Law alters nonqualified deferred comp rules

The American Jobs Creation Act of 2004, signed into law Oct. 22, includes sweeping changes in the tax rules governing nonqualified deferred compensation. Employers will need to consider and react to the new rules before the end of 2004.

The law severely restricts decisions regarding the timing and frequency of deferred compensation distributions, as well as the investment choices that can be offered to the recipient during the deferral period.

Benefits managers "are going to have to get familiar, more than they might like, with the details of the bill--in particular, with the definition of what is nonqualified compensation under the statute," said Jay Dorsch, chair of the employee benefits and executive compensation department at the law firm Cozen O'Connor in Philadelphia.

The reason: The bill's definition of deferred compensation broadly includes "arrangements that we haven't traditionally thought of as deferred compensation," said Joni Andrioff, an executive compensation attorney in the Chicago office of law firm Jones Day.

Traditional deferred compensation involved "an employee, typically an executive, who elects to defer part of compensation or part of a bonus until some future time, and who isn't taxed on the income until it's received," she explained. "But the new law picks up benefits such as stock appreciation rights, performance units, restricted stock units, supplemental executive retirement plans and even severance arrangements.

"The first thing HR managers should do is look at all their arrangements providing for deferred compensation and decide whether they're going to be covered by the new law," Andrioff said. Added Dorsch, "They've got to take an inventory of all their benefit programs as well as executive compensation, and sometimes it's not the same person who is charged with both. But a determination has to be made regarding which programs are going to be affected."

If benefits managers "have any kind of acquisition happening within their company, any type of divestitures, any type of sale of a certain line of business or operations where they may have inherited various plans from other entities, they may not be keeping track of them," cautioned Judy Thorp, the Chicago-based national partner in charge, compensation and benefits practice, at audit and tax firm KPMG.

The new law applies to all compensation earned or vested after Dec. 31, 2004. Current plans that are modified after Oct. 3, 2004, are subject to the new law. Treasury Department temporary regulations are due by Dec. 22.

Freezing Current Plans

"We're cautioning people about doing any type of amendment to an existing deferral arrangement," Andrioff said. "One option would be to freeze the existing arrangements and put them in a drawer, not to be touched, and consider adopting new plans prospectively."

Thorp noted a new requirement to report deferred compensation separately to the IRS on an annual basis, and suggested establishing a tracking system for pre-2005 deferrals and post-2005 deferrals. "Now, you're going to have pre-2005 election forms pertaining to 2004 or earlier deferrals, and new election forms for 2005 deferrals incorporating all these new rules. You have to look at all these administrative issues," she advised.

With many books closing at year-end, "you don't want to be caught at the 11th hour and not be in compliance," Thorp warned, since noncompliance could render the compensation immediately taxable, plus levy an additional 20 percent penalty tax plus interest.

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