Economic Evaluation Group, Inc.

A Concierge Employee Benefits Consulting & Brokerage Firm 
(516) 338-2800


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NON QUALIFIED DEFERRED COMPENSATION

Deferred compensation is an incentive compensation arrangement established by employers to provide retirement income and often death and disability benefits as well to selected employees. The arrangement is a contractual commitment between an employer and an employee or independent contractor which specifies when and how future compensation will be paid. When properly arranged, the employee (or the employee's beneficiary) can postpone income taxation of the deferred amounts until the time benefits are paid.

Deferred compensation is "nonqualified." Arrangements do not have to be preapproved by the IRS, and employers can discriminate in favor of selected employees. Also, when properly arranged, they are exempt from the regulatory requirements of ERISA Title I which are applicable to qualified retirement plans. A deferred compensation arrangement typically provides that an employee will receive a stipulated sum for a fixed period of time (or for life) beginning at a future date such as the employee's retirement. If an employee dies after payments have begun, the arrangement may direct that the remaining benefit be paid to the employee's designated beneficiary.

The arrangement may provide that the employee will receive future compensation as a result of a current salary reduction or in lieu of a bonus or salary increase. This is sometimes called a true deferral arrangement.

An alternative to true deferral is the salary continuation arrangement. Here, the employer commits to pay future compensation to the employee in addition to current earnings, which are not reduced by participation in the arrangement. Providing compensation and benefits to owner-employees and key executives is a continuing concern to businesses large and small. However, the regulatory environment imposed on qualified retirement plans coupled with escalating costs and anti-discrimination rules have made executive benefit planning through qualified plans impossible for, or unappealing to, many businesses.

Deferred compensation arrangements address this problem by giving employers a nonqualified tool that rewards selected executives by helping them set money aside for retirement, death and disability. In many cases nonqualified arrangements are used as a supplement to an existing qualified retirement plan.

The following are positive indicators for deferred compensation:

  • - A 'C' corporation is the employer;
  • - The employer wishes to benefit a select, highly compensated employee or a select group of highly compensated employees;
  • - The employer has a need to attract, retain, or reward one or more employees;
  • - The employee is "maxed out" on contributions to or benefits from a qualified retirement plan; or
  • - The employer has no qualified retirement plan in place and does not want to establish one.

A deferred compensation arrangement can provide business owners with a degree of flexibility that is unavailable in a qualified plan:

  • - The business can cover "top-hat" employees only in a deferred compensation arrangement without running afoul of anti-discrimination rules or minimum funding standards.
  • - Also, they can provide a different level of benefits for different employees.
  • - No government-imposed vesting rules apply and the plan can be customized to suit many individual fact situations.
  • - Paperwork and administrative costs are kept to a minimum since compliance requirements are minimized.

 

To obtain the desired tax benefits (no tax to employees until benefits are received), the deferred compensation arrangement must be considered "unfunded." In an unfunded arrangement, the employee has only a contractual right-an unsecured promise to receive benefits in the future. An arrangement is considered unfunded if:

  • - There is no reserve set aside to pay promised benefits, or
  • - Reserves so established remain a general asset of the corporation, subject to invasion by the corporation's creditors.

 

Thus, the employee cannot be entitled to a current beneficial interest in the funds if the arrangement is to be considered unfunded for tax purposes. This is an important point, because employees defer taxation until they actually receive benefits in an unfunded arrangement.When the employer sets aside specific assets to meet its future obligations, with the select employee as beneficiary, and these assets are out of reach of general creditors, the arrangement is considered to be funded and the amounts set aside by the employer are currently taxed to the employee.

In order to defer income taxation, benefits must generally be forfeitable if the select employee fails to meet some condition(s) under the arrangement. However, no risk of forfeiture is required if the employer's creditors can reach the arrangement fund.

Generally, the select employees are not taxed until they actually receive deferred compensation payments as long as three conditions are met:

  • - The income deferral is agreed upon before compensation is earned;
  • - The deferred amount is not unconditionally placed in trust or escrow; and
  • - The promise to pay is merely a contractual obligation not evidenced by notes or secured in any other way.
  • - Distributions are taxed as ordinary income to the employee or beneficiary as made.

 

 

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Economic Evaluation Group, Inc.

© 2016 Economic Evaluation Group, Inc.

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Economic Evaluation Group, Inc. Specializes in Group Health Insurance (Group Medical Insurance). EE Group is located in Melville, Long Island, New York and service all over the United States and Canada.

 

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