S Corp Saving Plan (Q or NQ)

[HJ]

For a S Corp owner making $300k per year, what is his best option in saving money for himself and getting a tax advantage?  Is it a qualified plan that involves profit sharing or can there be a NQ plan that gets funded thru a bonus he gives himself?  I am looking for answers that include examples using numbers.

[QDROphile]

S corp ownership and NQDC do not go very well together.  Your question bothers me because of the implication that you are advising someone without the knowledge or experience to do so competently.  I would feel better if you were an S Corp owner getting started on ideas about tax-advantaged savings and are exploring terminology that you have heard.

[jpod]

• I would like to give HJ the benefit of the doubt and that he/she is in fact the S corp owner poking around looking for ideas.  If that's the case, HJ should start with his or her regular tax advisor, who already has pertinent facts about HJ, rather than a message board (even this one!).     

[Calavera]

Assuming HJ is the S-corp. owner - It most likely will be a combination of a qualified defined benefit plan with 401k/Profit Sharing plan. Talk to your accountant and/or google for a small actuarial businesses/consultants for a proper advice.  

[Larry Starr]

HJ,

You are looking for examples with numbers where you have a clear lack of understanding (which is fine) of NQDC. Also, you gave us absolutely no information that is really needed to give you even a hint of an answer. How old is he?  Are there employees?  What kind of business is this (is the income steady)?  How much income does he need to live on (if he needs $250k, then $300k doesn't leave much for a plan)?

The comment about a combination plan with a defined benefit might be right, but it is WAY premature to even mention it without the kind of information requested above. Doctors don't suggest operations until they at least examine the patient; that's an operation looking for a reason, and that's not the way this should be done.

Bottom line, you really  need to be talking to a qualified consultant who can ask the right questions, get the right answers, and THEN talk about what makes the most sense.

[Patricia Neal Jensen]

No such thing as an S Corp NQDC plan.

[QDROphile]

49 minutes ago, Patricia Neal Jensen said:

No such thing as an S Corp NQDC plan.

Not true, but circumstances where such a plan would be tolerable for the owners are unusual.  

[Larry Starr]

21 hours ago, Patricia Neal Jensen said:

No such thing as an S Corp NQDC plan.

Sure there is, but NOT for a 100% owner of the S Corp.

[Patricia Neal Jensen]

No such thing as an S Corp NQDC plan.   

 

Larry Starr... exactly the point.  Who else would such a plan be benefiting?

[Larry Starr]

3 hours ago, Patricia Neal Jensen said:

No such thing as an S Corp NQDC plan.   

 

Larry Starr... exactly the point.  Who else would such a plan be benefiting?

Ummm.... an S corp (like any other business entity) could have use for a NQDC for key employees that they wish to offer "golden handcuffs" to.  Perfectly normal and common.  On what basis do you keep suggesting that an S Corp can't have a NQDC plan?  I'm confused by your statements.

[XTitan]

Agree with Larry.  I've seen plenty of S Corp NQDC plans; they can benefit key execs who aren't shareholders.

[jpod]

Sure, but I suspect that most people when they hear "NQDC" are thinking elective and fully vested deferred compensation, which, if informally funded, has no attribute other than a tax deferral for the service-provider.  If I were an S corp owner I don't know that I would want to have to put away money for an employee in 2018 but not be able to get a deduction for that money until a year or more later.   

[Larry Starr]

23 hours ago, jpod said:

Sure, but I suspect that most people when they hear "NQDC" are thinking elective and fully vested deferred compensation, which, if informally funded, has no attribute other than a tax deferral for the service-provider.  If I were an S corp owner I don't know that I would want to have to put away money for an employee in 2018 but not be able to get a deduction for that money until a year or more later.   

I have to say I am completely baffled by what your first sentence means.   If YOU were an S Corp owner where a NQDC program for a key employee was the appropriate answer to a determined need, than a NQDC would be the answer.  You second sentence simply means that you really don't understand the value of a NQDC plan.  Maybe googled "rabbi trusts" and see if that doesn't help your understanding.

[jpod]

Thanks for the kind words Larry.  Please consider changing your attitude a bit when responding on this Board.  Do you know what "informally funded" means?  It means depositing money in a Rabbi Trust, or in a custodial account in the name of the Employer, or something comparable, but in either case it means CASH OUT THE DOOR instead of reinvested in the business or put in the S corp owner's pocket, but in the NQDC context there isn't a corresponding tax deduction, even if the NQDC is fully vested.  That's a nice tax deferral for the employee (but with the obvious credit risk), but a lousy deal for the S corp owner.  I wasn't talking about unfunded SERPs or other unfunded retention-type incentives.     

[Larry Starr]

Dear Jpod,

Nothing I said in my response was untoward. I really do not understand what the first sentence means; maybe it's me, but I really don't think so. 

