457(f) and 409A interplay

[Locust]

A question, a note, and a comment on the interplay between 457(f) and 409A -

1. Question - Notice 2005-1 says that 457(f) arrangements are subject to 409A - that the requirements of 409A are in addition to the requirements of 457(f).

So far as elections to defer, this would seem to require that the arrangement would have to provide for the election to defer to be made prior to the year the compensation was earned.

But I don't know what this means regarding the payment rules because 457(f) controls the timing of the taxation, not the constructive receipt rules that applied before 409A.

My question - So really - 457(f) plans aren't affected by 409A that much, are they? Because the timing of the taxation is governed by 457(f) not 409A. The primary changes that would have to be made include: the initial deferral election, and conformity with the new definition of "substantial risk of forfeiture" if there is one.

2. Note - Rolling vesting schedules seem to be gone under Notice 2005-1, which says: . . . any extension of a period during which compensation is subject to a substantial risk of forfeiture . . . is disregarded for purposes of determining whether such compensation is subject to a substantial risk of forfeiture." Q-10

3. Comment - 409A has liberated the IRS on these deferred compensation plans. I only do a handful of these arrangements each year, and I'd always taken a conservative approach - pretty much in line with the IRS ruling position. Personally, I was surprised at how aggressive lawyers and consultants had become with these arrangements - financial triggers, haircuts, acceleration clauses. I saw one law firm's newsletter that said that rolling vesting schedules were the "norm" - well they weren't for my clients, and this makes me feel like something of a chump. I suppose this firm now has a lot of extra work - fixing all the 457(f) plans it's put into place all these years.

Comment 2 - When will Congress allow the IRS to be effective again?

Locust

[mbozek]

The IRS has stated that all plans subject to 409A will be required to have the provisions of 409A in the plan document, e.g., timing of deferrals, restrictions of distributions to key employees, prohibition on investment in off shore trusts, etc. Under 409A a key employee of a non profit will be required to defer distribution for 6 months after separation from service. E.g.,if a key employee' s 457f benefit is payable upon retirement, the distribution would be delayed for 6 months.

[Locust]

Mbozek - thanks very much for looking at and replying to my post.

I believe that the 6 month restriction on payments applies only to key employees of publicly traded companies.

The other restrictions in 409A that you mention would not seem to be common for nonprofit or governmental employers.

Would you agree that the only significant changes of 409A would seem to be the timing of deferrals and the elimination of rolling vesting (and possibly other substantial risk of forfeiture "schemes")?

Oops - I hadn't thought about the deferral of the taxation of earnings under 457(f). What would be the effect of a 457(f) plan provision that allowed an executive to defer payment of an amount that is already vested? For example, 100% vested if still employed on 12/31/2006, but with the right to defer payment until 2008? Is this an impermissable deferral of the earnings from 1/1/2007 to 2008?

[mbozek]

You are correct. Key ee of NP are not restricted. I dont understand the deferral of the earnings. If the payment is vested why would the earnings not be currently taxed?

[Locust]

The earnings on the account when it becomes vested are taxed, but the earnings thereafter are not taxed until paid or "made available."

Example: year 1 - contribution of $8,000. Year 3 - account of $10,000 (that includes $8,000 contribution and earnings on contributions through year 3) is vested. Payment of that account occurs in year 5, when the account is worth $12,000. Result: Year 3 - taxed on $10,000, year 4 - taxed on $0, and year 5 - taxed on $2,000.

Is it possible that if you elected in year 4 to delay payment from year 5 until year 8 that you'd have a 409A issue on the income part of the account (income after year 3)?

It looks that way to me - the earnings are taxable when made available, which is the constructive receipt standard, and the way I am thinking 409A works, 409A is now the standard for constructive receipt.