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Cancel 409A/457(f) SERP in exchange for split dollar loan regime


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Large nonprofit health systems are being approached frequently by consultants offering proposal to rescind executives 409A/457(f) SERPs in direct exchange for split dollar loan regime arrangement of substantially equal value (but generally a very different "payment" time/form than under the 409A/457(f) SERP).  Push for these proposals now seems to be to help nonprofit employer avoid or reduce 4960 excise taxes where these SERP values would exceed $1M at vesting.  Anybody seeing these along with the legal opinions from the promoters that these "swaps" "should not" run afoul of 409A or 457(f)??  Thoughts on whether this violates anti-substitution/anti-exchange rules under 409A/457(f) and if not - why? 

If an executive and employer bilaterally agreed to cancel SERP in exchange for loan regime split dollar arrangement, should executive insist on indemnification from employer for potential 409A/457(f) infractions/penalties if the promoter's "should be ok" doesn't ultimately align with IRS views on audit - or even at Tax Court?

I appreciate any insight as to how these proposals are being greeted by employer's counsel.

 

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I'm interested to hear others' opinions as well as I see this issue frequently. 

I'm not aware of any specific guidance, but personally I think if you have a plan subject to 409A/457(f) you're going to have some difficulty getting around the substitution and/or exchange rules under both. The circumstances may occasionally get you past the presumption of a substitution, but I think in most cases it would be difficult unless the two events (forfeiture of NQDC and implementation of split dollar) are truly unrelated in time and amount.

I see rescission most frequently in short-term deferral agreements that are exempt from both 409A and 457(f). In that case, you don't invoke either set of substitution/exchange rules. I have heard some of the opinion that you need to comply with the 409A rules for making an initial deferral election on a payment that would otherwise be a short-term deferral (1.409A-2(a)(4)) or deferring a forfeitable right (1.409A-2(a)(5)). I think there's a good argument that neither of those rules apply when you are forfeiting one right and obtaining a new, different right. 

For what it's worth, this is from the BNA Portfolio on Insurance-Related Compensation:

Exchanging Nonqualified Deferred Compensation Plan Benefits for the Proceeds of Life Insurance Under a Split-Dollar Plan (Benefit Swapping)--

Before the enactment of §409A, nonqualified deferred compensation benefit swapping was popular. Since the enactment of §409A, the swapping of a benefit from a plan covered by §409A would likely constitute an impermissible distribution as a “substitution” and a violation of §409A. The technique is also probably not available to a nonqualified deferred compensation plan grandfathered under §409A. Such a swap probably constitutes a material modification that causes loss of the grandfathering and brings it under §409A, hence a substitution and a violation that cause immediate taxation. However, for a nonqualified deferred compensation plan that is exempt from §409A, such as one that qualifies for the short-term deferral exemption, the technique may still be viable, although its availability is not clear. In the present environment, this technique should be considered aggressive.

...

The IRS had not approved (or disapproved) these transactions in a revenue ruling or letter ruling before the enactment of §409A, but many were being executed (as reflected in proxy statements). The authors and many other commentators believed these pre-§409A transactions did not create taxable income for the executive on the exchange under either the economic benefit or constructive receipt theories, discussed in V.B.2.c., above. Similarly, the other possible theory under which the transaction could be taxed, the assignment of income theory, also appeared not to apply, because the participant would be releasing, not assigning, the benefit and was forgoing a benefit taxable only in the future for a benefit that was currently taxable.

...

 

In the authors’ opinions, giving up a benefit would not be taxable, and taxation of the new benefit should be determined under the rules applicable to that benefit if the transaction does not constitute a §409A “substitution of benefits.” There is no direct authority for these transactions, especially after enactment of §409A, so the technique must be considered aggressive. 
 
Practice Tip: The enactment of §409A with its prohibition against “substitution of benefits” has greatly reduced the number of supplemental plans (SERPs) that might now qualify for the swap technique in the first instance. Only nonqualified deferred compensation plans not subject to §409A, primarily supplemental plans that qualify for the short-term deferral exemption (“vest and pay” supplemental plans), might qualify. As noted, even then, the swap technique should be considered an aggressive benefit planning technique.
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  • 2 months later...

I think the proposed 457(f) regulations would preclude exchanging a 457(f) benefit for a split dollar arrangement in an attempt to bring it outside of the reach of 457(f). Proposed regulations Section 1.457(f)-12(d)(1)(i) provides, in the last two sentences:

"An amount of compensation deferred under a plan that provides for the deferral of compensation within the meaning of section 457(f) and this section does not cease to be an amount subject to section 457(f) and this section by reason of any change to the plan that would otherwise recharacterize the right to the amount as a right that does not provide for the deferral of compensation with respect to such amount. In addition, any change under the plan that results in an exchange of an amount deferred under the plan for some other right or benefit that would otherwise be excluded from the participant's gross income does not affect the characterization of the plan as one that provides for a deferral of compensation."

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18 hours ago, kgr12 said:

I think the proposed 457(f) regulations would preclude exchanging a 457(f) benefit for a split dollar arrangement in an attempt to bring it outside of the reach of 457(f). Proposed regulations Section 1.457(f)-12(d)(1)(i) provides, in the last two sentences:

"An amount of compensation deferred under a plan that provides for the deferral of compensation within the meaning of section 457(f) and this section does not cease to be an amount subject to section 457(f) and this section by reason of any change to the plan that would otherwise recharacterize the right to the amount as a right that does not provide for the deferral of compensation with respect to such amount. In addition, any change under the plan that results in an exchange of an amount deferred under the plan for some other right or benefit that would otherwise be excluded from the participant's gross income does not affect the characterization of the plan as one that provides for a deferral of compensation."

I think this is probably right, but in my experience the plan being terminated is usually a short-term deferral and therefore not "a plan that provides for the deferral of compensation within the meaning of section 457(f)."

Maybe I'm not getting the more aggressive pitches where terminating a plan subject to 457(f) is proposed.

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