If you find it hard to take critical comments, I am sorry for that.  These forums are intended as educational opportunities for the many people who are "lukers" (they read the material but rarely participate, which is just fine). 

When someone posts something that is not correct. the many folks who read that need to be informed that it is not correct or they will perpetuate the incorrect understanding. That is why many of us help out on these boards.

And as to your second sentence that I noted, my comment stands unaltered.  REGARDLESS of the mechanism used to provide the NQDC (a rabbi trust is for SOME additional protection of the ultimate recipient of the promise made by the employer; it is an option , not a requirement), it is NOT a "lousy deal" for the business owner if he is negotiating it with a key employee BECAUSE that key employee is critical to the continuation of the business.  You just keep showing that you really do not understand the value of a NQDC agreement, even after it is clearly explained.  You seem to think all these employers are doing something that they don't understand and is bad for them.  I assure you that is not the case. 

Employers don't offer them (and S Corp has NOTHING to do with the issue) because they are BAD for the employer.  I really don't mean to offend you, but you keep saying things that are simply not the case with NQDC agreements that I have been involved with for over 30 years.  We'll agree to disagree. 

BTW, I actually do know what informal funding is all about.  You have a problem when you say the NQDC is "fully vested"; it is specifically NOT fully vested if it is subject to a substantial risk of forfeiture. By definition, it is NOT fully vested if it is subject to a substantial risk of forfeiture.  Actually, "fully vested" is a term that is not used in NQDC discussions or agreements, because it only muddies the water.  It is either funded or not funded, and that is the substantive issue.  Fully vested means nothing if you have a substantial risk of forfeiture.

I really don't mean to hurt your feelings; just being direct.

[EBECatty]

5 hours ago, Larry Starr said:

BTW, I actually do know what informal funding is all about.  You have a problem when you say the NQDC is "fully vested"; it is specifically NOT fully vested if it is subject to a substantial risk of forfeiture. By definition, it is NOT fully vested if it is subject to a substantial risk of forfeiture.  Actually, "fully vested" is a term that is not used in NQDC discussions or agreements, because it only muddies the water.  It is either funded or not funded, and that is the substantive issue.  Fully vested means nothing if you have a substantial risk of forfeiture.

I must be used to different terminology. Or maybe you have a more specific definition of "NQDC" than I do. Genuinely curious. 

I see vesting all the time in the NQDC world where "substantial risk of forfeiture" is a vesting concept in the sense of "if you work here for five years you will become fully vested in the employer match to the NQDC plan and your employer match account will no longer be subject to a substantial risk of forfeiture." Vesting in the sense that you can quit and walk away with the full account balance. A retention aspect. 

I encounter funding as a completely separate issue. An NQDC balance can be fully vested (in the sense described above) and still be unfunded in the sense that the employer has not set aside funds for the employee that are beyond the reach of the employer's creditors. Funded vs. unfunded is an issue, but not one that I encounter very often in the typical NQDC plan design conversation. Being "unfunded" does not mean it's subject to a "substantial risk of forfeiture." 

[jpod]

You're right; Larry was just being "fancy" with his language.  Everyone who works with NQDC plans equates "vesting" with "no SRF."   And I agree that whether to informally fund or not is an entirely separate issue.  However, if you were an employee of a private company, would you be willing to defer part of your compensation if it wasn't going to be parked somewhere so you can "see it" and manage its investments through some type of informal funding vehicle?  For example, if you can defer your $20,000 bonus, and the employer says "I won't set it aside in a segregated account, but I promise to pay it to you with interest at X% per year when you leave employment," would you be happy with that?   I suspect most would not be happy with that.  So, my only point is that if I am an S corp owner I would have no interest in putting cash aside and out of my or my company's hands without the benefit of a current tax deduction.    

[Larry Starr]

18 hours ago, EBECatty said:

I must be used to different terminology. Or maybe you have a more specific definition of "NQDC" than I do. Genuinely curious. 

I see vesting all the time in the NQDC world where "substantial risk of forfeiture" is a vesting concept in the sense of "if you work here for five years you will become fully vested in the employer match to the NQDC plan and your employer match account will no longer be subject to a substantial risk of forfeiture." Vesting in the sense that you can quit and walk away with the full account balance. A retention aspect. 

I encounter funding as a completely separate issue. An NQDC balance can be fully vested (in the sense described above) and still be unfunded in the sense that the employer has not set aside funds for the employee that are beyond the reach of the employer's creditors. Funded vs. unfunded is an issue, but not one that I encounter very often in the typical NQDC plan design conversation. Being "unfunded" does not mean it's subject to a "substantial risk of forfeiture." 

