On June 17, the House approved the American Jobs Creation Act (H.R.4520), which
would make several significant changes to the rules on nonqualified deferred
compensation (NQDC). The Senate approved similar NQDC provisions in the
Jumpstart Our Business Strength (JOBS) Act (S.1637). Now, lawmakers must work out a
compromise between the two bills. Although the legislation and the politics surrounding
the bills are still evolving, employers that sponsor NQDC arrangements should prepare for
the possibility of new rules.
The American Jobs Creation Act and the JOBS Act would impose new restrictions on NQDC
arrangements, but the effects of the legislation could extend well beyond arrangements
generally considered “nonqualified deferred compensation.”
New Requirements and Restrictions for Nonqualified Plans
Under the American Jobs Creation Act and the JOBS Act, failure to comply with the NQDC
requirements would cause all compensation deferred under the plan — to the extent it is not
subject to substantial risk of forfeiture and had not been previously included in income —
to be includible in gross income and subject to interest penalties. General requirements in
the legislation include:
- Restrictions on distributions. Accelerations would be prohibited and distributions
generally would be permitted only upon separation from service, death, disability or an
unforeseeable emergency; or at a specified time or pursuant to a fixed schedule; or due
to a change in ownership or control of the corporation.
- Requirements relating to the timing of deferral elections. Initial deferral elections
generally would have to be made during the taxable year preceding the year in which
the services are performed.
- Restrictions regarding elections to change the timing of a distribution or form of
payment. Subsequent elections to delay a payment or change the form of a distribution
would not take effect for at least 12 months and must delay the initial payment by at
least five years.
- Prohibition on offshore funding. Assets set aside or transferred outside the United
States for purposes of paying benefits under an NQDC plan would be treated as property
transferred in connection with the performance of services, whether or not the assets
were available to pay the claims of general creditors.
- Taxation if assets are restricted upon change in employer’s financial health.
Assets restricted to the payment of benefits under an NQDC plan in connection with
a change in the employer’s financial health would be treated as a transfer of property
under section 83.
- W-2 reporting of NQDC. Employers would have to report amounts deferred under a
nonqualified plan on the W-2.
Conference Committee Must Negotiate Differences
The NQDC provisions in the American Jobs Creation Act and the JOBS Act are similar. But
there are some important differences, which must be reconciled by a conference committee
that will be assigned to work out a compromise between the two bills. For example, under
the Senate-approved JOBS Act, the investment options available in the NQDC arrangement
would have to be “comparable to” those offered by the employer’s qualified defined contribution
plan with the fewest investment options. The American Jobs Creation Act does not
include this provision. In addition, the JOBS Act would prohibit the deferral of gains from
the exercise of stock options, restricted stock and other employer securities.
The JOBS Act and the American Jobs Creation Act also have different effective dates. The
JOBS Act would apply to compensation deferred after December 31, 2004. The American
Jobs Creation Act would apply to compensation deferred after June 3, 2004, but would
grandfather compensation deferred between June 4, 2004, and December 31, 2004, as long
as an irrevocable election or binding agreement was in place on June 3, 2004. In addition,
under the American Jobs Creation Act, a subsequent election relating to compensation
deferred before June 3, 2004, would subject such compensation to the act’s new rules.
Scope of Act Extends Beyond Traditional Nonqualified Plans
The JOBS Act and the American Jobs Creation Act would define “nonqualified deferred
compensation” as any plan that provides for the deferral of compensation other than a
qualified employer plan or any bona fide vacation leave, sick leave, compensatory time,
disability pay or death benefit plan. Currently, NQDC is not defined as arrangements
under which participants choose to defer their compensation. So the bills’ restrictions
would extend to nonqualified defined benefit arrangements — and could be applied to
stock options, restricted stock units and other compensation arrangements.
Effective Date and New Election Requirements Could Create Compliance Problems
The American Jobs Creation Act and the JOBS Act would require that plan participants
make their initial election deferrals in the taxable year preceding the year in which they
will perform the services associated with the compensation. This provision presents special
concerns involving the timing of enactment and the effective date of the act, as well as
deferrals from bonuses and long-term incentive programs.
If it’s enacted this year, the legislation could take effect for compensation deferred beginning
in 2005 or earlier. An early effective date may not give employers enough time to accept
and process elections for services that will be performed during the 2005 taxable year.
Employers may wish to change their election process to help smooth the transition if new
rules are enacted this year.
The election requirement could also pose problems for deferrals from bonuses that would
be paid in 2005 based on services performed in 2004. Unless the legislation provides
transition relief or employees made deferral elections in 2003, deferrals from such bonuses
could be prohibited. In the future, employers would have to ensure compliance with the
The election requirement could create significant difficulties for companies that pay long-term
incentive bonuses over a period of several years, since elections would have to be
made in advance of the first payment — in some cases, three or four years before the final
payment would be made. Report language that accompanies the American Jobs Creation
Act states that the Treasury regulations would provide that, “in appropriate circumstances,
elections to defer incentive bonuses earned over a period of several years may be made
after the beginning of the service period, as long as the election is made at least 12 months
before the earliest date on which the incentive bonus is initially payable. The Secretary
may consider other factors in determining the appropriate election period, such as when
the amount of the bonus payment is determinable.”
Outlook and Action Steps
Different employers could be affected differently, depending on their current plans and
practices and the final legislation. The timing of further legislative action and the ultimate
outcome of the legislative debate are unclear. But, if changes are enacted this year, employers
might be hard-pressed to implement the new rules in time to meet the new deadlines.
Congressional leaders have not yet appointed a conference committee to negotiate a compromise
between the American Jobs Creation Act and the JOBS Act. So, we don’t know when —
or even whether — lawmakers can achieve a compromise between the two bills this year.
Although it would be premature to make significant changes just yet, now is the time to
read up on the legislation and prepare for the possibility of important changes to come.