C O U N S E L O R ’ S C O R N E R A TRAP FOR THE UNWARY PUNITIVE PENALTIES UNDER IRC SECTION 409A BY PETER LANGDON, KOLEY JESSEN A critical component to every business is its people. Employees invariably look to employers to provide employee benefits, such as health insurance. An often-overlooked employee benefit that can help both large and small businesses attract, retain, and reward employees is non-qualified deferred compensation. Professional advisors should be familiar with non-qualified deferred compensation to provide optimal professional services in raising this potential benefit and to identify potential issues regarding the maintenance and operation of non-qualified deferred compensation so that punitive penalties may be avoided. Non-qualified deferred compensation is essentially compensation earned in one taxable year and paid in a subsequent taxable year.1 The primary scenario in which non-qualified deferred compensation arrangements arise is the retention of service providers, particularly high-level, or high-performing, team members. A similar situation in which these arrangements arise is when an organization is targeting a particular individual to join its team. Non-qualified deferred compensation arrangements are typically found in employee incentive plans, employment agreements, separation agreements, and individual non-qualified deferred compensation agreements. Non-qualified deferred compensation is typically structured in the form of a plan in which multiple participants participate, as opposed to individual agreements. However, individual agreements providing for non-qualified deferred compensation are not uncommon. As an example, suppose High Tech Inc. wants to retain its chief financial officer (CFO) for a period of time in the future. As a result, High Tech Inc. and its CFO enter into an agreement on Sept. 1, 2022, wherebyHigh Tech Inc. will credit $10,000 to a hypothetical account for the CFO on Jan. 1 of each year for five years beginning in 2023. The CFOwill also contribute a specified portion of the CFO’s annual bonus to the account each year. The CFO’s deferred compensation and the employer’s contributions will then be paid out upon the CFO’s retirement in equal annual installments over a period of 10 years. This arrangement would be subject to Internal Revenue Code (IRC) Section 409A as non-qualified deferred compensation. As an additional example, assume High Tech Inc. wishes to implement a long-term retention tool for a business development executive that provides a benefit of having an interest in the underlying value of High Tech Inc.’s stock so that such individual has “buy in” to grow the company. However, High Tech Inc. does not want to give up any actual equity. High Tech Inc. would be wellsuited to offer this employee shares of phantom stock that track the underlying value of the stock of High Tech Inc. without giving up any actual equity. Alternatively, High Tech Inc. could also consider I S S U E 4 , 2 0 2 2 16 nebraska cpas
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