Eight years ago, the IRS announced it intended to provide additional regulatory guidance on nonqualified deferred compensation plans (NQDC) of state and local governments and tax-exempt entities. Taxand USA provides an update.
Recently, IRS officials informally indicated that this guidance will be issued very soon. We believe that means the formal guidance may be issued by the end of this year or early in 2016 — although the IRS is not operating under any public deadlines, so it may still take some time before the guidance is issued.
While Section 457(f) of the Internal Revenue Code (IRC) applies to NQDC plans provided by not-for-profit and government entities, Section 409A applies more broadly to NQDC plans. Although Section 457(f) and Section 409A both apply to NQDC plans of tax-exempt employers, the two IRC sections have conflicting terms.
Under Section 457(f), amounts deferred become includable in taxable income when those amounts are no longer subject to a “substantial risk of forfeiture.” However, when a substantial risk of forfeiture is imposed after the legally binding right to compensation occurs (often referred to as a “rolling risk of forfeiture”), the risk of forfeiture may be recognised as a proper income deferral approach under Section 457(f), but not under Section 409A. This inconsistency is expected to be addressed in the upcoming guidance. Observers expect the IRS guidance to align the definition of substantial risk of forfeiture more closely to the Section 409A definition.
Perhaps after waiting for more than eight years, the advisory community will receive guidance in the form of proposed regulations under Section 457(f). These proposed regulations may also open the door to additional regulations under Section 409A. Does this mean another round of plan amendments for the many existing NQDC plans sponsored by tax-exempt organisations? The answer is “it depends.” The actual regulations will dictate the need for plan amendments. Certainly, that may be the price we have to pay for a promise that is (finally) kept.