004.

(4.) See Rev. Proc. 2008-3, Sec. 3.01(43), 2008-1 IRB 110.

(5.) See, e.g., Carnahan v. Comm.,TC Memo 1994-163 (controlling shareholder's power to withdraw corporate funds is not sufficient to cause constructive receipt), affd without opinion, 95-2 USTC [paragraph] 50,592 (D.C. Cir. 1995).

(6.) Rev. Proc. 2009-3 2009-1 IRB 107, 2008-1 IRB 110.

(1.) Rev. Proc. 2009-3, Sec. 3.01(42), 2009-1 IRB 107; Rev. Proc. 71-19, 1971-1 CB 698, as amplified by Rev. Proc. 92-65, 1992-2 CB 428.

(2.) Let. Rul. 9436051.

(3.) See ERISA Secs. 4(b), 201, 301, 401, 4021.

(4.) ERISA Sec. 201(2).

(5.) See, e.g., Demery v. Extebank, 216 F.3d 283 (2d Cir. 2000) ("select group" requirement was met where plan was offered to 15.34% of employees, since they were all either management or highly compensated employees).

(6.) Carrabba v. Randalls FoodMkts, Inc., 252 F.3d 721 (5th Cir. 2001), cert. denied, 26 EBC 2920 (US Sup. Ct. 2001).

(7.) 489 U.S. 101 (1989).

(8.) Goldstein v. Johnson & Johnson, 251 F.3d. 433 (3d Cir. 2001).

(9.) Garratt v. Knowles, 245 F.3d 941 (7th Cir. 2001).

(1.) Let. Rul. 2001116406.

(2.) See, e.g., Sproullv. Comm., 16 TC 244 (1951), aff'd per curiam, 194 F.2d 541 (6th Cir. 1952); Rev. Rul. 60-31, sit. 4, 1960-1 CB 174.

(3.) Rev. Rul. 60-31, 1960-1 CB 174, 177.

(4.) See Minor v. U.S., 772 F.2d 1472, 85-2 USTC [paragraph] 9717 (9th Cir. 1985).

(5.) Cf. Treas. Reg. [section] 1.83-3(e).

(6.) See, e.g., Casale v. Comm., 247 F.2d 440 (2d Cir. 1957) (the Service has said it will follow this decision, Rev. Rul. 59- 184, 1959-1 CB 65); Rev. Rul. 72-25, 1972-1 CB 127; Rev. Rul. 68-99, 1968-1 CB 193; TAM 8828004; Rev. Rul. 60- 31, 1960-1 CB 174.

(7.) Goldsmith v. U.S., 586 F.2d 810, 78-2 USTC [paragraph] 9804 (Ct. Cl. 1978).

(8.) See, e.g., Let. Ruls. 9517019, 9510009, 9505012, 9504006, 9427018, 9403016, 9347012, 9323025, 9309017, 9142020.

(1.) See, e.g., Minor v. U.S., 772 F.2d 1472, 85-2 USTC [paragraph] 9717 (9th Cir. 1985); see also McAllister v. Resolution Trust Corp., 201 F.3d 570 (5th Cir. 2000); Goodman v. Resolution Trust Corp., 7 F.3d 1123 (4th Cir. 1993).

(2.) See Let. Ruls. 8901041, 8509023.

(3.) See, e.g., Rev. Rul. 72-25, 1972-1 CB 127 (annuity contract); Rev. Rul. 68-99, 1968-1 CB 193 (life insurance).

(4.) See Childs v. Comm., 103 TC 634 (1994), aff'd, 89 F.3d 856 (11th Cir. 1996).

(5.) IRC Sec. 409A(b)(2); Notice 2006-33, 2006-15 IRB 754.

(6.) IRC Sec. 409A(b)(5).

(7.) IRC Sec. 409A(b)(1); Notice 2006-33, 2006-15 IRB 754.

(8.) IRC Sec. 409A(b)(5).

(9.) Notice 2006-33, 2006-15 IRB 754.

(10.) IRC Secs. 409A(b)(3), 409A(b)(5).

