Watch this video and learn about the NQDC (409A) – Deferred Compensation Plans and how you can implement one easily
What does the TV show Suits have to do with a deferred compensation and an insurance consulting firm? Well, Mike Ross, while running from the cops, runs into the interview room of Harvey Specter, a Harvard Lawyer who is interviewing new associates.
During their brief encounter, Mike is quizzed on a number of legal matters, one of which is 409A. Check out this clip at 2:30 where the topic comes up.
Tuesday, March 26, 2019 at 6:23PM
IRS Notice 2019-09 provides guidance intended to help “applicable tax-exempt employers” determine whether compensation paid to their most highly compensated employees will be subject to the 21 percent excise tax imposed under Code Section 4960. Notice 2019-09 is indeed helpful to those of us who have to interpret the provisions of Code Section 4960. But tax-exempt employers subject to Code Section 4960 have serious work to do in order to comply with these relatively new rules, and some tax-exempt employers will be disappointed in the results. (In general, compensation paid by a Section 501(c)(3) organization will be subject to the requirements of Code Section 4960, so we will simply reference tax-exempt employers for these purposes.)
Excise Tax Under Code Section 4960
Enacted as part of the 2017 Tax Cuts and Jobs Act, Code Section 4960 imposes a 21 percent excise tax on: (1) compensation paid by a tax-exempt employer to a “covered employee” in excess of $1 million in any year; and (2) “excess parachute payments” paid by a tax-exempt employer to a covered employee. A Section 4960 excess parachute payment is a payment made contingent upon a termination of employment, if the payment amount equals or exceeds the terminating employee’s average annual taxable compensation over the preceding five years. The tax on an excess parachute payment is due on the portion of the payment that exceeds the covered employee’s average annual compensation (not just the portion in excess of $1 million).
Covered Employees and Related Organizations
The identification of covered employees is a major topic addressed by Notice 2019-09. In general, a covered employee is an individual who is one of the five highest paid employees of the exempt organization in any taxable year beginning after December 31, 2016. There is no minimum compensation threshold that applies in determining covered employee status. And, perhaps most important, once an individual is identified as a covered employee she will remain a covered employee – forever. This means that a tax-exempt employer must identify its covered employees every year and keep track of them on an ongoing basis.
A tax-exempt employer must identify its covered employees based not only on remuneration paid by that employer, but also taking into account remuneration for services performed by the individual as an employee of any “related organization” of the employer. Under Notice 2019-09, a related organization is any entity that is under common control with a tax-exempt employer using a more-than-50 percent control test. This approach may create headaches for many tax-exempt employers, who are used to the 80 percent control test that generally applies in determining the members of a controlled group of exempt organizations. So a tax-exempt employer within an integrated health system, for example, must determine the extent to which remuneration must be imputed to an employee for services from a related organization that may only be 50 percent owned by the employer in determining covered employee status. Moreover, an individual can be deemed to be an employee of more than one tax-exempt employer. Therefore, it is possible that a single employee could be a covered employee with respect to more than one tax-exempt employer within a system. Finally, given the “forever” status of covered employees, the recordkeeping headaches will multiply when, for example, two health systems merge.
Compensation Is Considered Paid When Vested and on a Calendar Year Basis
Code Section 4960 states that compensation will count toward the $1,000,000 threshold when it ceases to be subject to a substantial risk of forfeiture (i.e., when it vests), rather than when it is paid. But Notice 2019-09 includes a helpful grandfathering rule. Specifically, amounts that were earned and vested prior to the employer’s taxable year beginning in 2018 do not count toward the threshold.
Notice 2019-09 also clarifies that the excise tax is determined on a calendar year basis, not based on the taxable year of the employer. This should reduce the administrative burden that might otherwise arise if employers were required to allocate compensation paid during a single calendar year to multiple fiscal years.
