Source: https://cheiron.us/cheironHome/viewArtAction.do?artID=179
Timestamp: 2019-04-26 10:23:00+00:00

Document:
Comments and Public Hearing: The IRS requests comments on all aspects of the proposed rules, including whether special transition rules should apply for plans established (i.e., compensation deferred) before the proposed applicability dates. Comments are due on or before September 20, 2016. A public hearing will occur on October 18, 2016.
Action Needed Now: Sponsors of affected deferred compensation arrangements should assess the potential impact of these regulations, including whether plan design changes are necessary or desirable. Additionally, sponsors should decide whether to submit comments to the IRS.
Section 457 applies to nonqualified deferred compensation plans established by state and local governments and tax-exempt employers (collectively referred to herein as "eligible employers"). There generally are two types of nonqualified deferred compensation plans under § 457 - eligible plans defined in § 457(b) and ineligible plans defined in § 457(f). Generally, if a nonqualified deferred compensation plan maintained by an eligible employer does not satisfy the requirements to be an eligible plan, compensation deferred under such plan is includable in income under the rules of § 457(f).
Compensation deferred under an ineligible plan is includible in the gross income of the participant or beneficiary on the later of the date the participant or beneficiary obtains a legally binding right to the compensation or, if the compensation is subject to a substantial risk of forfeiture at that time, the date the substantial risk of forfeiture lapses. The amount of compensation that is includible in gross income as of the applicable date is the present value of such deferred compensation.
The proposed regulations address the interaction of the rules under § 457(f) and § 409A, noting that the rules under § 457(f) apply to plans separately and in addition to the requirements under § 409A. Thus, a deferred compensation plan of an eligible employer that is subject to § 457(f) may also be a nonqualified deferred compensation plan that is subject to § 409A.
Likelihood of Occurrence and Enforcement: An amount is not subject to a substantial risk of forfeiture if, based on facts and circumstances, the forfeiture condition is unlikely to occur or unlikely to be enforced. Factors to be considered in determining the likelihood of enforcement include the past practices of the employer; the level of control or influence of the employee with respect to the organization and those responsible for enforcing the forfeiture; and the enforceability of the provisions under applicable law.
Involuntary Severance from Employment: Under these proposed regulations, if a plan conditions right to payment on an involuntary severance from employment without cause, "that right is subject to a substantial risk of forfeiture only if the possibility of forfeiture is substantial."2 For this purpose, an involuntary severance from employment without cause includes a voluntary severance from employment for good reason, discussed below.
At the time the non-compete agreement becomes binding, the facts and circumstances must show that the employer has a substantial and bona fide interest in preventing the employee from performing the prohibited services and that the employee has a bona fide interest in engaging, and an ability to engage, in the prohibited services. Relevant factors taken into account include the employer's ability to show significant adverse economic consequences that likely would result from the prohibited services; the marketability of the employee based on specialized skills, reputation, or other factors; and the employee's interest, financial need, and ability to engage in the prohibited services.
The present value of the amount to be paid upon the lapse of the substantial risk of forfeiture (as extended, if applicable) must be materially greater than (i.e., more than 125%) the amount the employee otherwise would be paid in the absence of the substantial risk of forfeiture (or absence of the extension).
The initial or extended substantial risk of forfeiture must be based upon the future performance of substantial services or adherence to a non-compete agreement.
The period for which substantial future services must be performed may not be less than two years (absent an intervening event such as death, disability, or involuntary severance from employment).
The agreement creating or extending the substantial risk of forfeiture must be in writing and made, in the case of initial deferrals of current compensation, before the beginning of the calendar year in which any services giving rise to the compensation are performed, or at least 90 days before the date on which an existing substantial risk of forfeiture would have lapsed.
Comments are requested on whether special provisions for newly eligible employees are needed in the context of § 457(f) arrangements, and if so: (i) whether the existing plan aggregation and first year of eligibility rules under the § 409A regulations should apply for § 457(f), and (ii) how to define an aggregated single plan (versus multiple plans) to prevent manipulation of the rules.
The proposed § 457 regulations' recognition that a non-compete agreement can create a substantial risk of forfeiture represents a significant departure from the § 409A regulations, under which a covenant not to compete does not create a substantial risk of forfeiture for purposes of § 409A.
Under the proposed regulations, a plan provides for the deferral of compensation for purposes of Code § 457(f) if a participant has a legally binding right during a taxable year to compensation that, pursuant to the terms of the plan, is or may be payable in a later taxable year. Generally, a participant does not have a legally binding right to compensation if, based on the terms of the arrangement and relevant facts and circumstances, it may be unilaterally reduced or eliminated by the employer after the services creating the right have been performed.
The proposed regulations provide that a deferral of compensation does not occur with respect to any amount that would be a short-term deferral under the § 409A regulations, substituting the definition of a substantial risk of forfeiture provided under the proposed regulations for the definition of substantial risk of forfeiture under § 409A.3 For example, a deferral of compensation does not occur with respect to any payment that the participant actually or constructively receives by the March 15th following the end of the first calendar year in which the right to the payment is no longer subject to a substantial risk of forfeiture.
An arrangement under which an employee receives recurring part-year compensation that is earned over a period of service less than 12 months (for example, a school year comprised of 10 consecutive months) does not provide for the deferral of compensation if it does not defer payment of any of the recurring compensation beyond the last day of the 13th month following the first day of the service period for which the recurring part-year compensation is paid. Additionally, the total amount of the recurring part-year compensation cannot exceed the annual compensation limit under Code § 401(a)(17) ($265,000 for 2016) for the calendar year in which the service period commences.