(1.) See Dependahl v. Falstaff Brewing Corp., 491 F. Supp. 1188 (E.D. Mo. 1980), aff'd in part, 653 F.2d 1208 (8th Cir. 1981), cert. denied, 454 U.S. 968 (1981) and 454 U.S. 1084 (1981).

(2.) See Belsky v. First Natl Life Ins. Co., 818 F.2d 661 (8th Cir. 1987).

(3.) For courts finding plans backed by life insurance or annuities to be unfunded, see Reliable Home Health Care Inc. v. Union Central Ins. Co., 295 F.3d 505 (5th Cir. 2002); Miller v. Heller, 915 F. Supp. 651 (S.D.N.Y. 1996); The Northwestern Mut. Ins. Co. v. Resolution Trust Corp., 848 F. Supp. 1515 (N.D. Ala. 1994); Darden v. Nationwide Mut. Life Ins. Co., 717 F. Supp. 388 (E.D.N.C. 1989), aff'd, 922 F.2d 203 (4th Cir.), cert. denied, 502 U.S. 906 (1991); Belka v. Rowe Furniture Corp., 571 F. Supp. 1249 (D. Md. 1983).

(4.) See DOL Adv. 92-22A (cash value element of split dollar life insurance policy under death benefit plan is not a plan asset); DOL Adv. Op. 92-02A (stop-loss insurance policy backing medical expense plan obligations is not plan asset of death benefit plan); DOL Adv. Op. 81-11A (corporate-owned life insurance is not plan asset of death benefit plan).

(5.) DOL Adv. Op. 94-31A.

(6.) But see Miller v. Heller, 915 F. Supp. 651 (S.D.N.Y. 1996) (in holding that a deferred compensation plan is an unfunded top hat plan, the court interpreted footnote three in Advisory Opinion 94-31A to mean that the DOL's entire analysis for determining whether assets are plan assets is not relevant to the issue of whether the plan is funded).

(7.) See, e.g., DOL Adv. Op. 92-13A. See also DOL Adv. Op. 90-14A (great deference is given to the position of the IRS regarding deferred compensation plans when determining, for ERISA purposes, whether a top hat plan is funded).

(8.) Centre v. Comm., 55 TC 16 (1970); Morse v. Comm., 17 TC 1244 (1952), aff'd, 202 F.2d 69 (2nd Cir. 1953). See Treas. Reg. [section] 1.83-3(e).

(9.) IRC Sec. 264(a)(1).

(10.) IRC Secs. 56-59.

(1.) Casale v. Comm., 247 F.2d 440 (2nd Cir. 1957) (the IRS has said it will follow this decision, Rev. Rul. 59-184, 1959-1 CB 65); Rev. Rul. 72-25, 1972-1 CB 127; Rev. Rul. 68-99, 1968-1 CB 193; Let. Ruls. 8607032, 8607031; TAM 8828004. See also Let. Rul. 9122019. But see Goldsmith v. U.S., 586 F.2d 810, 78-2 USTC [paragraph] 9804 (Ct. Cl. 1978) discussed in Q117.

(2.) Frost v. Comm., 52 TC 89 (1969).

(3.) IRC Sec. 72(u).

(4.) See Let. Rul. 8406012.

(5.) Let. Rul. 9241006.

(6.) See Let. Rul. 9344038.

(7.) See Let. Ruls. 8906022, 8741078. See also Berry v. U.S., 593 F. Supp. 80 (M.D.N.C. 1984), affdper curiam, 760 F.2d 85 (4th Cir. 1985) (a guarantee does not make a promise secured, because the guarantee is itself a mere promise to pay); Childs v. Comm., 103 TC 634 (1994) (same), aff'd, 89 F.3d 856 (11th Cir. 1996).

(8.) TAM 9336001.

(9.) Let. Rul. 8406012.

(10.) Let. Rul. 9331006.

(1.) Let. Rul. 9443006.

(2.) See Rev. Rul. 69-50, 1969-1 CB 140, as amplified in Rev. Rul. 77-420, 1977-2 CB 172; TAM 9336001.

(3.) See Childs v. Comm., 103 TC 634 (1994), aff'd, 89 F.3d 856 (11th Cir. 1996).

