Code Section 457A was enacted to address "offshore deferred compensation" and includes a transitional rule which exempts deferrals of compensation from Code Section 457A if those amounts are attributable to pre-2009 services and such amounts are distributed to participants prior to 2018. Plans that intended to take advantage of this transitional rule should have been amended in 2009 to provide for mandatory plan distributions no later than 2017, even if the participants remain employed. For background information on Code Section 457A, see our client alert from 2009.
We are sending this communication as a reminder to clients given the unusual nature of the mandatory distributions to participants who are active employees. Further, since the distribution timing was generally fixed in 2009, the company could easily overlook the distribution if there has been employee turnover or changes in corporate organization and plan administration. In some cases, plan terms may require that distributions be made as early as January 2017.
Who is Affected
While the original focus of Code Section 457A was companies incorporated in so-called "tax-haven" jurisdictions, the guidance provided in Notice 2009-8 expanded the reach of the provision to potentially any deferred compensation plans with participants performing services in any foreign country. That being said, the following categories of companies are likely impacted by the mandatory 2017 distribution requirement:
- Companies that were organized using a "tax haven" parent company in 2009, even if the company subsequently redomicilled to a jurisdiction with extensive tax treaty networks. For this group of companies, board compensation plans were often impacted by Section 457A.
- Companies that offered deferred compensation plans and arrangements to US taxpayer expatriate employees and determined that Code Section 457A could potentially apply. This determination was often based on the actual employment/secondment structure that was utilized for the employees. In any event, it would be prudent to review arrangements for this employee group to identify if the mandatory 2017 distribution language was included.
- Companies that acquired companies in groups #1 and #2 above. Existing plans set up to benefit from these transitional rules may not have been cashed out in the acquisition transaction.
While the definition of deferred compensation is similar to that under Code Section 409A and potentially far reaching, this mandatory distribution provision will principally be limited to formal elective deferred compensation plans, supplemental executive retirement plans, and RSU/PRSU deferrals which would have generally been modified to provide for distributions to occur upon the earlier of (i) separation from service, or (ii) a date in 2017.
Recommended Next Steps
- Identify plans and arrangements which could potentially include the mandatory 2017 distributions (including legacy arrangements of acquired companies where there are still active employees). Also identify if any third parties need to be notified or directed.
- Determine whether communication to the impacted participants is appropriate.
- Confirm tax withholding arrangements for the distributions which will be subject to ordinary income taxation.
- In some cases, distributions will be made to NEOs or Board Members and these distributions may be significant and will need to be reported in the applicable proxy and the distributions may be significant. Consider the potential impact of the mandatory plan distributions on proxy reporting. Finally, it should be noted that there may be proposals by the new US Administration to modify deferred compensation rules. In the absence of any specific proposals at this time, we would advise making distributions in accordance with the stated plan provisions. Further, any reforms are more likely to address the application of Section 457A in future years, rather than this one-time transitional rule, especially given its associated revenue estimates.
Finally, it should be noted that there may be proposals by the new US Administration to modify deferred compensation rules. In the absence of any specific proposals at this time, we would advise making distributions in accordance with the stated plan provisions. Further, any reforms are more likely to address the application of Section 457A in future years, rather than this one-time transitional rule, especially given its associated revenue estimates.