Mastering IRC 457(f): Guidance for ERISA Counsel in Structuring Deferred Compensation Plans for Nonprofit Entities

Description

The regulations under Section 457(f) provide planning opportunities for nonprofit entities in structuring deferred compensation plans for executives. This has become particularly important with the passage of new tax reform legislation that adds a 21% tax penalty on most tax-exempt organizations that pay their "covered employees" compensation that either exceeds $1 million for the taxable year or is treated as an "excess parachute payment."

Compensation that is no longer subject to a substantial risk of forfeiture (i.e., vested) as defined under IRC Section 457(f) will be included for calculating these amounts in the year the compensation vests, even if paid or taxed in a subsequent year.

Employee benefits and ERISA counsel for nonprofit entities will need to master the ins and outs of IRC Section 457(f) and the proposed 457 regulations to advise their clients on structuring compensation arrangements to maximize tax benefits for the executives and the organization, and to minimize the amounts that will exceed the $1 million threshold or be treated as excess parachute payments.

A powerful tool for counsel is to defer compensation to a later period when the executive may have lower taxable wages. However, once a covered employee, always a covered employee, so post-termination payments may not even escape the new penalties.

Counsel must understand when compensation is subject to a substantial risk of forfeiture and when that risk lapses. The proposed regulations provide some available tools when the risk of forfeiture lapses, such as during a post-termination noncompete period, a provision adding a "rolling risk of forfeiture."

The proposed regulations also created specific compensation arrangements exempt from the requirements of IRC Section 457(f), such as separation pay plans or short-term deferrals. In drafting these agreements, counsel must understand the relationship between IRC Sections 457(f) and 409A, so executives aren't subject to severe penalties for either a document or operational failure under the plan.

Listen as our experienced panel provides a critical analysis of IRS Section 457(f) regulations and implications of tax reform, as well as offers guidance on opportunities and limitations in structuring executive compensation plans for exempt organizations.