(4.) See McAllister v. Resolution Trust Corp. 201 F.3d 570 (5th Cir. 2000); Goodman v. Resolution Trust Corp. 7 F.3d 1123 (4th Cir. 1993) (both underscoring that beneficiaries of rabbi trusts take the risk of trust assets being subject to the claims of the employer's general creditors for the benefit of favorable tax treatment).

(5.) See Let. Rul. 8113017.

(6.) IRC Sec. 409A(b)(2); Notice 2006-33, 2006-15 IRB 754.

(7.) IRC Sec. 409A(b)(4).

(8.) IRC Sec. 409A(b)(1); Notice 2006-33, 2006-15 IRB 754.

(9.) IRC Sec. 409A(b)(4).

(10.) Notice 2006-33, 2006-15 IRB 754.

(1.) See Rev. Proc. 92-64, 1992-2 CB 422, 423.

(2.) See Rev. Proc. 92-64, 1992-2 CB 422, 423, Secs. 4.01 and 5.01.

(3.) See sections 1(d) and 13(b) of the model trust, at 1992-2 CB 424 and 427; but see Goodman v. Resolution Trust Corp., 7 F.3d 1123 (4th Cir. 1993) (assets in a rabbi trust must be subject to the claims of creditors at all times).

(4.) See Let. Rul. 8906022 (employer established a rabbi trust and its corporate parent also guaranteed the obligations).

(5.) See section 3(b)(1) of the model trust, at 1992-2 CB 425.

(6.) See, e.g., Rev. Proc. 92-64, Sec. 3, 1992-2 CB 422, 423; Let. Ruls. 9732008, 9723013, 9601036.

(7.) See, e.g., Let. Ruls. 9525031, 9505012, 9452035.

(8.) See Let. Rul. 9525031.

(1.) See, e.g., Let. Ruls. 9732006, 9548015, 9542032, 9536027.

(2.) See, e.g., Let. Ruls. 9314005, 9242007, 9214035.

(3.) Rev. Proc. 92-64, Sec. 3, 1992-2 CB 422, 423.

(4.) See, e.g., Let. Ruls. 9542032, 9536027, 9443016.

(5.) See, e.g., Let. Ruls. 9314005, 9242007, 9214035, 8634031.

(6.) See, e.g., Let. Ruls. 9548015, 9517019, 9504006; see also Rev. Proc. 92-64, Sec. 4.02, 1992-2 CB 422, 423; sections 1(d), 1(e) and 3(b) of the model trust, at 1992-2 CB 424, 425.

(7.) See DOL Adv. Op. 94-31A, fn.3; DOL Adv. Op. 92-13A.

(8.) See Nagy v. Riblet Prod. Corp., 13 EBC 1743 (N.D. Ind. 1990), amended on other grounds and reconsideration denied, 1991 U.S. Dist. Lexis 11739 (N.D. Ind. 1991).

(9.) See Rev. Proc. 92-64, Sec. 3, 1992-2 CB 422, 423.

(10.) See Let. Ruls. 9242007, 9121069.

(11.) See Rev. Proc. 92-65, Sec. 3.01(c), 1992-2 CB 428.

(1.) See Let. Rul. 9505012.

(2.) See Let. Rul. 9501032.

(3.) See IRS Model Trust, section 5(a), Rev. Proc. 92-64, 1992-2 CB 425.

(4.) Let. Rul. 9505012.

(5.) Notice 2000-56, 2000-43 IRB 393.

(6.) See IRS Model Trust, sections 8(e) and 8(f), Rev. Proc. 92-64, 1992-2 CB 426.

(1.) See Rev. Proc. 2003-3, Secs. 3.01(35), 4.01(33), 2003-1 IRB 113; Rev. Proc. 92-64, Secs. 3 and 4, 1992-2 CB 422, 423.

(2.) See Let. Rul. 9530038.

(3.) Let. Ruls. 200116046, 200012083, 199924067, 9752018, 9752017.

(4.) Treas. Regs. [section] [section] 1.409A-2(a)(9), 1.409A-3(j)(5).

(5.) Notice 2006-79, 2006-43 IRB 763.

(1.) See Let. Ruls. 9423034 and 9414051, revoking Let. Rul. 9317037.

