Spreading the Word on New Rules for Deferred Compensation Plans

Companies may have breathed a sigh of relief in the fall when the Internal Revenue Service and the Department of Treasury issued guidance on new rules governing nonqualified deferred compensation plans. As part of that guidance, the IRS and Treasury extended the deadline for compliance to the end of 2006 from December 31, 2005.

But benefits attorneys are counseling employers to start bringing executives and their deferred compensation plans into compliance with the new rules sooner rather than later.

“This is groundbreaking legislation because it impacts areas that employers have never had to worry about before,” says Steven Friedman, an employee benefits attorney with Littler Mendelson in New York. “It impacts severance plans, employee agreements, incentive programs as well as traditional executive compensation agreements.”

Congress passed the new rules on deferred compensation in the wake of the Enron scandal to prevent executives from withdrawing money when their companies are in trouble. The onus of complying with the new rules, which apply to all employee payments made in years after the money is earned, is on employees themselves. Failure to comply with the rules could result in a 20 percent tax with interest.

However, since these arrangements usually involve top executives, it is in employers’ best interest to make sure everyone understands the rules. By not doing so, companies could be slapped with a lawsuit by an executive who claims that the employer did not provide sufficient information on the rule change, says John Graham, regional director of compliance research at the Segal Co., a New York consulting firm.

Under the old rules, there was latitude about when executives could withdraw money from their deferred compensation plans. The new rules state there are only six events that permit access to plans: agreed-upon date or event, death, disability, separation from service, change in company ownership or an unforeseeable emergency. Executives are not allowed to accelerate when they can access the money unless those events apply—and even then there are special rules about how they can make elections.

Compensation and HR managers need to understand that the new rules require a rewriting of their plans, says Liz Buchbinder, a partner in the Washington, D.C., office of Ernst & Young.

“They can’t just modify the plan a little,” she says. “The ramifications for doing something wrong are too huge.”

Companies need to document every compensation agree­ment and attempt at communication about those agreements, not only for good employee relations, but to have on file in case there’s a government audit, says Littler Mendelson attorney Friedman.

—Jessica Marquez