Deferred Compensation for Executives under Sec. 409A (Part I) — footnotes

¹“Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues and Policy Recommendations,” Joint Committee on Taxation, JCS 3-03 (February 2003), Vol. I, p. 12–15.

²These payouts were part of a much larger program of compensation for top management. In 1998, top executives recognized income of approximately $125 million from exercising stock options, and $24 million from removing restrictions from stock grants. For 2000, these numbers were $1.5 billion and $132 million respectively; see Joint Committee Report, note 1 supra, at p. 41.

³Sec. 409A(c).

⁴Notice 2005-1, IRB 2005-2, 274.

⁵Notice 2006-33, IRB 2006-15, 754.

⁶See id. and Sec. 409A(b).

⁷See Secs. 61 and 451(a); Regs. Sec. 1.451-1 and Rev. Rul. 60-31, 1960-1 CB 174, as modified by Rev. Rul. 70-435, 1970-2 CB 100.

⁸Rev. Rul. 60-31, note 7 supra.

⁹J.E. Reed, 723 F2d 138 (1st Cir. 1983). By contrast, see Example 4 in Rev. Rul. 60-31, note 7 supra, which involved an athlete’s signing bonus that was placed into escrow, to be payable, with interest, over five years. This was held to be taxable immediately to the athlete, because the money was irrevocably delivered to the escrow agent and the employer’s discretion had ended.

¹⁰Because the service provider in this case was a rabbi and the service recipient his congregation, this type of arrangement became known as a “rabbi trust”; see IRS Letter Ruling 8113107 (12/31/80).

¹¹E.T. Sproull, 16 TC 244 (1951), aff’d, 194 F2d 541 (6th Cir. 1952).

¹²Rev. Proc. 92-64, 1992-2 CB 422.

¹³One variation was a provision in the trust that if and when the employer otherwise became insolvent, all funds would automatically revert to the employer’s accounts for its general funds.

¹⁴Of course, if the automatic trigger occurred too close in time to actual insolvency, the employee ran the risk that the payment would constitute a fraudulent conveyance. Such a trust was sometimes referred to as a “rabbicular trust” (hybrid rabbi/secular trust).

¹⁵See note 12, supra.

¹⁶See note 4, supra.

¹⁷REG-158080-04 (10/4/05). These proposed regulations will probably be supplemented during the last half of 2006 and may become final as of Jan. 1, 2007.

¹⁸See Sec. 409A(d)(1) and (2) and Prop. Regs. Sec. 1.409A-1(a)(2) and (3).

¹⁹One has to distinguish between Sec. 457(b) arrangements and those under Sec. 457(f). As of the Economic Growth and Tax Relief and Reconciliation Act of 2001, amounts held in a Sec. 457(b) plan for the benefit of employees are taxable either when paid or “first made available” under the terms of the particular plan. For this purpose, “first made available” means the date, after termination, on which the plan authorizes actual distributions to commence. By contrast, compensation owed to an employee under a Sec. 457(f) plan (also referred to as an ineligible plan) is taxable in the full amount of benefits that are vested (or, expressed another way, for which there is no longer any “substantial risk of forfeiture”). Sec. 409A does cover Sec. 457(f) arrangements.

²⁰For this purpose, “certain” means (1) nonresident aliens and (2) persons who are classifiable as resident aliens solely by reason of the “substantial presence” test; see Prop. Regs. Sec. 1.409A-1(a)(3).

²¹See Prop. Regs. Sec. 1.409A-1(a)(3)(iii).

²²See Prop. Regs. Sec. 1.409A-1(a)(3)(iv).

²³See Prop. Regs. Sec. 1.409-1(c)(2)(ii).

²⁴See Prop. Regs. Sec. 1.409-1(c)(3)(i).

²⁵Preamble II-A, REG-158080-04, note 17 supra.

²⁶See Prop. Regs. Sec. 1.409A-1(b)(1).

²⁷See Notice 2005-1, note 4 supra, Q&A-4; and Prop. Regs. Sec. 1.409A-1(b)(1).

²⁸ “However, if the facts and circumstances indicate that the discretion to reduce or eliminate the compensation is available or exercisable only upon a condition, or the discretion to reduce or eliminate the compensation lacks substantive significance, a service provider will be considered to have a legally binding right to the compensation. Whether the negative discretion lacks substantive significance depends on the facts and circumstances of the particular arrangement” (Prop. Regs. Sec. 409A-1(b)).

²⁹Notice 2005-1, note 4 supra, Q&A-4; and Prop. Regs. Sec. 1.409A-1(b)(3) and (4).

³⁰See Prop. Regs. Sec. 1.409A-1(b)(4).

³¹The statute provides some relief for circumstances in which a service provider actually performs services in a foreign jurisdiction. Under Sec. 409A(b)(1), the compensation payable from those services may be placed in a trust and/or bank account located in that same jurisdiction.