(2.) See Let. Rul. 9752018.

(3.) Let. Rul. 200116046.

(4.) See, e.g., Let. Rul. 199902002.

(5.) IRC Sec. 404(a)(5); Treas. Regs. [section] [section] 1.404(a)-1(c), 1.404(a)-12(b)(2). See also Lundy Packing Co. v. U.S., 302 F. Supp. 182 (E.D.N.C. 1969), aff'dper curiam, 421 F.2d 850 (4th Cir. 1970); Springfield Prod, Inc. v. Comm., TC Memo 1979-23.

(6.) IRC Sec. 404(d).

(7.) Let. Rul. 199923045.

(8.) Albertson's, Inc. v. Comm., 42 F.3d 537 (9th Cir. 1994), vacating in part 12 F.3d 1529 (9th Cir. 1993), aff'g in part 95 TC 415 (1990) (divided court), en banc reh'g denied, (9th Cir. 1995), cert. denied, 516 U.S. 807 (1995); Notice 94-38, 1994-1 CB 350; Let. Rul. 9201019; TAM 8619006.

(1.) See Treas. Reg. [section] 1.404(a)-1(b).

(2.) See, e.g., Nelson Bros., Inc. v. Comm. TC Memo 1992-726.

(3.) Andrews Distrib. Co., Inc. v. Comm.,TC Memo 1972-146.

(4.) See IRC Sec. 162(m).

(5.) See IRC Sec. 280G.

(6.) See IRC Sec. 3401(a); Rev. Rul. 82-176, 1982-2 CB 223; Rev. Rul. 77-25, 1977-1 CB 301; Temp. Treas. Reg. [section] 35.3405-1T, A-18; cf. Let. Rul. 9525031 (contributions to rabbi trust were not subject to income tax withholding because they were not the actual or constructive payment of wages).

(7.) IRC Sec. 409A(b)(4).

(8.) IRC Sec. 457A(c).

(1.) Let. Rul. 9521029.

(2.) See Let. Rul. 9340032.

(3.) See IRC Secs. 3121(v)(2)(A), 3121(v)(2)(C); Treas. Reg. [section] 1.3121(v)(2)(a)(2); Buffalo Bills, Inc. v. U.S., 31 Fed. Cl. 794 (1994), appeal dismissed without opinion, 56 F.3d 84, 1995 U.S. App. Lexis 27184 (Fed. Cir. 1995); Hoerl & Assoc., EC. v. U.S., 996 F.2d 226 (10th Cir. 1993), aff'g in part, rev'g in part, and remanding 785 F. Supp. 1430 (D. Colo. 1992); Let. Ruls. 9443006 (fn. 1), 9442012, 9417013; 9347006, 9024069 as revised by Let. Rul. 9025067; TAMs 9051003, 9050006.

(4.) See IRC Secs. 3306(r)(2), 3306(b)(1).

(1.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(f), 31.3306(r)(2)-1(a).

(2.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(b)(4), 31.3306(r)(2)-1(a).

(3.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(c)(1), 31.3306(r)(2)-1(a).

(1.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(c)(2), 31.3306(r)(2)-1(a).

(2.) TAMs 9051003, 9050006.

(3.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(c)(1)(iii)(B), 31.3306(r)(2)-1(a).

(4.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(d)(2), 31.3306(r)(2)-1(a).

(5.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(e)(4)(i), 31.3306(r)(2)-1(a).

(6.) TAM 199902032.

(7.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(e)(1), 31.3306(r)(2)-1(a).

(8.) IRC Secs. 3121(v)(2)(B), 3306(r)(2)(B).

(1.) Treas. Regs. [section] [section] 31.3121(v)(2)-1(a)(2)(iii), 31.3306(r)(2)-1(a).

(2.) See IRC Sec. 1402(a); Treas. Reg. [section] 1.1402(a)-1(c).

(3.) See, e.g., Let. Ruls. 9609011, 9540003.

(4.) IRC Secs. 1402(a), 9022(b), 5123(a); Treas. Reg. [section] 1.1402(a)-1(c); Let. Rul. 8819012.

(5.) IRC Sec. 3121(a)(1).