You have appropriately combined the concept of "full vesting" with the elimination of a substantial risk of forfeiture (SROF).  That really are the same, or as I said previously, the concept of "full vesting" is a layman's term for the elimination of a SROF.  IRS only cares about SROF issue; if someone were to say somehow in a plan document that the beneficiary is "fully vested" but STILL subject to a SROF, the "fully vested" term would be meaningless.

Once there is no SROF and the participant can take his money if he wants, he is in constructive receipt of those funds (whether he takes them or not) and he will be taxable on them and the employer will get his long awaited deduction for that amount.

Folks might find the IRS Audit Techniques for NQDC instructive; they can be found here:

https://www.irs.gov/businesses/corporations/nonqualified-deferred-compensation-audit-techniques-guide

And I have to disagree with your final statement that being unfunded does not mean it's subject to a SROF, because that's exactly what it means.  Once it is NOT subject to a SROF, it moves to FUNDED status (constructively received if not actually received).  It may be a nuance, but it's a very important concept in NQDC programs; maybe the key one.

[Larry Starr]

5 hours ago, jpod said:

You're right; Larry was just being "fancy" with his language.  Everyone who works with NQDC plans equates "vesting" with "no SRF."   And I agree that whether to informally fund or not is an entirely separate issue.  However, if you were an employee of a private company, would you be willing to defer part of your compensation if it wasn't going to be parked somewhere so you can "see it" and manage its investments through some type of informal funding vehicle?  For example, if you can defer your $20,000 bonus, and the employer says "I won't set it aside in a segregated account, but I promise to pay it to you with interest at X% per year when you leave employment," would you be happy with that?   I suspect most would not be happy with that.  So, my only point is that if I am an S corp owner I would have no interest in putting cash aside and out of my or my company's hands without the benefit of a current tax deduction.    

JPOD: OK, now you are the S Corp owner (though it makes no difference what form of taxation your business takes, but let's say it is an S Corp).  You have a key employee who is the basis for all your profitability for the next 10 years!  If you lose him, you are out of business.  Don't you think you might now have an interest in offering a NQDC program for him if that's what is needed to keep you in business???? And he might very well want that established using a Rabbi trust for the additional protection it gives him.  All of a sudden, you either have a BIG interest in putting cash asided and out of your company's hands OR you go out of business because he goes to a competitor.  

That's all we are saying here.

[Larry Starr]

On 5/31/2018 at 8:22 AM, jpod said:

Thanks for the kind words Larry.  Please consider changing your attitude a bit when responding on this Board.  Do you know what "informally funded" means?  It means depositing money in a Rabbi Trust, or in a custodial account in the name of the Employer, or something comparable, but in either case it means CASH OUT THE DOOR instead of reinvested in the business or put in the S corp owner's pocket, but in the NQDC context there isn't a corresponding tax deduction, even if the NQDC is fully vested.  That's a nice tax deferral for the employee (but with the obvious credit risk), but a lousy deal for the S corp owner.  I wasn't talking about unfunded SERPs or other unfunded retention-type incentives.     

And I just re-read your prior post and noticed your comment about SERPs or other unfunded retention-type incentives and realized I failed to comment on this.  Those SERPs (Top Hat plans) or other unfunded retention-type incentives are EXACTLY what we have been talking about.  They are NQDC programs.  Take a look at the IRS Audit Guidelines I just posted and they will refer specifically to SERPS as one way these NQDC programs are provided.

[EBECatty]

Maybe I'm being dense and an example will help. Maybe we're saying the same thing a different way.

Take an employee of an S corp. He's able to defer a portion of his own salary and/or bonus into a nonqualified plan. The employer makes dollar-for-dollar matching contributions each year up to 5% of the employee's compensation. The employer also makes "discretionary" contributions each year. If the employee voluntarily resigns during the first five years following his initial participation in the plan, he forfeits all employer matching and discretionary contributions. The account balance is held in a separate bank account solely in the name of the employer; the employer's creditors can reach the account at all times. There is no security mechanism for payment beyond the employer's mere promise of payment in the future. The entire account balance (except for any portion that has been forfeited) is paid to the employee in one lump sum upon the earliest of termination of employment, death, disability, or change in control. 

Here's what I would say:

For purposes of "vesting" and "substantial risk of forfeiture" the salary/bonus deferrals are always fully vested and are never subject to a substantial risk of forfeiture. This triggers FICA taxes on the salary/bonus deferrals immediately upon contribution to the plan. 

For purposes of "vesting" and "substantial risk of forfeiture" the employer contributions during the first five years become fully vested at the end of year five and are no longer subject to a substantial risk of forfeiture. This triggers FICA taxes on all employer contributions at the end of year five. Future matching/discretionary contributions are fully vested and never subject to a substantial risk of forfeiture and are FICA taxed upon being credited to the plan. 

For purposes of "funding" the plan is always unfunded. Both salary/bonus and employer contributions at all times, whether before or after the end of year five when they become nonforfeitable. 

