Two years ago, Congress passed new laws that for the first time impose strict rules on "deferred compensation plans." Congress chose to define that term broadly as "the legal right to compensation in one year that is not paid until a future year." That definition includes all kinds of common arrangements not usually considered "deferred compensation:” employment offer letters, change in control agreements, stock options, bonuses, etc. Employers must understand how the law works to avoid triggering retroactive income taxes with interest and a 20% penalty.
Employers should therefore take the following steps to ensure that they do not unintentionally create a significant tax liability:
1. Identify all potential deferred compensation arrangements. As mentioned above, this potentially includes any employment or severance agreement and any incentive compensation program, including bonuses, stock options and stock appreciation rights.
2. Review the arrangements for compliance with the law. Certain arrangements are grandfathered out of the law; others have exemptions.
3. Consider alternatives for compliance with the law. If an arrangement is subject to the law, it must comply in operation even if the written terms of the arrangement do not. There are usually several options available to achieve compliance.
4. Prepare any required amendments. Arrangements subject to the law must comply by year-end 2007. Discuss any changes necessary with employees and record-keepers.
5. Adopt the changes by the end of 2007. This may require action by the Board or Compensation Committee, affected employees or consultants. For them to have time to do due diligence, employers should begin this process now.