Everyone relaxed when the House and Senate decided not to block deferred compensation plans as we know and love them.
Not so fast in the not for profit arena. In fact, it might have gotten doubly ugly for 457(f) plans. It is bad enough that 457(f) plans already had mountains to climb:
- Substantial Risk of Forfeiture – requires adherence to a contractual performance time to “vest”. Failure to meet that requirement causes a total loss of benefit. While it is true that the Internal Revenue Service has issued clarification that allows extension of the benefit vesting period under certain limited circumstances, the basic rule is “if you leave, you lose it.”
- Front Page Disclosure – not only do annual contributions get disclosed on Form 990 filings, but on distribution some 457(b) plans and most 457(f) plans will have distributions of headline proportions that are publicly disclosed and often reported on page one and the local evening news (even though they have already been disclosed during employment and may include personal deferrals).
- Booked Liabilities: the value of 457 plans must be carried as a liability.
- Creditor Risk: the promised benefit is subject to the claims of creditors in an employer insolvency.
2017 Tax Cuts and Jobs Act
Internal Revenue Code Section 4960 throws another wrench into the 457(f) works. On vesting, the plan becomes taxable compensation and the amount vested plus any other taxable compensation for the same year becomes subject to an employer paid tax (yes, even in a tax-exempt organization) at a 21% rate after a $1 million deductible. This applies to the five highest compensated employees of the organization. It includes income from “any related person or governmental entity”. Although regulations and rulings will be needed, it appears that the taxable amount could include amounts from certain foundations, major donors and controlling board members. If more than one related payer is involved, the tax is prorated.
Thus, if a 457(f) plan vests with $3.5 million and the executive in question has $500,000 in other taxable compensation for a total of $4 million, the employing institution itself will pay $630,000 in taxes (on $3 million) on top of federal and applicable state and local taxes paid by the plan participant. In some cases, the combined taxes could approach the 60% level.
This rule applies to 457(b) plans as well when there are large distributions or distributions in years when there are other taxable compensation items that take total compensation to over $1 million.
Is there an alternative? Yes. For further information and an analysis of your current program, contact Barry N. Koslow, JD, 781-939-6050(o) 781-724-6695(m) bkoslow@mkaplanners.com or Dennis Sexton 781-939-6050(o) 978-395-6741(m) dsexton@mkaplanners.com.
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To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this communication, including any attachments, was not intended or written to be used, and cannot be used, for the purpose of avoiding federal tax related interest or penalties. Securities offered through Advisory Group Equity Services, Ltd., member FINRA/SIPC/MSRB. dvisory services offered by Trust Advisory Group, Ltd., a registered investment advisor. 444 Washington Street, Suite 407, Woburn, MA 01801. 781-933-6100.
