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Guest Article

Deloitte

(From the March 27, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Release of Offshore Trust Transition Relief


As expected, the Internal Revenue Service released Notice 2006-33 (the "Notice") on March 21, 2006. The Notice gives employers until December 31, 2007 to comply with the IRC § 409A(b) rules that prohibit use of offshore trusts or arrangements that use restrictions on assets in connection with a change in the service recipient's financial health ("financial health triggers") in connection with nonqualified deferred compensation plans. The Notice does not give transition relief for assets transferred to trusts subject to section 409A(b) after March 21, 2006.

Effective Date

This release of guidance was required by the Gulf Opportunity Zone Act of 2005 (GOZA) which made the section 409A(b) trust rules effective January 1, 2005. This effective date applies whether or not the trust assets related to nonqualified deferred compensation were earned and vested on December 31, 2005.

Transition Period

Due to the retroactive effective date, Congress required Treasury to give guidance and transition relief within 90 days after the enactment of GOZA. Notice 2006-33 provides this guidance. Specifically, it grants relief through December 31, 2007 for assets and earnings credited to such assets 1) set aside or transferred to an offshore trust on or before March 21, 2006; or 2) placed in a trust with a financial health trigger on or before March 21, 2006.

If assets are located in the U.S. or are not subject to a financial health trigger on or after March 21, 2006, subsequent transfer outside of the U.S. or addition of a financial health trigger is not protected by the Notice. For example, assets that were located outside the U.S. as of December 31, 2004 and were subsequently transferred to the U.S. and were within the U.S. as of March 21, 2006, cannot be transferred back out of the U.S. in order to take advantage of the transition period in the Notice. Additionally, if a financial health trigger was removed from a trust in order to be in "good faith" compliance with section 409A, such trust provision cannot be added back to the trust, even if removed by the end of the transition period.

Plans can comply on or before December 31, 2007 with section 409A(b) by bringing grace period assets back to the U.S. (or a proper service jurisdiction), using such assets to make payments of the nonqualified deferred compensation (including payments upon termination of the plan), decoupling the assets from the plan, or eliminating any applicable financial health restriction.

Significantly, however, there is no relief for amounts that are not funded on March 21, 2006. Therefore, it is important that no new contributions or transfers be made to an offshore trust that is related to a nonqualified deferred compensation plan with participants who are U.S. taxpayers or to a trust with a financial health trigger clause.

The Notice does not provide further guidance on the application of section 409A(b), although it states that future guidance is intended. Specifically, the Notice does not provide guidance on when trust assets are considered "offshore" or what is required to bring them "onshore" or into a proper service jurisdiction. The statute specifically allows Treasury to issue guidance determining what other arrangements would be considered a trust. However, the Notice does not include a determination that any other arrangement should be treated in the same way as a trust.

The definition of "deferred compensation" for section 409A(b) generally mirrors the definition in proposed Treas. Reg. § 1.409A-1. Therefore, key exceptions to that definition, such as exceptions for certain foreign plans and short-term deferral arrangements, apply to section 409A(b) and thus, many common arrangements are excluded from the section 409A requirements.

Failure to comply with section 409A(b) by paying deferred compensation via assets in a trust or other arrangement outside the U.S. results in income inclusion for the participant at the time the assets leave the U.S. (unless they remain subject to a substantial risk of forfeiture). This rule does not apply if substantially all of the services that gave rise to the deferred compensation were performed in the jurisdiction where the assets are held. A similar income inclusion rule exists for trusts with a financial health trigger.


DeloitteThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608 , Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2006, Deloitte.


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