NQDC for pass-through entities

[Guest nkastner]

I have a case in which two individuals are trying to broker a merger of their companies. The new company will be an LLC (taxed as a partnership). Member A owns 75% of the company and Member B owns the remaining 25%. A has proposed a NQDC plan exclusively for B. B must remain with the company for 10 years to received the deferred comp.

I understand that the pass-through nature of the entity and the non-deductibility of the deferred comp mean that A and B will report higher net operating income on their individual returns as a result of this NQDC plan. My question is: So what?

From A's perspective: he's going to report 75% of the NOI on his return, but he's also going to take the deduction on the back end if the deferred comp is eventually paid out. If B fails to meet his contractual obligation, the entire deferred comp balance will return to A's coffers. Alternatively, he could have paid B normal compensation (i.e. guaranteed payments), for which he would have received a deduction, but he would also find himself out a pile of cash if B decided to walk away prematurely.

From B's perspective: he's going to report 25% of the increased NOI on his return, but like A, he's going to take a pro rata deduction on the back end. If he fails to meet his obligation, he's out the deferred comp, but since he failed to perform the required service, the money wasn't really his to "lose" in the first place. And regardless, it can be presumed that B was aware of the consequences of his actions when he quit, and subsequently factored that into his decision making.

And because A and B are trying to broker a merger of their businesses, it seems like both parties can negotiate the amount of the deferred comp to a point where both sides are amicable to the risks and trade-offs they are accepting.

In short, every argument I've seen against pass-through NQDC plans revolves around the pro rata reporting of the pass-through NOI. Since this is recaptured on the back end by at least one of the two parties, I fail to see the problem? Given that there are many smarter than I that seem to be on the other side of the argument, I suspect that I am overlooking some crucial detail. Please... enlighten me!

thanks,