What is Deferred Compensation and How Can Your Business Benefit from it?

Deferred Compensation

Many Florida companies benefit from using deferred compensation plans for a variety of reasons. Some startup companies lack the current cashflow to hire key employees; however, the company might be able to attract the right candidate by tying a portion of the employee’s compensation to future corporate earnings.

For example, a start-up company in Miami, Florida may struggle to bring in a high-level employee to manage the company, but by offering company stock options through a deferred income plan could attract candidates that the company couldn’t otherwise afford. Also, some companies use a deferred compensation plan as an incentive for an employee to stay with the company for an extended period of time.

What Is The Purpose Of Internal Revenue Code Section 409A?

Internal Revenue Code Section 409A (“Section 409A”) regulates nonqualified deferred compensation. An example of a nonqualified deferred compensation plan is one which discriminates in favor of highly compensated employees. Deferred compensation is defined as compensation earned in one year but paid out in a later year. Section 409A potentially governs a variety of benefit programs, including severance programs, employment agreements, bonuses programs, and deferred compensation plans.

Potential Penalties Under Section 409A

It is imperative to establish and maintain compliance when dealing with Section 409A because non-compliance comes at a high cost for both the employee and the employer. Non-compliance with Section 409A will result in:

  • All vested amounts being includable as income in the current tax year;
  • An additional 20 percent tax, plus interest; and
  • Other similar plans the employer has to be deemed non-qualifying.

How To Comply With Section 409A?

Section 409A has a broad reach so it is important to understand how to establish and maintain compliance when planning to offer deferred compensation to key employees. There are four requirements that must be met at the initial deferral. These requirements include:

  • The arrangement must be in writing;
  • The deferral amount must be specified or based on a formula that is nondiscretionary and objectively determinable;
  • The form of payment must be specified; and
  • The distributions of payments must be narrowly limited to one or more of six payment triggers, known as permissible payment events. The permissible payment events arise upon:
    • Separation from service (retirement, termination, resignation, etc.);
    • Disability;
    • Death;
    • Predetermined time or payout schedule;
    • Change in company control; and
    • Unforeseeable emergency.The penalties are steep and it’s best to comply from the beginning or to catch non-compliance as early as possible; therefore, it is imperative to have a tax attorney regularly review your deferred compensation plans to ensure that all plans are in accordance with Section 409A.

The penalties are steep and it’s best to comply from the beginning or to catch non-compliance as early as possible; therefore, it is imperative to have a tax attorney regularly review your deferred compensation plans to ensure that all plans are in accordance with Section 409A.

EPGD Business Law is located in beautiful Coral Gables, West Palm Beach and historic Washington D.C. Call us at (786) 837-6787, or contact us through the website to schedule a consultation.

*Disclaimer: this blog post is not intended to be legal advice. We highly recommend speaking to an attorney if you have any legal concerns. Contacting us through our website does not establish an attorney-client relationship.*

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