Deferred Compensation Was Subject to Substantial Risk of Forfeiture Where Employer Provided Twenty-Five Percent Match

(Parker Tax Publishing November 2016)

The IRS Office of Chief Counsel advised that where an employee entered into an agreement to defer payment of portion of his salary for three years, and his employer matched 25 percent of the deferred amounts, the deferred compensation was subject to a substantial risk of forfeiture under Code Sec. 409A. Accordingly, the taxpayer would not be required to currently include the amounts in gross income. CCA 201645021.

Background

Under the facts of CCA 201645021, a taxpayer entered into an agreement with his employer to defer a portion of his salary that would otherwise have been paid during a specified year, with payment of the deferred amount to be made as a lump-sum payment on January 1 of the third year following the deferment. The deferred amount would only be paid if the employee continued to provide substantial future services until the beginning of that third year.

Under the agreement the employee's salary was reduced by $600 each biweekly pay period (26 x $600 or $15,600) and the employer credited matching amounts to the employee's deferred compensation account of 25 percent of each salary reduction (26 x ($600 / 4) or $3,900) for a total amount deferred of $19,500. The matching amounts were credited each time the salary reduction amount would otherwise have been paid as salary.

An IRS attorney requested advice from the IRS Office of Chief Counsel (IRS) on whether the salary that the employee could have elected to receive as compensation would be treated as subject to a substantial risk of forfeiture under Code Sec. 409A.

Analysis

Code Sec. 409A generally provides that if a nonqualified deferred compensation plan fails to meet certain statutory constructive receipt rules, then all amounts deferred under the plan for all tax years are immediately includible in a participant's gross income to the extent the amounts are not subject to a substantial risk of forfeiture and were not previously included in gross income.

Reg. Sec. 1.409A-1(d)(1) provides that, in general, a substantial risk of forfeiture exists if the receipt of deferred compensation is conditioned on the performance of substantial future services, and the possibility of forfeiture is substantial. In addition, an amount will be considered subject to a substantial risk of forfeiture if the present value of the amount subject to forfeiture is "materially greater" than the present value of the amount the recipient otherwise could have elected to receive absent such risk of forfeiture.

The IRS advised that an amount that an employee could have elected to receive as salary can be treated as subject to a substantial risk of forfeiture under Code Sec. 409A if the employer provides a matching contribution resulting in a 25 percent increase in the present value of the amount deferred.

The IRS noted that, under the facts presented to it, the present value of the amount deferred by the taxpayer was 25 percent greater than the amount he otherwise could have received absent the addition of the substantial risk of forfeiture. The IRS stated that a 25 percent increase in the present value of the amount a service provider could have received absent the risk of forfeiture is a material increase. Accordingly, the IRS advised that the combined deferred amount of the taxpayer's salary ($15,600) plus the deferred amount of the employer's matching contribution ($3,900) was subject to a substantial risk of forfeiture for purposes of Code Sec. 409A. As such, the deferred amounts were not currently included in the taxpayer's gross income.

For a discussion of the tax treatment of amounts deferred under a nonqualified deferred compensation plan, see Parker Tax ¶135,505.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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