Code 457(f) Plans and Problems ... for Tax Exempt Orgs

(see also 457(f) "vesting roll forward" rules / Interaction with 4960 parachute limits)

2020.02.27  Take Warning: Tax Exempt Orgs.  This is happening too often. A valued executive gets ready to retire from a charity or other tax exempt organization, and is promised some form of severance or retirement benefit that will be paid for months or years afterward. Because the payout involves a fixed payout schedule, no one expects a tax disaster. That seems to have happened to a rabbi, who has just sued his synagogue's law firm for damages arising because, as an Illinois district court noted, "his deferred compensation plan was not tax-compliant" (Stanley E. Kroll v. Cozen O'Connor PC, case number 1:19-cv-03919, N.D.IL).  

  • What 457(f) requires: For plans subject to Code section 457(f), deferred compensation is included in the participant’s gross income for the first taxable year in which there is no substantial risk of forfeiture of the rights to the compensation. Section 457(f)(3)(B) provides that the rights of a person to compensation are subject to a substantial risk of forfeiture if the participant’s rights to the amounts deferred are conditioned upon the future performance of substantial services. Section 83 of the Code and the regulations thereunder provide additional assistance in determining what is a substantial risk of forfeiture and what kind of services are substantial for purposes of section 457(f). 
  • The Backstory: Section 457(f) is a sleeper of a tax provision, mainly because its application is limited to tax-exempt and governmental employers. By contrast, Section 409A has become the most widely-known (and dangerous) tax law that governs deferred compensation, whether it relates to public and private entities, and whether they are for-profit or not-for-profit. As a result of 409A's notoriety, many tax advisors and executives presume that a plan's compliance with Section 409A is alone sufficient to satisfy applicable tax laws for deferring compensation. 
  • The Problem: Section 409A permits an executive or other service provider to have compensation vest in one year, yet to defer tax until future years when payout occurs.  By contrast, Section 457(f) requires income inclusion as soon as vesting occurs for compensation payable from a not-for-profit organization. For instance, if such an organization unconditionally promises -- in a severance or retirement agreement -- to continue an executive's salary for 10 years after retirement, the present value of all 10 years of salary becomes taxable when the agreement is signed.

2019.01.22  457(f) Landmine Lurks for All Tax-exempt Organizations … Even the Small Ones!  “Maybe not today.  Maybe not tomorrow, but someday” … you are likely to have a golden parachute problem.  It’s not often that Casablanca and tax law intersect, but the above warning is apropos for any tax exempt organization that has a 457(f) plan. Plans of that kind are typically structured to avoid immediate income taxation for executives by deferring benefit payments until their termination of employment. No one would think this could trigger golden parachute penalties for the organization.  In the wake of IRS Notice 2019-09, however, tax-exempt organizations should think again.  Continued at ... 457(f) and 4960 Parachute Risks.

2018.10.05  Statute of Limitations and 457(f) Violations. What a mess. I just spent a week exhaustively analyzing the confluence of W-2c corrective filings, the amounts includible in income when 457(f) violations span open and closed tax years, and the going forward strategies for formulating a cost-effective strategy by which to go forward. This BenefitsLink exchange is thought provoking. Just email Mark for more info. 

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