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Deferred Compensation for Tax-exempt Organizations: New Proposed Regulations under Code Section 457

On June 21, 2016, the Internal Revenue Service (IRS) issued anticipated proposed Treasury Regulations prescribing rules under Section 457 of the Internal Revenue Code for the income taxation of deferred compensation arrangements for employees of tax-exempt organizations and state and local governments. The IRS also released new proposed Treasury Regulations under Code Section 409A.

Generally, the proposed regulations are more flexible and practical than the rules previously suggested by the IRS in Notice 2007-62 and also than what was expected by many practitioners. While the proposed regulations require clarification on a number of points, these new rules will provide useful guidance in designing compensation for executives of tax-exempt organizations. Among other things, these rules:

  • follow Code Section 409A in recognizing a termination by an employee for “good reason” as an involuntary severance from employment;

  • unlike under Code Section 409A, recognize required compliance with a noncompetition agreement as a substantial risk of forfeiture;

  • contrary to prior IRS policy statements, permit, in certain situations, elective deferral of current compensation and a rollover of existing substantial risk of forfeiture;

  • define bona fide severance pay plans that are exempt from Code Section 457, including by imposing a limit on the amount of severance that can be paid under such a plan of two times a participant’s prior year’s rate of compensation (similar to the Code Section 409A coverage exception), but without the alternative lower limit based on two times the limit for recognizing compensation under qualified plans;

  • define bona fide sick pay and vacation plans that are exempt from Code Section 457;

  • specify with flexibility how to determine present value when calculating the amount to be taxed under Code Section 457(f); and

  • emphasize that both Code Section 457(f) and Code Section 409A apply to most deferral arrangements.

The key provisions in the proposed regulations that relate to tax-exempt organizations are discussed in more detail in our recent client alert, which is available here.

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About this Author

Michael Sirkin, Proskauer Law Firm, Employee Benefits Attorney
Partner

Michael S. Sirkin is a senior partner and former co-chair of both the Employee Benefits & Executive Compensation Group and the Tax Department. He practices primarily in the areas of executive compensation and employee benefits, and frequently represents companies, compensation committees and senior executives in connection with executive employment, severance, equity and other compensation arrangements.

US Legal 500 has rated Michael as a leading lawyer nationally for more than ten years and noted that he...

212-969-3840
Steven Einhorn, Proskauer Law Firm, Tax Lawyer
Associate

Steven D. Einhorn is an associate in the Tax Department and a member of the Employee Benefits & Executive Compensation Group. Steven regularly advises public and private companies with respect to employee benefits and executive compensation matters, including compliance with ERISA, tax, corporate and securities laws and regulations affecting employee benefit plans, programs and arrangements. In addition, Steven advises clients with respect to the employee benefits and executive compensation issues related to corporate mergers & acquisitions and other forms of business transactions and reorganizations.

In the employee benefits area, Steven counsels on the design, implementation and ongoing concerns of employee benefit plans, including profit-sharing, defined benefit, cash balance, money purchase, 401(k), as well as nonqualified, severance and other welfare plans. He has represented clients on employee benefit matters pending with the Internal Revenue Service, the Department of Labor and the Pension Benefit Guaranty Corporation.

212-969-3182