Louis E. Michelson, A Professional Corporation

The IRS issued Proposed Treasury Regulations under Internal Revenue Code Section 457 regarding deferred compensation plans on June 22, 2016 which can be viewed at the following link.  At the same time, the IRS also released new Proposed Treasury Regulations under Internal Revenue Code Section 409A which can be viewed at the following link.

 

For those who have limited familiarity with this area the following glossary may help:

 

• “Eligible employers” includes tax-exempt non-profit and governmental employers.

 

• “Section 457(b) plan” – one type of deferred compensation plan that may be offered by eligible employers where employees are limited in the amount of compensation that may be deferred each year. In this type of plan, deferred compensation is taxed when paid or made available to the employee.

 

• “Section 457(f) plan” – another type of deferred compensation plan that may be offered by eligible employers where employees are not limited in the amount of compensation that may be deferred each year. This type of plan is sometimes referred to as an “ineligible plan.”   In this type of plan, deferred compensation is taxable to the employee when it becomes vested.  Vesting occurs when the compensation is no longer subject to a “substantial risk of forfeiture” (more on this concept below).

 

• “Section 409A” applies to compensation that workers earn in one year, but that is paid in a future year. This is referred to as nonqualified deferred compensation. This is different from deferred compensation in the form of elective deferrals to qualified plans (such as a 401(k) plan) or to a 403(b) or 457(b) plan.  See the following link for more information regarding Section 409A.

 

The Proposed Regulations are very lengthy, detailed and complex and this e-bulletin does not even scratch the surface of the new Regulations.  Nonetheless, one example may be instructive.

 

One eagerly awaited guidance in the new Proposed Regulations is the IRS definition of “substantial risk of forfeiture” that specifically applies to Section 457(f).  The Regulations define a substantial risk of forfeiture as follows:

 

An amount of compensation is subject to a substantial risk of forfeiture only if entitlement to the amount is conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation if the possibility of forfeiture is substantial.

 

This definition mostly tracks the definition from the Section 409A.  But in at least one area, non-compete agreements, the new Proposed Regulations definition is different from the Section 409A definition.   Under the Proposed Regulations, compensation contingent upon compliance with a non-compete covenant will be considered subject to a substantial risk of forfeiture if the following three conditions are satisfied:

 

• The covenant not to compete is pursuant to a written agreement that is enforceable under applicable law.

 

• The employer must consistently make reasonable efforts to verify compliance with all of the noncompetition agreements to which it is a party.

 

• When the agreement is entered into, the facts and circumstances show that the employer has a substantial and bona fide interest in preventing the employee from performing the services and that the employee has a bona fide interest in, and ability to, engage in the prohibited services.

 

Before the proposed regulations are adopted as final regulations, consideration will be given to any written or electronic comments that are submitted timely to the IRS.  A public hearing has been scheduled for October 18, 2016.  Comments and requests for a public hearing on the Regulations must be received by September 20, 2016.  If one is interested, one can send submissions to:

 

CC:PA:LPD:PR (REG-123854-12)

Room 5203

Internal Revenue Service

P.O. Box 7604

Ben Franklin Station, Washington, DC 20044.

 

Alternatively, submissions may be hand delivered Monday through Friday, between the hours of 8 a.m. and 4 p.m. to:

 

CC:PA:LPD:PR (REG-123854-12)

Courier’s Desk

Internal Revenue Service

1111 Constitution Avenue NW.

Washington, DC 20224

 

Submissions may be sent electronically via the Federal Rulemaking Portal at www.regulations.gov (IRS REG-123854-12).