Qualified and Non-Qualified Deferred Compensation Plans

Experienced New York City Attorneys Protecting the Rights of Executives

Deferred compensation refers to arrangements whereby employers pay income to employees in the year following the year in which they earned the income. Deferred compensation plans fall into two categories applied by the Internal Revenue Code: tax-qualified and non-qualified plans. Qualified plans need to stick to limits in how much compensation may be deferred and comply with other Internal Revenue Code restrictions. Non-qualified plans are not subject to the same limitations. If you are an executive who wants to learn more about qualified and non-qualified deferred compensation plans, you can consult the New York City executive compensation lawyers at Phillips & Associates.

Differences Between Qualified and Non-Qualified Deferred Compensation Plans

Issues with qualified and non-qualified deferred compensation plans can arise when an executive's employment agreement is being drafted. Qualified deferred compensation plans need to follow certain restrictions imposed by the Internal Revenue Code. The Internal Revenue Service oversees qualified plans. They are often established to provide deferred compensation, such as retirement benefits. They can take the form of 401(k) plans, profit-sharing plans, or defined benefit plans. Qualified plans have a substantial and comprehensive legal framework that needs to be followed. However, the regulations are detailed and complex, and sometimes issues arise under the regulations.

There is less security with non-qualified plans. Non-qualified deferred compensation plans are contractual arrangements. An employer may promise to pay an executive a particular benefit at some point in the future, often at retirement. However, non-qualified deferred compensation plans do not need to follow the same rules and limitations as qualified deferred compensation plans. They are usually designed to be more flexible, although specific rules must be followed with regard to tax treatment under Code Section 409A. This code section was enacted to stop the abuse of deferred compensation arrangements whereby executives would defer their receipt of income and incur tax liability for overly long periods of time. Executives who enter into non-qualified plans must be more proactive to protect their own interests. There is usually more negotiating room with non-qualified plans.

Qualified and non-qualified deferred compensation plans are significantly different in terms of how much security underlies the employer's promise. The biggest difference between these categories of deferred compensation plans is the types of funding that support benefits being paid. Qualified benefit plans have plan assets and a trust, whereas non-qualified plans do not set aside specific assets for benefits payments and are unsecured.

With regard to funding, a tax-qualified plan needs to be funded and held in trust for the sole purpose of paying benefits. A non-qualified deferred compensation plan is not supposed to be funded to achieve tax consequences other than those related to certain types of trusts. In addition, this type of plan is subject to an employer's creditors. In order to give security to an executive that benefits promised under a non-qualified plan will be paid, many employers fund the non-qualified benefit by using a rabbi trust, employer-owned life insurance, mutual funds, or other assets.

In addition to different rules regarding funding, there are also different rules regarding vesting, the timing of a tax deduction, and the scope of the employees who must be covered and under which terms under these plans.

Qualified deferred compensation plans involve required vesting schedules. It may be necessary to get spousal consent for the benefit to be paid. For non-qualified deferred compensation plans, there are more flexible vesting schedules. Usually, spousal consent is not required for distribution.

An employer deduction occurs at the time that there is a contribution to the trust with qualified deferred compensation plans. However, with a non-qualified deferred compensation plan, the deduction is matched to the employee's inclusion in income.

Earnings are tax-free for qualified deferred compensation plans. For non-qualified deferred compensation plans, earnings are taxed to an employer, which retains the assets, with some exceptions.

Hire a Knowledgeable Employment Lawyer in the Greater New York City Area

If you are an executive who is concerned about the differences between qualified and non-qualified deferred compensation plans, you should consult an experienced attorney to guide you. You can contact Phillips & Associates at (866) 229-9441 or use our online form to set up a free appointment. Our attorneys handle employment issues related to many forms of executive compensation, ranging from deferred compensation plans to stock options, in the Bronx, Queens, Brooklyn, Staten Island, and Manhattan; the Counties of Westchester, Nassau, and Suffolk; as well as Princeton, New Jersey and Philadelphia, Pennsylvania.