(6.) IRC Sec. 1402(b)(1).

(7.) Notice 97-6, 1997-1 CB 353. See also General Explanation oof Tax Legislatioon Enacted in the 104th Congress (JCT-12 96), n. 130, p. 140 (the 1996 Blue Book).

(1.) IRC Sec. 457(e)(13); Treas. Reg. [section] 1.457-2(e).

(2.) 2005-33 IRB 295.

(3.) Let. Rul. 2004-30013.

(4.) See Treas. Reg. [section] 1.457-2(f).

(5.) See Treas. Reg. [section] 1.457-2(h).

(6.) IRC Sec. 457(e)(11).

(7.) See Ann. 2000-1, 2000-2 IRB 294.

(8.) IRC Sec. 457(e)(11)(A)(ii).

(9.) IRC Sec. 457(e)(11)(C).

(10.) IRC Sec. 457(e)(11)(B).

(11.) IRC Sec. 457(e)(12).

(1.) TRA '86, Sec. 1107(c)(3)(B).

(2.) TAMRA '88, Sec. 1011(e)(6).

(3.) Notice 87-13, 1987-1 CB 432.

(4.) See TAMRA '88, Sec. 6064(d)(3); Let. Ruls. 9538021, 9334021, 9250008.

(5.) Let. Rul. 9549003.

(6.) Let. Rul. 9721012.

(7.) Let. Rul. 9548006.

(8.) Let. Rul. 9822038.

(9.) IRC Sec. 457(b)(6).

(10.) IRC Sec. 457(e)(11)(A)(ii).

(11.) Treas. Reg. [section] 1.457-12.

(12.) Sen. Rep. 95-1263 (Revenue Act of 1978), reprinted in 1978-3 CB (vol. 1) 364.)

(1.) IRS Information Letter 2000-0300.

(2.) See Let. Rul. 8950056.

(3.) IRC Sec. 457(b)(4).

(4.) Treas. Reg. [section] 1.457-4(b).

(5.) Rev. Rul. 2000-33, 2000-2 CB 142.

(6.) IRC Sec. 457(d)(1)(A).

(7.) IRC Sec. 457(e)(9)(B).

(8.) IRC Sec. 72(t)(9).

(9.) IRC Sec. 457(d)(1)(A)(ii); Treas. Reg. [section] 1.457-6(b).

(10.) EGTRRA 2001 Conf. Rep., reprinted in the General Explanation of EGTRRA 2001, p. 161.

(1.) Treas. Reg. [section] 1.457-6(b)(2).

(2.) Treas. Reg. [section] 1.457-6(c)(2).

(3.) KETRA 2005 Sec. 101; Notice 2005-92, 2005-51 IRB 1165.

(4.) Sanchez v. City of Hartford, 89 F. Supp. 2d 210 (DC 2000).

(5.) Treas. Reg. [section] 1.457-6(f)(1).

(6.) Treas. Reg. [section] 1.457-6(f)(2).

(7.) Treas. Reg. [section] 1.457-7(b)(3).

(8.) IRC Secs. 414(p)(10), 414(p)(11).

(1.) IRC Sec. 457(d)(2).

(2.) See IRC Sec. 401(a)(9)(A).

(3.) IRC Sec. 401(a)(9)(C).

(4.) IRC Sec. 401(a)(9)(C)(ii)(I).

(5.) Treas. Reg. [section] 1.401(a)(9)-2, A-2(e).

(6.) IRC Sec. 4974.

(7.) IRC Sec. 457(g); Treas. Reg. [section] 1.457-8(a).

(8.) IRC Sec. 457(b)(6); Treas. Reg. [section] 1.457-8(b).

(9.) See, e.g., Let. Ruls. 9517026, 9436015.

(10.) IR-2009-94, Oct. 15, 2009.

(1.) IRC Sec. 457(b)(2).

(2.) Treas. Reg. [section] 1.457-2(b).

(3.) Treas. Reg. [section] 1.457-4(c)(1)(iii).

(4.) Treas. Regs. [section] [section] 1.457-4(e)(1), 1.457-5.

(5.) Treas. Reg. [section] 1.457-4(e)(2).

