Funding deferred compensation with "notes"

[Guest Doug Johnston]

Our client would like to "fund" its nonqualified deferred compensation plan by issuing notes to the participants. The notes would be secured by company assets and would entitle the participant to annual interest payments, but the principal would be contingent upon completion of a specified number of years of service. Obviously, the annual interest payments would be taxable income to the participants, but the principal (although secured) would be subject to forfeiture. I realize there are other ways to secure deferred compensation, but this is the method the owner dreamed up. Are there any holes in it?

Also, the company is part of a controlled group. The owner would like to count the "select group" of key employees based on the whole group, but actually offer it disproportionately to key employees employed by the parent company. Is there any guidance on this?

[Kirk Maldonado]

Have you thought about the possible federal and state securities laws implications of issuing those notes?

[Guest wmacdonald]

To me, this is a complex approach to something that could be a lot easier, like a letter of credit etc. Why do you want to go this untested complex way?

[Everett Moreland]

Income will result immediately if the notes are transferable. I did something like this 15 years ago with notes and was concerned about some old cases dealing with notes. I would not use notes unless you are comfortable that they will not cause immediate taxation.

[Kirk Maldonado]

Everett Moreland:

Were those court decisions based on the economic benefit doctrine, or did the court employ some other line of reasoning?

[Everett Moreland]

Sorry, but after 15 years I have only a vague memory that I was concerned about the cases.