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IRS Releases New Deferred Compensation Proposal for NFPs

January 27, 2017

The IRS has issued proposal for new deferred compensation practices for nonprofits—new guidance will give organizations the opportunity to defer taxes.

Proposed regulations to Section 457 for deferred compensation plans have been issued by the IRS. This section of the Internal Revenue Code, IRC, authorizes tax-exempt and governmental employers to offer a 457(b) plan, 457(f) plan, or both to employees.

What is deferred compensation?

Any plan, arrangement or contract which permits employees, typically top-tier executives, to delay taxation on certain compensation or benefits that are earned in one tax year and payable in another future tax year is considered “deferred compensation”. Unless provided through a qualified plan under Section 457b, 403b or 401a, deferred compensation provided to tax exempt organization’s employees is subject to tax under section 457f of the IRC.

What is the role of a 457b plan?

The 457b plan permits employees of sponsoring organizations to defer income taxes on retirement savings into future years.

What can you contribute to such a plan?—employee salary deferrals, employer contributions (cannot exceed the IRS predetermined limit under IRC 402g- for 2015-2017, that amount is $18,000).
If you are over age 50, you are permitted to contribute an extra amount at the end of the current tax year. Keep in mind that these “catch-up” contributions are only allowed with governmental 457b plans. The catch up amount for 2015-2017 is $6,000.

And the 457f plan?

Tax exempt employers can supplement the retirement income of a select management group or highly compensated employees with a 457f plan. There is typically no annual limit on the amount of contributions that can be deferred on behalf of qualifying executives.

Enhancements for 457f

The proposed regulations for deferred compensation focus on enhancements for 457f plans. Specifically, the opportunity to delay the immediate taxation on deferred benefits to a participant under Section 457f has been proposed.

Also, under past guidance, participants could not extend the substantial risk of forfeiture past the date initially specified. The “substantial risk of forfeiture” is a standard applied by the IRS to decide whether or not deferred compensation and transfers of property should be taxed currently to the payee. In most circumstances, a substantial risk of forfeiture is present if an employee's right to deferred compensation or transferred property is contingent on the performance of substantial services in the future or on the occurrence (or non-occurrence) of a given event.

Leave and severance pay

The proposed regulations define leave and severance pay, which is notable since prior guidance did not have a concrete definition for this. Under the new regs, a bona fide sick or leave plan must demonstrate that its primary purpose is to provide for paid time off from work due to sickness, vacation or personal reasons.

These proposed changes could take years to finalize, so hang tight for now. Once finalized, these changes could open up many opportunities for your organization. We’ll keep you posted.

Questions? Contact any member of our Not-for-Profit Services Team.

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