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7 steps to cope with new deferred-comp rules

by on
in Compensation and Benefits,Human Resources

In 2004, Congress overhauled the tax rules for nonqualified deferred-compensation plans (see related article). The new rules took effect in 2005, but the IRS only recently issued final regulations.

Follow these seven steps to ensure full compliance under the final regs:

Step 1: Identify arrangements that provide a deferral of compensation. This requires employers to:
  • Identify service providers covered by the rules (e.g., staff, independent contractors, board members).

  • Identify arrangements that are deferrals of compensation.
Although certain “grandfathered arrangements” are exempt, the new rules apply to all other arrangements unless the IRS grants an exception.

Caution: Grandfathered status is lost if the arrangement is materially modified after Oct. 3, 2004.

Step 2: For each arrangement, decide between removing the deferral of compensation feature and complying with the rules. The deadline for making and documenting this decision is Dec. 31, 2007.

Tip: Weigh the benefits of providing deferred compensation against the costs of compliance and exposure to penalties.

Step 3: Design each arrangement to comply with the basic rules (i.e., restrictions on deferral elections, funding and distributions). Decide whether to adopt various special exceptions to the rules, which provide certain advantages but make plan administration more complex.

Step 4: Develop and implement policies and administrative procedures.

Tip: Designate someone to have ultimate responsibility for developing policies and procedures and for ensuring that they are followed.

Step 5: Prepare a written plan by Dec. 31, 2007. Under the final regs, the written plan must specify the terms as of Jan. 1, 2008, but is not required to specify the terms for the period prior to Jan. 1.

Step 6: Obtain service-provider elections as to time and form of payment by Dec. 31, 2007. But be aware that some elections result in noncompliance with the rules. Examples:
  • An election in 2007 to postpone a payment that would otherwise be received in 2007.

  • An election in 2007 that would cause a payment to be made in 2007 that would otherwise not be made in 2007.
Step 7: Evaluate compliance for the period between Jan. 1, 2005, and Jan. 1, 2008. The final regulations are effective for tax years beginning after 2007. Until then, the law requires good-faith compliance with the statute and earlier guidance in Notice 2005-1.

Tip: Review the plan operations to determine whether violations have occurred and take appropriate actions.

Contact your tax pro for assistance.

—Adapted from AccountingWeb, Inc., www.accountingweb.com.

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