While many of the executives who looted their corporations in the 1990s are now safely locked up, the damage they did lives on in the tax law.
Deferred compensation plans were favorite getaway vehicles for some notorious corporate malefactors. While they were busy pillaging their companies, they would send the proceeds safely offshore to fund lavish deferred executive compensation plans. Congress, as it often does, responded by firing into the crowd. Hence new Section 409A.
This tax provision requires taxpayers with "non-qualified" deferred compensation plans to jump through a large number of hoops to defer tax on the income. If they fail to jump just right, employees have to pay taxes on their deferred compensation, AND they have a 20% penalty, too. This applies even if they don't get the cash.
These rules apply to most compensation deferrals other than "qualified" retirement plans. Profit-sharing and 401(k) plans, for example, are qualified retirement plans, so they are not subject to Section 409A. In contrast, many deferred bonus plans and executive supplemental plans are subject to the new rules. The new rules also apply to some "non-compete" agreements for employees and to deferral arrangements with independent contractors.
Some taxpayers have concluded that these plans are no longer worthwhile. If old plans are terminated and the proceeds distributed to the owners before year-end, the plans don't have to deal with the new rules. If the plan isn't terminated by year-end, taxpayers will be unable to change their mind without meeting Section 409A's requirements
W-2, 1099 REPORTING
The new law requires employers with these plans to disclose amounts deferred for 2005 on 2005 W-2s. Taxpayers with such plans need to be ready to meet these rules when they issue W-2s in January. Similar rules require Form 1099 disclosure of deferred compensation amounts for independent contractors - for example, deferred director fees.
THESE RULES ARE ALREADY IN EFFECT
While you have until the end of 2006 to get your deferred compensation documents in line with the new law, you need to run them according to the new rules now. That means, among other things, that any deferrals for 2006 must be irrevocably elected in writing by the end of 2005.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to