Deferral of Deferred Comp/Bonus into 401(k)?

[Guest FAQ]

Can a payment from a deferred bonus arrangement qualify as "compensation" for purposes of a 401(k) profit sharing plan and therefore be deferred into a 401(k) and considered when determining profit sharing?

Facts: Employer pays a bonus to an executive at the end of 5 years if the executive does not terminate employment (other than due to death or retirement). At the end of the 5 years (but prior to the time the bonus becomes payable), the executive can elect to defer payment of the bonus for 5 years.

If the bonus is deferred for 5 years, I'm not sure whether the payment, once made, can be treated as "compensation." Clearly bonuses can be included in a plan's definition of compensation. However, the 415 regulations include this statement:

"...any distributions from a plan of deferred compensation are not considered as compensation for section 415 purposes regardless of whether such amounts are includible in the gross income of the employee when distributed. However, any amounts received by an employee pursuant to an unfunded non-qualified plan are permitted to be considered as compensation for section 415 purposes in the year the amounts are includible in the gross income of the employee." Treas. Reg. §1.415-2(d)(3).

I'm puzzled by a number of things, including: (1) what's the difference between a "distribution from a plan of deferred compensation" and amounts "received by an employee pursuant to an unfunded non-qualified plan" (and why the difference in treatment)? (2) whether the deferred bonus arrangement described above is a "plan of deferred compensation" (or an "unfunded non-qualified plan"), and (3) whether in the year it is paid a portion of the deferred bonus can be deferred into a 401(k) plan or considered when determining the amount of a profit sharing contribution, assuming the plan's definintion of compensation includes such amounts.

Perhaps I am reading too much into this? Is it possible to include the deferred bonus in the plan's definition of compensation, but the definition would have to be tested for discrimination (ie not a safe harbor definintion)?

Thanks in advance for any thoughts.

[QDROphile]

Would it help to observe that an unfunded nonqualifed plan is a subset of deferred compensation plans (if the plan provides for deferral of compenstation, which is implied in the passage) and that a qualified retirement plan is a subset of deferred compensation plans?

As for the difference, contributions to qualified plans will have taken into account taxable compensation for the year related to the benefit accrual. For example, in addition to section 415, the section 401(a) (17) limit applies. Nonqualified deferred compensation is usually not taken into account for accrual under qualified plans, and is not included in taxable income, in the period of deferral, but then is included in taxable compensation upon receipt by the participant (or distribution by the plan if you prefer to see it that way). The receipt (end of deferral) can be at a time when the participant is actively employed and eligible for qualified plan benefit accrual. Since the formerly deferred compensation did not help the participant under the qualfied plan while deferred, it can help (at least for section 415 puposes) when it comes into taxable compensation. It is not much help under section 415 any more. I trust that you see no issue with excluding distributions from a qualified plan from income for section 415 purposes -- income was taken into account under section 415 when the benefit was accrued. Counting the benefit would amount to double counting the compensation on which the benefit was based, among other things

The real reason that there is a difference in treatment is because Congress said so.