457A: 2017 Deadline to Pay on Certain Offshore Deferred Compensation

August 2017

If you have a deferred compensation arrangement with an offshore employer located in a tax haven jurisdiction, you should be aware of an upcoming deadline of December 31, 2017 for compensation earned during 2005-2008 but not yet paid to you.[1]


Background

Employees of US companies who defer compensation outside of a tax-qualified plan (e.g., a 401(k) plan) enjoy the tax benefit at the expense of the employer, which must wait until the amounts are paid before claiming a corresponding deduction.  By contrast, offshore employers located in non-tax jurisdictions can provide deferred compensation to their US employees and suffer no economic consequences, since the timing of the deduction for the related compensation is not relevant when the employer does not have any tax liability.  In absence of the quid pro quo relationship among US employees and such tax-indifferent employers, Section 457A is intended to promote parity among US taxpayers by eliminating the ability to defer compensation from these offshore employers.


Development

Pursuant to Section 457A, deferrals attributable to services performed after 12/31/2004 and before 1/1/2009 must be included in your US taxable income no later than 12/31/2017. Plans that initially provided for payment after 2017, should have been amended by 12/31/2011 to establish a new distribution date that conforms with Section 457A. If your plan was not timely amended by 12/31/2011 and distribution (or income inclusion) is still scheduled to be made after 2017, the deferred amount is in violation of Section 457A and subject to a 20% additional tax and premium interest charge. Upon any untimely attempt to comply with 457A by changing the distribution date to fall within this year, the same penalties would still apply, but under Section 409A instead – Section 457A’s sibling that broadly governs all nonqualified deferred compensation arrangements. Section 409A generally prohibits accelerating distributions prior to the originally scheduled payment date.

After 2008, compensation earned from an offshore employer in a non-tax jurisdiction generally cannot be deferred beyond 12 months following the end of the taxable year in which vesting occurred, otherwise Section 457A requires income inclusion on the vesting date and imposes a 20% additional tax and premium interest charge (at the underpayment rate plus one percent). Whereas, compensation paid within 12 months after the end of the employer’s taxable year in which such payment is vested is exempt from Section 457A under a short-term deferral exemption. For example, assuming the offshore entity has a fiscal year ending on December 31 and the 2016 incentive compensation was vested on 12/31/2016, such incentive compensation must be paid not later than 12/31/2017 to be exempt from Section 457A and avoid the additional 20% tax and premium interest charge. For purposes of Section 457A, vesting must be conditioned upon the future performance of substantial services only; an employee’s compensation is treated as vested if such person’s right to compensation is subject to a performance-based condition only. 


Action Items

The IRS provides complex guidance (Notice 2009-8) with respect to the application of Section 457A. Parties to deferred compensation arrangements should ensure that (i) the service provider’s right to compensation is conditioned upon the future performance of substantial services (i.e., a service-based condition and not a performance-based condition); (ii) such compensation is paid within Section 457A’s 12-month short-term deferral period; and (iii) any outstanding deferrals related to services performed prior to 2009 are to be distributed by end of this year in accordance with the plan amendment adopted by 12/31/2011 to conform with Section 457A (or, if grandfathered, in accordance with the originally scheduled payment date/event).


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Return to Compensation & Benefits Newsletter - Summer 2017
 

[1] Deferred amounts that were earned and vested in a taxable year before 1/1/2005 are not subject to 457A under its grandfather provision and can be paid in accordance with the originally schedule date, provided the arrangement was not materially modified after 10/3/2004