Severance Pay Below $1 million Can Be Subject to the Excise Tax
Excess parachute payments paid to a covered employee can be subject to the 21 percent excise tax even if those payments amount to less than $1 million. While conceptually similar to the “golden parachute” concept under Code Section 280G, which applies where a payment is made in connection with a change in control of a for-profit company, Notice 2019-09 takes an expansive view as to what is an excess parachute payment under Section 4960. Subject to only a few exceptions, most types of compensation triggered by an involuntary separation can potentially be considered a parachute payment. For example, payments made contingent upon complying with a non-compete are included, as is the value of benefits where vesting is accelerated, even if no actual payment is made. An involuntary separation from service for this purpose generally includes an employee’s termination of employment without cause, an employee’s failure to renew a contract, and a termination of employment by an employee for good reason. There are also special provisions defining separation from service broadly to include certain changes to the service relationship, even if an employee is still employed by the tax-exempt employer. The total payments in the nature of compensation that are contingent upon an involuntary separation from service will only be parachute payments if they are three or more times the employee’s base amount (which is the measure of taxable compensation applied under Code Section 280G). Excess parachute payments equal the portion of the parachute payments that exceeds the base amount.
Multiple Employers Within a Tax-Exempt Controlled Group Can Each Be Subject to Tax
Notice 2019-09 confirms that separate tax-exempt members of a controlled group can each be subject to the excise tax. (Think of a health system made up of multiple hospitals and other institutional health care providers.) This means that each tax-exempt employer must separately determine which of its employees are covered employees rather than determining the five highest paid employees across the entire integrated health system. So a controlled group of tax-exempt employers could potentially have several employers with dozens of employees earning compensation that triggers the excise tax. Consistent with this idea, the Notice includes rules for allocating the excise tax among a tax-exempt employer and related organizations. A careful application of these rules will be particularly important in a health system with covered employees who provide services to, and receive compensation from, more than one related organization.
The Good News?
The IRS expects to issue further guidance regarding the application of Code Section 4960. In the meantime, tax-exempt employers may determine the applicability of the excise tax based on a “good faith, reasonable interpretation” of Code Section 4960, informed by Notice 2019-09. Accordingly, tax-exempt employers who are subject to Code Section 4960 should adopt consistent and reasonable approaches to the application of the excise tax based on all of the facts and circumstances. For tax-exempt employers that are part of a large group, we suggest a coordinated strategy starting at the parent entity and working down from there.
Eric D. Altholz |
BRYN MAWR, Pa., Dec. 3, 2018 /PRNewswire/ — The American College of Financial Services today announced a set of newly elected officers to its Alumni Board of Advisors, who will take their positions on January 1, 2019. The Alumni Association preserves and promotes The American College’s traditions, purposes and growth by strengthening The College’s relationship with alumni and friends.
The new Alumni Board of Advisors officers are:
President – Kevin Baldwin, CLU®, ChFC®, CAP®
Kevin Baldwin is the co-founder of B & L Financial Architects and has over 30 years of experience in the financial services industry. He has successfully built a career general agency for Penn Mutual, created a brokerage distribution channel for Aetna and Lincoln Financial Group, and established the National Life Academies and the Regional Rising Leaders Prospecting agent training schools. Most recently, Kevin oversaw MassMutual’s Department of Field Training and Development. Kevin earned his bachelor’s degree in history and political science from the University of Connecticut and has served on the Alumni Board for a decade.
Vice President – Lucas J. Quaccia, CLU®, CLF®, ChFC®
Luke Quaccia is a Managing Partner at New York Life, where he has worked since joining the organization in 2000 as an agent. After qualifying for Executive Council three times, Luke transitioned into his role as Partner in 2003, earned Senior Partner in 2008 and was promoted to Managing Partner of the Chicago North Shore General Office in 2009. In May 2015, he moved into his current role leading the Central California General Office. He earned his bachelor’s degree in economics from Stanford University and has served on the Alumni Board for five years.
2nd Vice President – Lynnette Muleady, MSM, CLU®
Lynnette is the Director of the Agent Development Center at State Farm and has over 17 years of financial services industry experience. Lynnette was appointed to her current role in March 2018, where she oversees a team that provides training and leadership development for future independent contract agents and interns. She earned her bachelor’s degree in international studies from Michigan State University and her master’s degree in management and leadership from the American College of Financial Services. She has served on the Alumni Board for three years.