(6.) Treas. Reg. [section] 1.457-4(e)(3).

(7.) Treas. Regs. [section] [section] 1.457-4(e)(2), 1.457-4(e)(3).

(8.) Treas. Reg. [section] 1.457-4(e)(4).

(9.) IRC Sec. 457(c).

(10.) IRC Sec. 457(e)(14).

(11.) See, e.g., Let. Rul. 9823014.

(12.) IRC Secs. 457(e)(5), 457(e)(6), 457(e)(7).

(1.) IRC Sec. 457(b)(3); Treas. Reg. [section] 1.457-4(c)(3).

(2.) Treas. Reg. [section] 1.457-4(c)(3)(i).

(3.) See, e.g., Treas. Reg. [section] 1.457-4(c)(3)(D)(vi), Ex. 3.

(4.) Treas. Reg. [section] 1.457-4(c)(3)(ii).

(5.) See Treas. Regs. [section] 1.457-4(c)(3)(iii), 1.457-4(c)(iv).

(6.) See Treas. Reg. [section] 1.457-4(c)(3)(v).

(7.) IRC Sec. 414(v)(6)(A)(iii); Treas. Reg. [section] 1.414(v)-1(a)(1).

(8.) IRC Sec. 414(v)(5).

(9.) IRC Sec. 414(v)(2)(D).

(10.) Treas. Reg. [section] 1.457-4(c)(2)(i).

(11.) IR-2009-94, Oct. 15, 2009.

(12.) IRC Sec. 457(e)(15); Treas. Reg. [section] 1.457-4(c)(2)(i).

(1.) Treas. Reg. [section] 1.414(v)-1(f)(1).

(2.) IRC Sec. 414(v)(3)(A).

(3.) Treas. Reg. [section] 1.457-4(c)(2)(ii).

(4.) IRC Sec. 457(e)(9); Notice 98-8, 1998-4 IRB 6.

(5.) See IRC Sec. 457(e)(10); Let. Ruls. 199923010, 8946019, 8906066.

(6.) Treas. Reg. [section] 1.457-10(b)(1).

(7.) Let. Rul. 9540057.

(8.) IRC Sec. 457(d)(1)(C); Treas. Reg. [section] 1.457-7(b)(2).

(9.) IRC Secs. 402(c)(8)(B), 403(b)(8)(A)(ii).

(1.) IRC Sec. 457(e)(16).

(2.) IRC Secs. 457(d)(1)(C), 3401(a)(12)(E).

(3.) IRC Sec. 457(d)(1)(C).

(4.) EGTRRA 2001 Conf. Rep., reprinted in the General Explanation of EGTRRA 2001, pp. 161, 162.

(5.) IRC Sec. 457(e)(17).

(6.) Rev. Proc. 2003-3, Sec. 3.01(36), 2003-1 CB 113.

(7.) Treas. Reg. [section] 1.457-8(b)(1).

(1.) Treas. Reg. [section] 1.457-10(d).

(2.) Let. Rul. 9008043.

(3.) IRC Sec. 457(a)(1)(A); Treas. Reg. [section] 1.457-7(b)(1).

(4.) Section 101(e), KETRA 2005; Notice 2005-92, 2005-51 I.R.B. 1165.

(5.) IRC Sec. 457(a)(1)(B); Treas. Reg. [section] 1.457-7(c)(1).

(6.) Treas. Reg. [section] 1.457-7(c)(1).

(7.) Treas. Reg. [section] 1.457-7(c)(2)(i).

(8.) Treas. Reg. [section] 1.457-7(c)(2)(ii)(A).

(9.) Treas. Reg. [section] 1.457-7(c)(2)(ii)(B).

(1.) Treas. Reg. [section] 1.457-7(c)(2)(iii).

(2.) Treas. Reg. [section] 1.457-7(c)(2)(iv).

(3.) Treas. Reg. [section] 1.457-7(c)(2)(i).

(4.) See, e.g., Let. Ruls. 9517026, 9436015.

(5.) IRC Sec. 457(f)(1)(A); Treas. Reg. [section] 1.457-11(a)(1).

(6.) IRC Sec. 457(f)(3)(B); Treas. Reg. [section] 1.83-3(c).

