A Front Pages 6/29/06 2:59 PM Page vii About the Authors...iii Preface...v Chapter 1: Introduction to Nonqualified Deferred Compensation Plans...1 Overview of Nonqualified Deferred Compensation after 409A...1 In General...1 Nonqualified Plans Versus Qualified and Other Plans After Code Section 409A...2 What is Nonqualified Deferred Compensation Under 409A?...4 Why Use Nonqualified Deferred Compensation Plans?...7 Qualified Plans Versus Nonqualified Plans...7 When Qualified Plan Contributions Are Not Enough...8 The Retirement Income Gap...9 Increasingly Important Component of the Compensation & Benefit Package...15 Best Benefits Marketing Opportunity in Decades...16 The Major Changes...16 Broken Plans Under Code Section 409A & Subsequent Guidance...17 Fixing Broken Nonqualified Plans...17 Accounting Changes Have Made Equity Compensation Less Attractive and Cash Compensation More Attractive...18 Sarbanes-Oxley & SOX SEC Regulations...19 Split Dollar Life Insurance Final Regulations & 409A...20 New 457 Nonprofit Nonqualified Plan Law & Regulations...21 Voluntary Bonus Deferral Plans Are In Demand Again...22 Expensing of Equity Compensation Arrangements...22 Getting Started...23 Summary...24 Chapter 2: Basics of Nonqualified Plan Types, Their Design & Uses...29 Types of Nonqualified Deferred Compensation Under Code Section 409A...29 Plan Types After Code Section 409A...29 Designing Nonqualified Plans After 409A Choice of Plans...32 Deferral Account Balance Plans...32 Supplemental Nonaccount Balance & Account Balance Plans...33 Death Benefit Only Plans...34 Permissible Parties to Nonqualified Deferred Compensation Plans...35 In General...35 Outside Directors and Independent Contractors Under 409A...36 Nonqualified Deferred Compensation Plans Between Accrual Based Parties...37 Nonqualified Plan for Non-Governmental Not-for-Profit Organizations...38 History...38 vii
A Front Pages 6/29/06 2:59 PM Page viii Ineligible 457(f) Nonqualified Plans for Select Management Groups & the Highly Compensated of Nongovernmental Nonprofit Organizations...40 When is Nonqualified Deferred Compensation Appropriate?...42 In General...42 Use Opportunities...43 General Case Considerations...45 Selecting the Plan Type...46 Typical Plan Components...47 Written & Legally Binding Plan Requirement...47 Deferral Plans...48 Supplemental Plans...52 Death Benefit Only Plans...53 Split Dollar Life Insurance Plans...53 General Plan Design Parameters...54 Unfunded Versus Funded Plans...55 Vested Benefits...56 In General...56 Use of Endorsement Split Dollar Contracts as an Asset Reserve...57 Vested Benefits and ERISA...58 Vested Death Benefits...59 Nonqualified 457(f) Plans...59 Federal Credit Unions...60 Advance IRS Letter Rulings & Plan Documentation...61 Chapter 3: Creating an Asset Reserve and Illustrating Deferred Compensation Plans...65 Informal Funding of Deferred Compensation Plans...65 In General...65 The Pay-As-You-Go Approach (NO ASSET RESERVE)...66 The General Asset Reserve Sinking Fund Approach...68 The Corporate-Owned Annuity (COA) Approach...69 The Corporate-Owned Life Insurance (COLI) Approach...70 Types of Corporate Insurance Contracts...72 COLI Purchase Strategies...73 The Taxable Investments (Mutual Funds & Other Securities) Approach...74 Company Stock Approach...76 Illustrating and Explaining Nonqualified Deferred Compensation Plans...76 In General It s All About the Plan...76 Financial Information Employers Typically Want to See and Need to Know About a Plan...77 Overcoming Plan Design, Financial, & Accounting Issues and Objections...83 Other Elements of Successful Presentation...86
A Front Pages 6/29/06 2:59 PM Page ix Chapter 4: Federal Tax Implications of the Plan...89 Introduction...89 Overview of IRC Section 409A...91 Scope of the Law...91 Definitions...94 409A Detail Requirements...97 Prohibited Acceleration...100 Funded Plan Limitations...100 409A Penalties and IRS Income Tax Reporting...100 Federal Income Taxation of the Employer...101 In General...101 Plan Tax Consequences...102 Taxation of Assets in the Employer s Asset Reserve...104 Taxability of Non Life Insurance Investments as an Asset Reserve...107 Taxability Under the Corporate Alternative Minimum Tax (AMT)..109 Federal Income Taxation of the Executive...109 In General...109 IRC Section 457 Eligible Plans...110 IRC Section 457(f) Ineligible Plans...111 Current Income Taxation Consequences...112 Pre 409A Income Law...113 Constructive Receipt Doctrine...113 IRC Section 451 Substantial Limitation or Risk...113 Economic Benefit Doctrine...115 IRC Section 83 Transfers of Property & IRC Section 83 Substantial Risk of Forfeiture...117 Income Taxation of Retirement Benefits...118 Income Taxation of Death Benefits...119 Income Taxation of Severance Benefits...119 Federal Estate Taxation...120 In General...120 Death Benefit Only (DBO) Plans...122 Federal Gift Taxation...126 Federal Generation-Skipping Transfer Taxation...128 State Taxation Issues...128 State Income Taxation Upon Deferral...128 State Income Taxation Upon Distribution...128 Use in Partnerships or Limited Liability Companies...129 Use in S Corporations...130 Chapter 5: ERISA Requirements...139 Introduction...139 Reporting and Disclosure Requirements...140 Participation, Vesting, and Funding Requirements...142 Fiduciary Requirements...143 Claims Procedures...144 Plan Termination Insurance...145 ix
