Section 457A, which was passed as section 801 of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 as part of the recent bailout legislation, provides that the nonqualified deferred compensation made available by certain “tax-indifferent” entities is includible in income upon the lapse of a substantial risk of forfeiture. Section 457A will have the greatest impact on entities not already subject to Section 457(f), which imposes a similar income-inclusion rule.
Section 457A requires the inclusion in income of nonqualified deferred compensation when the amounts are no longer subject to substantial risk of forfeiture. It was intended to limit offshore deferred-compensation arrangements by hedge funds but, as drafted, it applies broadly to “nonqualified entities,” which includes “foreign corporations” and partnerships that do not allocate a “substantial portion” of their income to taxable entities. The foreign-corporation and foreign-person rules will likely affect only a small percentage of tax-exempt organizations. However if a tax-exempt organization is a partner in a partnership, Section 457A could apply to the partnership’s deferred-compensation arrangements. In general, the following rules apply:
The Twenty-Percent Rule. Section 457A applies if the percentage of income allocated to tax-indifferent parties exceeds twenty.
Substantial Risk of Forfeiture. Substantial risk of forfeiture exists only while substantial future services are required. Performance-based conditions are disregarded.
Short-Term Deferral. Amounts are not subject to Section 457A if paid within twelve months following the end of the taxable year in which they are no longer subject to substantial risk of forfeiture.
Coordination with Section 409A. For Section 409A purposes, an amount is treated as “paid” when it becomes includible in income under Section 457A.
Amounts Includible. The amounts includible under Section 457A are the amounts of the deferred income no longer subject to substantial risk of forfeiture, if such amounts are definitely determinable. Otherwise, the compensation is includible when determinable, at which time an additional twenty-percent tax and premium interest are also imposed.
Transitional Rules. Until July 1, 2009, a plan may be retroactively amended to provide that deferred compensation that would not otherwise vest until after January 1, 2009, will vest prior to January 1, 2009, provided that the amendment is made for all similar arrangements. Further, for compensation attributed to years prior to January 1, 2009, the distribution dates may be amended through December 31, 2011, and such amendments will not be treated as an impermissible acceleration or jeopardize the status of amounts vested before January 1, 2005 as “grandfathered” under Section 409A.