Proposed Tax Reform Targets Executive Deferred Compensation

Buried deep within the 429 pages of the tax reform proposal, titled the “Tax Cuts and Jobs Act,” is a provision that would significantly change the landscape for executive deferred compensation plans. Specifically, Section 3801 of the Act, titled “Nonqualified Deferred Compensation,” would move the point of taxation of most forms of deferred compensation from the time of actual payout to the executive, which is generally the case under the current rules, to the point at which the executive need no longer perform substantial services in order to receive the compensation; e.g., the point at which the funds “vest.”  Other changes are proposed, but this single timing issue would remove much of the appeal of deferred compensation plans. The changes, if they become law, would affect not just deferrals of cash compensation, but also equity forms of compensation such as stock options and stock appreciation rights.

The Act would also repeal the current compliance regime for nonqualified deferred compensation, known as the “Enron rules” (because they were inspired by manipulation of deferred compensation by certain Enron executives), and codified at Code Section 409A, which have been in place since 2005.  The new rules, if passed into law, will be set forth under Section 409B of the Code.

This is not the first time that Congress has proposed these changes to deferred compensation; a version of them appeared in the Tax Reform Act of 2014, also under Section 3801 of that bill.  An excellent and detailed overview of the those earlier proposed changes appeared in the Summer 2014 issue of the Benefits Law Journal.  The article deserves re-reading now that deferred compensation reform is back on the table under the Tax Cut and Jobs Act.