A Front Pages 6/29/06 2:59 PM Page x What Is a Select Group of Management or Highly Compensated Employees?...145 When Is a Plan Unfunded for ERISA Exemption Purposes?...148 ERISA-Proofing Your Plan...152 Use of a Rabbi Trust...155 ERISA and IRC Section 409A...155 Summary...156 Chapter 6: Accounting for Nonqualified Deferred Compensation Plans...163 Introduction...163 Fundamentals of Accounting...164 In General...164 The Balance Sheet...165 Income Statement...166 Basic Accounting Mechanics...167 Accounting for Deferred Compensation Plans Separate Accounting for Benefits & Any Plan Connected Assets...168 Accounting for the Benefits...169 In General...169 Historical Accounting For Nonqualified Deferred Compensation Plans...170 APB Opinion No.8 Accounting for the Cost of Pension Plans...170 APB Opinion Number 12 Omnibus Opinion 1967...170 Statement of Financial Accounting Standards 87 Employers Accounting for Pensions...171 Current Practice Using FAS 106...172 Statement of Financial Accounting Standards 106 Employers Accounting for Postretirement Benefits Other than Pensions...174 Statement of Financial Accounting Standards 109 Accounting for Income Taxes...176 Nonqualified Defined Contribution Arrangement Example...176 Nonqualified Defined Benefit Arrangement Example...180 Preretirement Death Benefits and Other Adjustments In Plans...185 FASB Plans to Reconsider Postretirement Benefits Accounting Beginning 2006...185 Accounting for Popular General Asset Reserve Choices...187 In General...187 Mutual Funds...187 Corporate Stock Treasury Stock...189 Corporate Owned Life Insurance...190 In General...190 Historical...191 Cash Surrender Value Method...191 The Ratable Charge Method...191 The Accrual Basis Method...192 The Economic Benefit Method...192 x
A Front Pages 6/29/06 2:59 PM Page xi Current Practice...193 Cash Surrender Values and Premiums...193 Death Benefits...196 Policy Loans...197 Income Tax Accounting Impact of Various Assets Held as a General Reserve...198 Hedge Income Tax Accounting Prohibited...199 Chapter 7: Securing the Plan s Benefits...203 Introduction...203 COLI and Other Assets...205 Annuities...206 Rabbi Trusts...207 In General...207 History...208 Rabbi Trust Design Requirements in Light of Revenue Procedures 92-64, 92-65, and 97-3...209 Advantages and Disadvantages...211 Impact of 409A on Rabbi Trusts...211 Secular Trusts...212 In General...212 Employee-Grantor Secular Trusts...213 Employer-Grantor Secular Trusts...213 Secular Trust Summary...215 Rabbi/Secular Trusts and Non-Sectarian Trusts...215 Surety Bonds and Indemnity Insurance...216 Third-Party Guarantees...219 Plan Document Provisions...220 Conclusion...224 Chapter 8: Miscellaneous Plan Considerations...229 Reasonable Compensation Considerations...229 Federal Income Tax Concerns...229 Golden Parachute Rules...233 State Corporate Waste Law Concerns...234 Social Security and Federal Unemployment Tax Considerations...236 Background...236 Pre-1983 Amendments...237 Social Security Amendments of 1983...238 Proposed & Final Regulations...239 What Plans are Covered Under FICA/FUTA?...239 Special Timing Rule and Nonduplication Rule...240 Account Balance Versus Nonaccount Balance Plans For FICA Purposes...241 Death Benefits...242 Are Social Security Benefits Reduced? The Work Test & Earned Income Rules...242 Independent Contractors...244 xi
A Front Pages 6/29/06 2:59 PM Page xii Summary...244 General & 409A Withholding & Reporting for Income Tax Purposes...246 In General...246 Form W-2 Requirements After 409A...247 SEC Considerations...248 Introduction...248 Proxy Disclosure Requirements Background...249 History of Pre-2007 Proxy Disclosure...250 Pre-1993 Proxy Disclosure...250 1993 Disclosure Requirements...251 Defined Benefit Plans Pre 2006...252 Proposed Proxy Disclosure Regulations 2006...252 Nonqualified Plan Disclosure Issues Under the SEC s 2006 Amendments...256 What Should a Narrative Nonqualified Deferred Compensation Plan Disclosure Look Like?...258 Plan Proxy Descriptions After the Dependahl Case...259 Sample Proxy Statement Description...264 SEC Form 8-K Accelerated Disclosure Requirements For Executive & Director Compensation...265 Securities Registration Requirements & Issues...267 NYSE & NASDAQ Prior Shareholder Approval Requirements...270 In General...270 Controlling Shareholder Situations...271 Constructive Dividend & Deductibility Issues...271 Nonqualified Deferred Compensation Plans & Bankruptcy...272 Nonqualified Plan Benefits & Divorce...274 Nonqualified Plan Impact on Existing Qualified Plans?...276 Nonqualified Plans in Global Companies (U.S. or Foreign)...277 Business Exchange Provisions on COLI Contracts...279 Financial Institutions and Nonqualified Deferred Compensation Plans & Bank-Owned Life Insurance (BOLI)...280 Chapter 9: Specimen Documents...287 Designing & Documenting a Nonqualified Deferred Compensation Plan...287 Introduction...287 General Design Parameters...288 Common Nonqualified Plan Design Traps...291 General Guidelines & Requirements of a Nonqualified 451 Deferred Compensation Plan Document In Light of 409A...293 Summary...295 Sample Documents...296 Introduction...296 Index...353 xii