Secretary – Matthew E. Schiff, CLU®, ChFC®
Matthew Schiff is the President of Schiff Benefits Group, LLC, where he specializes in the design, implementation, financing and ongoing administrative support of supplemental executive benefits programs. Matthew has nearly 30 years of experience in the financial services industry, and previously served as a Managing Director with NYLEX Benefits, a subsidiary and the executive benefits consulting arm of New York Life. Matthew earned his bachelor’s degree in economics from Tulane University and has served on the board for two years.
“We are excited to welcome this new leadership group for our Alumni Board of Advisors,” said George Nichols III, President and Chief Executive Officer of the American College of Financial Services. “Their expertise as forward-thinking leaders in the financial services industry will enable them to continue to fortify our alumni bonds and enhance our programs for the next generation of advisors and graduates.”
ABOUT THE AMERICAN COLLEGE OF FINANCIAL SERVICES
The American College of Financial Services was founded in 1927 and is the nation’s largest nonprofit educational institution devoted to financial services. Holding the highest level of academic accreditation, The College has educated one in five financial advisors across the United States and offers two master’s degrees in management and financial services and prestigious financial planning designations such as the Retirement Income Certified Professional® (RICP®), Chartered Life Underwriter® (CLU®), Chartered Financial Consultant® (ChFC®) Wealth Management Certified Professional® (WMCP®) and education leading to the Certified Financial Planner™ (CFP®) certification. The College’s faculty represents some of the foremost thought leaders of the financial services profession. For more information, visit TheAmericanCollege.edu.
SOURCE The American College
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The American College of Financial Services Announces New Leadership for Alumni Board of Advisors
I had the honor of speaking at the annual meeting of the Million Dollar Round Table in June of 2017. Below, please find an audio copy of my presentation and what we do for our clients…..
Congratulations to our very own Jayne N. Schiff, MSFS, CLU, ChFC, CAP, REBC, MPS for being inducted into the American College of Financial Services Alumni Hall of Fame. Clink on the link below for the official press release.
Phantom Stock Plans
Phantom stock plans are written contractual arrangements between the company and the key employee which are designed to mimic actual stock ownership. These plans generally involve the granting of a stated number of stock units which are credited to the key employee’s account. Each unit has the equivalent value of an outstanding share of the employer’s common stock. The benefit provided to the key employee under the simplest form of phantom stock plan equals the appreciation in the value of the “phantom” stock between the date the employee is credited with the phantom shares and the date the benefit is paid.
Instead of merely paying a benefit equal to the appreciation in value of the “phantom” stock between the date the “phantom” shares are granted and the payment date, it is possible to structure the benefit so that it equals the entire value of the “phantom” shares as of the payment date. In addition, if the intent is to closely mimic actual stock ownership, the key employee’s “phantom” stock account could be credited with all cash, stock dividends, and stock splits which are attributable to the “phantom” shares.
Payment of the benefit generally occurs upon termination of employment as a result of retirement, death or disability, or at a specified future date, depending upon the company’s preference. The benefit can be paid out in installments (either in cash or common stock of the company) over a period of years. Generally, the benefits are paid in cash because the company does not want the key employee to actually have direct stock ownership.
Consequences of Phantom Stock Plan
A. Key Employee – No tax is payable by the key employee at the time the “phantom” stock is credited to the employee’s account. The employee is taxed when the benefit is actually paid and there is no further substantial risk of forfeiture.
If the plan is designed to make annual payments to the phantom plan participants to replicate the cash and stock distributions made to the company’s actual stockholders, the payments are taxable to the phantom plan participant as ordinary income and deductible to the company when paid.
B. Company – There is no deduction available to the company upon the initial crediting of the “phantom” stock to the employee’s account under the phantom stock plan. When the employee is paid the benefit, the company is entitled to a compensation deduction for the same amount as the employee includes in income.
C. Compliance with Employee Retirement Income Security Act of 1974 (ERISA) – Phantom stock plans are generally designed as “top hat” plans which are unfunded and maintained by the company for a select group of management or highly compensated employees. This exempts the plan from most of ERISA’s provisions. In order to comply with the ERISA reporting requirements for “top hat” plans, there is a one-time filing with the United States Department of Labor.
