Nonqualified Deferred Compensation and the Pre-Statutory Limits on Deferral
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Description
This section introduces the problems relating to the recognition of income and the deferral of income by a cash method taxpayer participating in a nonqualified deferred compensation plan and discusses the enactment of IRC Section 409A to deal with these problems. A taxpayer on the cash receipts and disbursements method of accounting is entitled to defer the recognition of gross income until the income item—whether in the form of cash, property, or services—is actually or constructively received. While this principle appears straightforward enough, it raises a number of questions. First, to what extent should contractual rights to future cash payments be separately regarded as an item of property for income recognition purposes? Furthermore, what rights or elections possessed by the taxpayer are sufficient to place the taxpayer in constructive receipt of future payments? These questions have arisen primarily in the context of nonqualified deferred compensation arrangements. Until Congress stepped into the fray in 2004 with the enactment of IRC Section 409A, the field of nonqualified deferred compensation represented a Wild West of sorts in the tax planning arena. Taxpayers and their advisors pushed the limits of deferral of income recognition offered by the cash method with little in the way of administrative oversight. The goal of their efforts was to secure the future payment obligations to the greatest extent possible while maximizing the control enjoyed by the employee (or other service provider) over the investment of the deferred funds and the date the funds ultimately would be paid—all without subjecting the deferred payments to current taxation. Designing these arrangements entailed navigating a host of doctrines that developed as a means of reasonably limiting the opportunities for deferral under the cash method: (a) the economic benefit doctrine (which was codified through the enactment of IRC Section 83); (b) the constructive receipt doctrine; and (c) the cash equivalency doctrine. This chapter is dedicated to describing these doctrines of income recognition under the cash method and tracing their development to the point of congressional action through IRC Section 409A. A disclaimer is warranted here at the outset: IRC Section 409A changes the results of many of the cases and rulings discussed in this chapter, particularly with respect to salary deferral elections and payment acceleration rights. The statute, however, does not operate as a wholesale replacement of the income recognition doctrines detailed in this chapter. Rather, IRC Section 409A augments those doctrines by triggering current income recognition of deferred payments in certain instances where the taxpayer otherwise would have been entitled to deferral. To the extent IRC Section 409A does not apply to a particular arrangement, the economic benefit doctrine, the constructive receipt doctrine, and the doctrine of cash equivalency remain relevant in determining when the compensation income will be recognized for tax purposes. Although a separate chapter of this treatise is dedicated to IRC Section 409A, this chapter concludes with a brief description of how the legislation augments the underlying doctrines of income recognition. Most deferred compensation arrangements of state and local governments and tax-exempt employers (other than churches) are subject to additional rules under IRC Section 457, and IRC Section 457A provides yet more rules for nonqualified deferred compensation arrangements of certain “tax indifferent parties.”
Source Publication
Bender's Federal Income Taxation of Retirement Plans
Source Editors/Authors
Alvin D. Lurie
Publication Date
2008
Recommended Citation
Hellwig, Brant J., "Nonqualified Deferred Compensation and the Pre-Statutory Limits on Deferral" (2008). Faculty Chapters. 758.
https://gretchen.law.nyu.edu/fac-chapt/758