The proposed regulations provide substantial guidance on plans that are treated as not deferring compensation for purposes of § 457. These include bona fide vacation leave, sick leave, compensatory time, severance pay, disability pay, and death benefit plans, plus plans that solely pay length of service awards to bona fide volunteers (or their beneficiaries).
The written terms of the plan must provide that the severance benefits will be paid no later than the last day of the second calendar year following the calendar year in which the severance from employment occurs.
Any other action or inaction that constitutes a material breach by the eligible employer of the agreement under which the participant provides services.
The participant is required to provide notice to the eligible employer of the existence of any of the applicable condition within a period not to exceed 90 days after the initial existence of the condition(s). Upon receipt of such notice, the employer must be given a period of at least 30 days during which it may remedy the condition(s) before being required to pay any benefits. Also, the amount, time, and form of payment upon severance is substantially the same as the amount, time, and form of payment that would have been made available upon an actual involuntary severance from employment (to the extent such right to payment exists).
Window Programs: A window program is defined as a program established by an employer to provide separation pay in connection with an impending severance from employment. To qualify as a window program, the program must be offered for a limited period (typically no longer than 12 months). A program is not offered for a limited period if there is a pattern of repeatedly providing similar programs. Relevant facts and circumstances for determining whether a pattern of similar programs exists include whether: (i) the benefits are because of a specific reduction in workforce (or other operational conditions), (ii) there is a relationship between the separation pay and an event or condition, and (iii) the event or condition is temporary and discrete or is a permanent aspect of the employer's operations.
Voluntary Early Retirement Incentive Plans: A voluntary early retirement incentive plan is described as a bona fide severance pay plan (as defined above) under which payments are made as an early retirement benefit, a retirement-type subsidy, or an early retirement benefit that is greater than a normal retirement benefit and are paid in coordination with a qualified defined benefit pension plan.
The participant is determined to be totally disabled by the Social Security Administration or the Railroad Retirement Board.
The proposed regulations set forth rules for determining the amount included in income under § 457(f). In general, the amount included in income is the present value of compensation deferred under ineligible plans. The proposed regulations provide specifics as to how the present value is to be determined.
The rules for determining present value under these proposed regulations are similar to the rules for determining present value in the proposed § 409A regulations, including similar loss deduction rules.4 One difference, however, is that income inclusion under § 457(f) and the present value calculation under the proposed regulations is determined as of the applicable date, whereas income inclusion § 409A and the present value calculation under the proposed § 409A regulations is determined as of the end of the service provider's taxable year. Comments are requested on whether it is appropriate to provide any additional exceptions from the application of the rules currently described in the proposed § 409A regulations to amounts includible in income under § 457(f) in order to account for the different manners in which the two provisions apply to an amount deferred.
Qualified Roth Contribution Program: Eligible governmental plans may include a qualified Roth contribution program, as defined in Code § 402A(c)(1), under which designated Roth contributions are included in income in the year of deferral and qualified distributions are excluded from gross income.
Certain Distributions for Qualified Accident and Health Insurance Premiums: The rules for the taxation of eligible governmental plan distributions now provide that distributions from an eligible governmental plan relating to an eligible public safety officer under Code § 402(l) are excluded from gross income for the taxable year in which they are paid.
Rules Related to Qualified Military Service: HEART Act5 requirements are adopted for eligible governmental plans to require that, where a participant dies while performing qualified military service, the participant's survivors are entitled to any additional benefits that would have been provided under the plan if the participant had resumed and then terminated employment on account of death. In addition, leave for certain military service is treated as a severance from employment for purposes of the plan distribution rules under eligible plans.
For a plan maintained pursuant to one or more collective bargaining agreements (CBAs) which have been ratified and are in effect on the date of publication of the final regulations, these regulations would not apply to compensation deferred under the plan before the earlier of (1) the date on which the last of CBAs terminates (determined without regard to any extension thereof after the date of publication of the final regulations) or (2) three years after the date of publication of the final regulations.
If legislation is required to amend a governmental plan, the proposed regulations will apply only to compensation deferred under the plan in calendar years beginning on or after the close of the second regular legislative session of the legislative body with the authority to amend the plan that begins after the date of publication of the final regulations.
The proposed regulations provide plan re-design opportunities for existing sponsors of § 457(f) plans, and may spur other eligible employers to supplement their current compensation package(s) with one or more new deferred compensation arrangements.
Cheiron pension consultants can assist governmental and tax-exempt employers in understanding the impact of the proposed regulations on their deferred compensation plans and assist with plan design changes.
1 On the same date, IRS also issued new proposed regulations under Code § 409A, a copy of which is at this link.
2 See proposed § 1.457-12(e)(1)(i).
3 Because there is considerable overlap between the definition of substantial risk of forfeiture for purposes of § 457(f) and the definition of substantial risk of forfeiture for purposes of § 409A, in many cases amounts that are not deferred compensation subject to § 457(f) also are not deferred compensation subject to § 409A.
4 Under those rules, if a participant previously included an amount of deferred compensation in income, but the amount of compensation subsequently paid is less than the amount included in income because of forfeiture or loss, then participant is entitled to a deduction for the amount permanently forfeited or lost.
5 The Heroes Earnings Assistance and Relief Tax Act of 2008.
6 A copy of Notice 2008-62 is here.

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