D. Informal Funding – While the payment of the plan benefits cannot be “secured”, it is possible to informally fund the benefit payments by having the company accumulate cash, or other asset, or purchase a life insurance policy on key employees’ lives. However, the policy cash value, as well as the death benefit, must be subject to the general creditor claims of the company in order to avoid the arrangement being treated as a “funded” arrangement.
E. Accounting – The company must charge its earnings with compensation expense over the period during which the phantom stock is outstanding in an amount equal to the fair market value of the value accrued to the employee under the plan.
F. Compliance with Section 409A – Section 409A of the Internal Revenue Code was enacted as part of the American Jobs Creation Act of 2004 and sets forth various requirements relating to deferred compensation plans. A phantom stock plan is a form of deferred compensation and will need to be carefully structured to avoid any adverse tax consequences to the key employee under Section 409A. If the plan fails to satisfy the requirements of that section, the key employee would be taxed on the unpaid amount deferred under the plan and would be subject to penalties. Correctly structured the plan should qualify under Section 409A so that there will not be a problem of the key employee having income before the benefit is actually paid.
Issues to Consider
For companies that want to offer their key employees the opportunity to share in the company’s success without giving up an actual equity stake in the company, phantom stock plans provide a great deal of flexibility. Because these plans are written contractual relationships, the company is not subject to the legal requirements which would normally apply if the key employee received actual stock. The plan may be creatively structured with measuring criteria and vesting schedules that act as “golden handcuffs” to retain valued employees and to align the key employees’ interests with those of the company.
In determining whether to implement a phantom stock plan, some of the considerations are as follows:
1. Which key employees will participate? In order to obtain exemption from most of ERISA provisions, the plan must be designed to benefit a select group of management or highly compensated employees.
2. When will the “phantom” shares be granted and when will they vest?
3. What will be the cutoff or triggering events requiring payment (i.e., death, disability, retirement, termination of employment or a specific date)?
4. How is the payment of the benefit to be made? Generally it will be made in cash as opposed to the company stock. Will the company have sufficient cash to pay the benefit?
5. Should the obligation of the company be informally funded through the acquisition of life insurance policies on the lives of those individuals covered by the phantom stock plan or with other investments?
6. Will the compensation liabilities shown on the company’s books as a result of the phantom stock plan have any adverse effects on the company’s ability to obtain financing?
7. Will the payment of the benefit be in one lump sum or spread over a period of time?
8. How many “phantom” shares will be initially granted? Will there be any crediting for the equivalent of any cash dividends, stock dividends, or stock splits which would be attributable to the phantom shares? Keep in mind that the “phantom” shares while not direct equity interests in the company, dilute the existing equity of the company’s shareholders by reducing assets by the value of the new obligations.
9. How will the valuation of the company be conducted in order to determine the value of the shares? The associated costs of the valuation need to be incorporated into the decision to implement a phantom stock plan.
Examples of plan designs:
- Employer will create a performance metric equal to a fixed dollar amount or percentage of profits, each year the value of the funds put aside will grow based upon the growth of the business or fixed rate of return
- Employer may assign a number of shares to the key person based upon a percentage of salary, which may or may not tie into the performance of the company.
- Employer might create a straight non-qualified “profit share” equal to a percentage of earnings and each year those funds could increase in value but not vest until retirement, change of control or death of the primary shareholder – thus creating a true golden handcuff.
An Employee Stock Ownership Plan, or ESOP, is one option if you are a looking to sell your business. Listen to this discussion about Employee Stock Ownership Plans, hosted by The American College with Matthew Schiff, CLU and Dan Zugell of Business Transition Associates as it pertains to some options that closely held business owners have in today’s economic environment
As a business owner, one of the best ways of maximizing the sale of your largest assets, is by exploring what an Employee Stock Ownership Plan(ESOP) can do for you.
When selling your company to an ESOP, you can sell part of your shares or all of your shares, are even schedule when the stock will be sold. When combined with the tax efficiency of the ESOP plan, and the ability to still control the operations of the company, the owner has the opportunity to have his cake and eat it too.
That said, ESOPs are not for everyone. And the discussion on this video will walk you through the high level benefits and pitfalls. If you are interested in learning more, then dive into the second and third video about the topic.
We look forward to hearing from you, and helping in a customized plan design that fits your needs.