taxation of benefits

[k man]

by way of plan design, what can be done to defer the inclusion of income in a NDC plan beyond separation from service? The law is essentially straight forward with respect to section 83 and constructive receipt. Can this be accomplished by putting additional restrictions in the plan? specifically i am thinking of a payout over a few years?

[mbozek]

If the plan permits a participant could elect to recieve periodic payments provided that such an election is made before the benefits become availiable to the participant because of a triggering event such as termintion of employment disability, etc. The IRS policy is that a participant should elect an installment payment option at the inception of the plan to avoid c/r but very participants make such an election because they do not know what their financial needs will be at termination. The safest way to avoid c/r is for a participant to make an election to receive installment payouts in the tax year prior to the year the benefits first become available under the plan. You should consult a tax advisor to review the current state of the law and the options which can be available under the plan.

[k man]

the plan document presently does not contain alternative payout options. i assume amending the plan would not be a problem so long as the election is irrovacable. this would get around the constructive receipt issue. what do you think?

[pjkoehler]

kman: Sec. 83 is not applicable to traditional deferred compensation plans because the term "property" does not include the employer's mere unsecured and unfunded promise to pay money in the future. Treas. Reg. 1.83-(e). The twin doctrines of constructive receipt, codified at Sec. 451, and economic benefit, codified at Sec. 402, govern the timing of taxation of deferred compensation generally. I suggest you read the Martin case with respect to an employee's second election to change a lump sum method of payment to an installment method and/or defer the benefit commencement date. Martin v. Comr. , )96 T.C. 814 (1991), appeal dism'd (10th Cir. 1992). The tax court laid out a five-factor analysis in holding that an employee permitted to make a second election to change the method of payment from lump sum to installment was not in constructive receipt of the entire amount.

[k man]

pjkoehler, excellent post. i am reviewing the martin case right now but along the lines of an annuity option, do see any impediment to adding this provision to an existing plan?

[pjkoehler]

kman: Although the IRS has not been actively litigating constructive receipt second election cases post-Martin, even if the proposed plan amendment is on "all fours" with the facts in Martin, you might, out of an abundance of caution, consider amending the plan to provide two different installment option elections with respect to current plan participants: (1) a first-time election for their future deferrals (i.e. the first day of the calendar year following the effective date of the amendment) and (2) a second election as to their earlier deferrals, i.e. those subject to a pre-amendment election, on the condition that the second election must provide for the same form of benefit as the first-time election. This would eliminate some of the potential administrative burden of bifurcated accounts, while limiting the deferrals subject to IRS challenge to those subject to a second-election.