Permitted frequency of participant investment elections for NQ Def Com

[Guest rfsimon]

Has anyone obtained any informal reading from the IRS on the permitted frequency for participant investment election changes under a non-qualified deferred compensation plan? I have seen PLRs approving plans which allow participants to change their investment elections as frequently as monthly and 3x per quarter. Would daily or weekly elections be permitted, analogous to a qualified plan? Theoretically, I see no difference between monthly and daily changes for non-qualified plans; however, this may be

a "smell-test" factor more than anything else. Your views are appreciated. Thanks in advance.

[Guest kevinc]

We administer non-qualified deferred comp. plans and we have never seen anything more specific than what you describe. However, for plans that are funded with COLI, it would be administratively impracticable to allow asset allocation changes so often because of the need to continue to match the assets with the outstanding benefit liabilities i.e. one would have to continually move monies at the carrier level if people with large account balances changed their allocations frequently. We typically allow for a reallocation at the beginning of the plan year and 2 subsequent reallocations throughout the year. This has worked well for our clients and is manageable administratively. I hope this helps.

[Guest EAKarno]

So long as the plan participants understand that their investment elections are merely hypothetical benchmarks and that they have no rights or incidents of ownership in whatever medium, if any, is used to fund the plan, then there should be no problem with daily investment changes. As the previous answer correctly noted, however, matching plan assets with plan liabilities is difficult on a daily basis with COLI. If mutual funds are used, however, daily changes will result in recognition of taxable gains and probably certain sales charges that are waived only if the fund is held at least 6, 12, or 24 months.

[pjkoehler]

The frequency with which a NQDC plan permits a participant to affect the hypothetical rate of return by communicating investment instructions to the rabbi trustee goes to the issue of the participant's dominion and control over the benchmark assets, which is not squarely a factor considered by the constructive receipt doctrine for purposes of determining the timing of income inclusion. One issue that you may be missing is the "unfunded" nature of the plan for ERISA "top hat" exemption purposes. The DOL has been less forthcoming in articulating its position for this purpose. One school of thought takes the view that the DOL would apply principles akin to the "economic benefit" doctrine, which does consider the degree of "dominion and control" exercised as an incident of ownership. Thus, while a well-drafted plan and rabbi trust agreement may interpose the sort of restrictions that amount to a substantial risk of forfeiture for purposes of avoiding the application of the constructive receipt doctrine until the end of the deferral period, notwithstanding a plan that permits daily investment changes, you are in much murkier waters with respect to whether the plan is "unfunded" from an ERISA "top hat" exemption viewpoint.

[Edited by PJK on 09-21-2000 at 01:08 PM]

[Guest EAKarno]

Phil, oh great another Big 5 opinion on deferred compensation. Is D&T as confident of this one as they were when they sold the idea of deducting deferred compensation interest as a current expense to Albertsons.

First of all, there is no Code Section 1221(B).

Second, I do seem to recall a recent IRS ruling that allowed for deferred recognition of income in connection with a series of short-term derivatives, such as interest rate swaps, used over a longer period to hedge against certain liabilities until the liability is settled. In no way, shape, or form, however, should that be read to allow for the deferred recognition of income from ordinary mutual funds traded to hedge against deferred compensation.

[Guest]

PJK wrote:

"I believe there are several accounting firms that would consider offering a tax opinion letter on this point under appropriate facts and circumstances."

Without commenting on the merits of the described transaction, what sophisticated taxpayer would rely on a tax opinion from one of these Big 5 peddlers (who, incidentally, are into your pocket for a percentage of the tax savings)? My experience is that if you want a disinterested opinion go to a respected law firm.

My two cents but would be interested in other reactions . . .

[Guest EAKarno]

Apologies to PJK, of course there is a Section 1221(B), however, my June 1999 CCH version of the Code simply lists a Section 1221, no subsections (a) or (B), that runs from subparagraph 1 through 5. Its not even close to being complete. Guess its time to use a better service than CCH.

Nevertheless, the hedging transactions described in 1221(b)would not seem to be a very close match to the use of mutual funds in a nonqualified plan. The section seems to be clearly aimed at currency and interest rate swaps and other like derivatives. Because these securities have very short terms and may be used to hedge against longer term liabilities, deferring the taxable gain or loss on each short term settlement until the liability is settled makes sense. Moreover, since there are two sides to these hedging techniques, such a deferral of gain or loss recognition may be tax nuetral to the government. The same cannot be said for mutual funds.