(7.) IRC Sec. 457(f)(1)(B); Treas. Reg. [section] 1.457-11(a)(4).

(8.) H. Rep. 95-1445 (Revenue Act of 1978), reprinted in 1978-3 CB (vol. 1) 227; Sen. Rep. 95-1263 (Revenue Act of 1978), reprinted in 1978-3 CB (vol. 1) 364.

(9.) Treas. Reg. [section] 1.457-11(a).

(1.) IRC Sec. 457(f)(2); Treas. Reg. [section] 1.457-11(b).

(2.) Treas. Reg. [section] 1.457-11(d)(1).

(3.) Treas. Reg. [section] 1.457-12.

(4.) Treas. Reg. [section] 1.457-9.

(5.) See, e.g., Let. Ruls. 200009051, 9713014, 9701024, 9444028, 9430013, 9422038.

(6.) Let. Ruls. 9815039, 9805030.

(7.) Let. Rul. 9835017.

(8.) Notice 2000-38, 2000-33 IRB 174.

(9.) Rev. Rul. 82-46, 1982-1 CB 158; Temp. Treas. Reg. [section] 35.3405-1, A-23.

(1.) Notice 2000-38, 2000-33 IRB 174.

(2.) See IRC Secs. 3121(a)(5), 3121(v)(2), 3306(b)(5), 3306(r)(2). See also Let. Rul. 9024069, as modified by Let. Rul. 9025067; compare SSA Inf. Rel. No. 112 (Dec. 1993).

(3.) IRC Secs. 3306(c)(7), 3121(b)(7).

(4.) IRC Sec. 3121(a)(5)(I).

(5.) Rev. Act of 1978 Sec. 131 (as amended by TEFRA 1982 Sec. 252); TRA 1986 Sec. 1107(c)(4). See Foil v. Comm., 91-1 USTC [paragraph] 50,016 (5th Cir. 1990); Yegan v. Comm.,TC Memo 1989-291.

(6.) Gamble v. Group Hospitalization, 38 F.3d 126 (4th Cir. 1994).

(7.) GJarratt v. Knowles, 245 F.3d 941 (7th Cir. 2001).

(1.) ERISA Secs. 4(b)(5), 201(7), 301(a)(9), 4021(b)(8).

(2.) See, e.g., Let. Rul. 199923056.

(3.) IRC Sec. 422; Treas. Reg. [section] 1.422-2.

(4.) See IRC Sec. 422(a) (incorporating by reference the nonrecognition provisions of IRC Sec. 421(a)(1)).

(5.) IRC Secs. 424(c)(1), 424(c)(4).

(1.) IRC Sec. 422(a)(1).

(2.) IRC Secs. 421(b), 422(c)(2).

(3.) IRC Sec. 1001(a).

(4.) IRC Sec. 421(a)(2).

(5.) IRC Sec. 421(a)(3).

(6.) IRC Sec. 421(b).

(7.) Notice 2002-47, 2002-28 IRB 97.

(8.) Prop. Treas. Regs. [section] [section] 1.6039-1, 1.6039-2.

(1.) IRC Secs. 83(a), 83(e)(3).

(2.) Treas. Reg. [section] 1.83-7(b)(1).

(3.) Treas. Reg. [section] 1.83-7(a).

(4.) IRC Sec. 83(a).

(5.) IRC Sec. 83(b)(1).

(6.) IRC Sec. 83(h).

(7.) See Rev. Rul. 79-305, 1979-2 CB 550; Rev. Rul. 78-185, 1978-1 CB 304.

(8.) Treas. Reg. [section] 1.409A-1(b)(5).

(9.) Notice 2006-79, 2006-43 IRB 763.

(10.) Let. Rul. 199901006.

(1.) Ann. 2000-97, 2000-48 IRB 557; Ann. 2001-7, 2001-3 IRB 357.

(2.) IRC Sec. 6039(a).

(3.) IRC Sec. 83(a).
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Title Annotation:FEDERAL INCOME TAX ON INSURANCE AND EMPLOYEE BENEFITS
Publication:Tax Facts on Insurance and Employee Benefits
Date:Jan 1, 2010
Words:29141
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