Page 109 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 3. Current versus Deferred Compensation 95

13. Compensation deferred cannot be considered pay during the period of deferral for
purposes of determining benefits under qualified pension and profit-sharing plans. In
testing compliance, pay must satisfy an IRC Section 414(G) definition, such as W-2 or
gross pay. Care should be taken to ensure that life insurance and disability protection
is not similarly reduced. Thus, while this has little effect on short-term deferrals
(except for installments payable after retirement), it has considerable impact on long-
term deferrals not payable until after retirement. The result can be a very significant
reduction in the company pension plan payments—the magnitude being a factor of
the percentage of earnings deferred. Such a position was described by the IRS in
Revenue Ruling 68-454 when it disallowed compensation deferred by certain officer-
employees. However, in accord with Revenue Ruling 69-145, it would appear that
such compensation could be recognized if all employees were eligible to defer com-
pensation. Revenue Ruling 80-359 added that if the proportion of lower-paid employ-
ees who made deferrals was equal to or greater than the higher-paid, the basis for
calculating benefits would not be viewed as discriminatory in favor of the prohibited
group. However, given the low limits on qualified plans, this is only a theoretical
disadvantage.
14. Payment beginning at the time of retirement from the company can create another
problem, namely, when the individual is “retiring” from company A to join company B.
The earnings from the new employer will significantly reduce, if not totally eliminate,
any tax advantage the executive hoped to receive on the deferred payments. However,
careful planning and specific language in the deferral contract can essentially eliminate
this problem. Namely, the contract with company A should indicate that payments
begin when the employee ceases full-time employment (not simply employment with
company A). In addition, it may be advantageous to indicate that payment should
begin the year after the year in which full-time employment ceases. In case of a person
retiring late in the year, sufficient earnings may have been accumulated to eliminate
favorable tax treatment of any deferral payments that year.
15. Some committees only allow the executive to state preferences (current vs. deferred) in
percentages (e.g., 25 percent immediate and 75 percent deferred). This approach does
not recognize that the individual’s current needs are absolute, not relative. Thus, using
the above percentage example, everything would be fine if the total award were $400,000
and the individual’s current needs were $100,000. But what if the committee decided the
executive should only receive a total of $200,000? In this case the immediate amount
($50,000) would be one-half of the needed $100,000.
This problem can be overcome simply by allowing the executive (at the beginning of
the agreement so as to obviate constructive receipt problems) to indicate the dollar
amount desired currently or deferred, with the balance going to the other. Thus, the
executive could indicate a preference for the first $100,000 in cash with the rest
deferred, or conversely, the first $200,000 deferred with the rest payable currently. An
additional refinement would be to combine that absolute and the relative (e.g., the first
$100,000 or 25 percent, whichever is greater, payable immediately, with the balance
deferred).
16. If the deferred payments are designed to continue after the death of the employee, such
payments will probably be included in the decedent’s estate in accordance with Section
2039 of the Code. In addition, if the payment would have been considered taxable