Can the sponsor of a NQDC plan be a related entity to the employer?

[mariemonroe]

Corporation #1 wants to incentivize Employee #1 by offering him a non-qualified deferred comp (NQDC) plan which will be funded solely by the Corporation - there will be no employee deferrals.

Corporation #1 is a part of a brother-sister controlled group with Corporation #2.

Employee #1 is employed by Corporation #1 and is not an employee of Corporation #2.

Is it possible for Corporation #2 to be the sponsor of a NQDC plan for Employee #1 which Corporation #2 would also fund?

[jpod]

When you say the "sponsor," what do you mean? Given that we are talking about a non-qualified plan, I think the only pertinent issue is whether the employer or another entity will be bearing the cost of the deferred compensation that is ultimately paid out. If that entity is someone other than the employee's employer, there could be some tricky tax issues as between the two corporations (unless they are filing as a consolidated group).

[mariemonroe]

When you say the "sponsor," what do you mean? Given that we are talking about a non-qualified plan, I think the only pertinent issue is whether the employer or another entity will be bearing the cost of the deferred compensation that is ultimately paid out. If that entity is someone other than the employee's employer, there could be some tricky tax issues as between the two corporations (unless they are filing as a consolidated group).

I mean Corporation #2 would be the one funding the plan and would accrue the contributions on its books.

I am not sure whether they file a consolidated return but will check this out.

[QDROphile]

The 409A regulations define "employer" and generally use a controlled group approach. Check the regulations. A separate question is what happens if one or another controlled group members becomes insolvent. Can one protect the employee by putting the deferred compensation obligation with the stronger sister? What is the protection against creditors, considering that the benefit must be unfunded?

[Guest Harry O]

Corporation 2 will not be entitled to deduct any payments to Employee 1 since it is not benefiting from Employee 1's services. I'm not sure brother-sister companies can file consolidated returns but I do agree there may be some deemed dividend/capital contribution issues vis a vis Corporation 1 & 2 and the shareholders.

[mariemonroe]

I did check the regs and this is what I found:

1.409A-1(g) Service recipient. Except as otherwise specifically provided in these regulations, the term service recipient means the person for whom the services are performed and with respect to whom the legally binding right to compensation arises, and all persons with whom such person would be considered a single employer under section 414(b) (employees of controlled group of corporations), and all persons with whom such person would be considered a single employer under section 414© (employees of partnerships, proprietorships, etc., under common control). For example, if the service provider is an employee, the service recipient generally is the employer (including all persons treated as a single employer under section 414(b) or ©). Notwithstanding the foregoing, section 409A applies to a plan that provides for the deferral of compensation, even if the payment of the compensation is not made by the person for whom services are performed.

[Steelerfan]

there are more issues that 409A. I think Harry O is on the right track. Rev rul 84-68. corp 2 would be considered by the IRS to have made a capital contribution to corp 1 and a constructive payment by corp 1 to the employee. corp one gets deduction. but don't quote me on that.

[Just Me]

Although already mentioned above, I think one of the biggest issues is that the amount credited under the plan is not subject to claims of the employer's creditors...therefore, there may be a significant constructive receipt issue.

[Steelerfan]

she didn't say anything about a rabbi trust.

[Guest Sieve]

Yes, mariemonroe said nothing about what kind of trust, if any, the funds are being placed in. But she did say that the contributions are "accruing on the books", so I suspect the funds are not being segregated but just remaing among other corporate assets--thus, no constructive receipt. Of course, if it is in a rabbi trust, there's no constructive reciept, either. Funds would have to be set aside in some kind of trust in order to be constructively received. Frankly, it's not clear what question mariemonroe is really asking. As has been pointed out, just because the arrangement must comply with Section 409A's convoluted rules doesn't answer such questions as whether one corp. eventually can take a deduction for paying out of a NQDC plan to a non-employee who is an employee of the controlled group (which has been addressed already by other posters), which entity is liable to the employee if the assets disappear, etc.

[Steelerfan]

409A's rules re controlled groups are there mostly to prevent an employee from terminating from a company, taking a distribution and then taking a job with a related employer. It doesn't care specifically who sponsors an arrangement, etc.

Another considerations is FICA taxes on vested benefits. generally the entity for whom services are performed withholds FICA. My cursory understanding of the rules tells me that payment will have to be treated as made by corp 1 even though "funded" by corp 2. The IRS calls this fiction "triangulation", in order to "impute" the expense to the organization for whom services are performed. I have a feeling you can do what you want, but I don't know all the ins and outs of how to account for it, etc.

[mariemonroe]

Thanks everyone for your thoughful comments. You all raised lots of issues I hadn't thought about.