From the audit guidelines: "An unfunded arrangement is one where the employee has only the employer's "mere promise to pay" the deferred compensation benefits in the future, and the promise is not secured in any way.... A funded arrangement generally exists if assets are set aside from the claims of the employer's creditors, for example in a trust or escrow account."

I read your post as saying as soon as you reach year five the employer matching/discretionary contributions are "funded," constructively received, and taxed immediately even if not paid until termination, death, disability, or CIC. I just don't follow. 

The IRS audit guidelines seem pretty clear in the "unfunded vs. funded" section that those terms only refer to the unfunded "mere promise of payment" vs. the funded account "beyond the reach of the employer's creditors." 

The amounts in my example above would not be received (actually or constructively) until paid, then would be income taxed at that point. 

The risk of the employer not being able to pay, or refusing to pay, vested amounts in the future does not keep them at a substantial risk of forfeiture. 

What am I missing?

[Larry Starr]

I'm only going to take this through the first step; your example is a complicated and very unusual design in many ways.  But let's just look at what you said.

You said: ". The account balance is held in a separate bank account solely in the name of the employer; the employer's creditors can reach the account at all times. There is no security mechanism for payment beyond the employer's mere promise of payment in the future."

You then said: "For purposes of "vesting" and "substantial risk of forfeiture" the salary/bonus deferrals are always fully vested and are never subject to a substantial risk of forfeiture."

I have a fundamental problem with what you are saying.  There IS a substantial risk of forfeiture if the funds are reachable by the creditors.  It is just that simple. 

With that fundamental error, it makes no sense to try to parse the rest of your complicated situation.

Do you think I'm wrong?

[EBECatty]

On 6/2/2018 at 6:39 AM, Larry Starr said:

I'm only going to take this through the first step; your example is a complicated and very unusual design in many ways.  But let's just look at what you said.

You said: ". The account balance is held in a separate bank account solely in the name of the employer; the employer's creditors can reach the account at all times. There is no security mechanism for payment beyond the employer's mere promise of payment in the future."

You then said: "For purposes of "vesting" and "substantial risk of forfeiture" the salary/bonus deferrals are always fully vested and are never subject to a substantial risk of forfeiture."

I have a fundamental problem with what you are saying.  There IS a substantial risk of forfeiture if the funds are reachable by the creditors.  It is just that simple. 

With that fundamental error, it makes no sense to try to parse the rest of your complicated situation.

Do you think I'm wrong?

I'm not sure; that's what I'm trying to understand. I guess at bottom my question is for what purpose, tax, or code section are you referring to a SROF? If for purposes of constructive receipt and you are using that term interchangeably with "substantial limitation on receipt," then yes I agree. 

I think we may be using the same words to refer to two different concepts. I'm just trying to better understand as I'm used to using those terms in very specific ways and have not heard them used otherwise. 

Maybe a simpler example would be better. Say you have a tax-exempt employer subject to 457(f). The employer and employee agree that $10,000 will be credited to the employee's hypothetical account balance by the employer each year for 10 years. The entire amount will be paid in one lump sum upon the employee's separation from service. If the employee voluntarily resigns before the end of 10 years, he forfeits the entire balance. There is no funding mechanism at all; it's a simple promise to pay in the future. 

The employee is still working after 10 years, and the employer has credited a hypothetical account balance of $100,000. The employee voluntarily retires 5 years after that and is paid $100,000. 

I think we would all agree under 457(f) the entire $100,000 balance would be subject to income and FICA taxes at the end of the 10-year period (the point at which it is no longer forfeitable even if the employee voluntarily resigns). Section 457(f) and 3121 refer to the end of the 10-year period (i.e., the vesting date) as the date the substantial risk of forfeiture lapses. Even if the $100,000 can be reached by the employer's creditors for the next five years before payment, for purposes of 457(f), 3121, and 409A, it's no longer subject to a substantial risk of forfeiture.

Say you have the same plan design for a taxable employer. For purposes of FICA taxes under 3121 the entire $100,000 would be subject to FICA at the end of the 10-year period because the "substantial risk of forfeiture" lapses. It also would no longer be subject to a SROF as defined in 409A.

Until separation and payment in the taxable-employer scenario, the $100,000 would be subject to substantial limitation on receipt to delay income tax for purposes of constructive receipt, but I've never heard or used the term "substantial risk of forfeiture" to define that aspect.

I've also never heard the end of the 10-year period in my example as the date on which the NQDC plan goes from being "unfunded" to "funded." Those are very clearly different concepts in my experience (and per the IRS audit guidelines you reference). 

[JeniferWilliams]

Great and very interesting topic, learning lots more thing here.

[jpod]

Credit risk is not a SRF; not for 409A or 457(f).