Tax and ERISA Considerations Associated With Nonqualified Severance Benefit Plans Sponsored By Professional C Corporations

Nonqualified deferred compensation arrangements are used by employers to attract and keep employees, allow them to save money for the future, and provide extra pay and incentives. However, these arrangements are usually not backed by any assets, so there is a risk that the employer may not be able to pay. There are ways to secure the payment, but they come with tax and legal issues. This article discusses how a professional service corporation in Florida, like a law firm, can pay a departing shareholder for work they did before leaving. It talks about the tax and legal issues involved in setting up a plan to do this, and briefly mentions some other legal and financial matters that might come up. The PSC and its shareholders have a contract to decide how they will be paid for their work. This is to make sure everyone knows what they will get and to show that the payments are for work, not just extra money. The PSC’s ability to pay in the future depends on collecting money it is owed. If the PSC is sued and has to pay money, it might have to use the money it is owed to pay the judgment. For employees, income tax is generally based on the money or property they receive from their employer. If an employer promises to pay an employee in the future, it usually doesn’t count as income until the employee actually gets the money. If the employer uses an insurance policy or annuity to secure the promise, the employee may have to count the value of that policy as income.

For employers, the rules for when they can deduct money they pay to employees are different. If an employer promises to pay an employee in the future, they can usually deduct that money when the employee actually gets it. The rules for deducting money for pensions and annuities are a bit complicated, but basically the employer can usually only deduct the actual amount they paid, even if the employee counts more as income.

In both cases, the exact rules for how and when money is counted for income and deductions can be a little complicated, and different for different situations. If a company promises to pay its shareholder money in the future, they can take a tax deduction for it as long as it’s a reasonable amount for the work the shareholder did. If the company buys life insurance for the shareholder but keeps ownership, they can’t deduct the premiums. Any increase in the value of the insurance or annuity may increase the company’s taxes. If the shareholder dies, the company doesn’t have to pay income tax on the insurance money, but they may have to pay a different type of tax. When the company pays the shareholder, they have to take out taxes like they would for regular income. ERISA is a law that applies to retirement and employee benefit plans. Most nonqualified deferred compensation plans are subject to ERISA rules, unless they meet the requirements for a “top-hat” plan, which is for a select group of high-level employees and has fewer rules to follow. The Department of Labor has not given clear guidance on what exactly qualifies as a “top-hat” plan, so there is some uncertainty about it. A top-hat plan can help a company avoid taxes and regulations, but employees may worry about getting paid in the future. Companies want to find a way to guarantee payment without dealing with more rules. It’s a tough problem with no perfect solution. To determine if a plan is “unfunded” under ERISA, you need to look at whether the benefits are paid out of the employer’s general assets or from separate assets that are protected from the employer’s creditors if they go bankrupt. In a court case and a DOL opinion letter, it was decided that certain plans were not funded because the plan documents said that the participants only had the rights of an unsecured creditor of the employer and that the funds could be used to pay off the employer’s creditors. This meant that the plan participants couldn’t make a claim under ERISA for the benefits. In some cases, employers can set up special benefits for certain key employees that don’t have to follow all the usual rules under a law called ERISA. For example, in a case involving Falstaff Brewing, the employer set up a life insurance plan for key employees that was funded by the company. Because of the specific way the plan was set up, it didn’t have to follow all the usual reporting and disclosure rules under ERISA. In another case, a company set up a life insurance plan and a separate deferred compensation plan for key employees, and because of the way the plans were structured, they didn’t have to follow all the usual rules under ERISA. Two employees sued their employer trying to get back money they said was owed to them under a retirement plan. They argued that the plan was funded because they owned life insurance policies, but the court said the plan was unfunded because it didn’t have any assets from the employer backing it up. If the plan had been funded, the employees would have had an easier time winning their case. Also, the rules for who can be part of this kind of plan are not very clear. In a recent opinion letter, the DOL defined a “top-hat” group as a small number of high-ranking employees who have significant influence over their benefit plans. The letter suggests that the group should be a relatively small percentage of the employer’s overall workforce. A court case found that a plan benefiting around 15% of employees was still considered a “top-hat” plan. So, when creating a “top-hat” plan, it’s important to limit participation to top-level employees and those with a lot of control in the organization, and keep the percentage of eligible employees relatively low. Deferred compensation plans offer benefits but have challenges in balancing tax consequences and security. It is possible to structure a funded arrangement to provide security for highly compensated employees while also avoiding immediate tax consequences and most ERISA requirements. This can be achieved by setting up separate plans, using an insurance-based funding arrangement, having benefits paid out of the employer’s general assets, and ensuring a substantial risk of forfeiture for the benefits. It’s important to be aware that an employer’s rights in a welfare benefit plan could be subject to attachment by creditors. Different types of deferred compensation plans include stock options, stock appreciation rights, and retirement plans. This text discusses various tax laws and regulations related to employee compensation, split-dollar life insurance arrangements, and annuity contracts. It mentions specific court cases and IRS notices related to these tax issues. It also explains the tax treatment of certain types of insurance and annuities. This is a legal article about retirement plans and tax laws. It’s written by lawyers who specialize in these areas. They’re members of professional organizations and active in community organizations. We want lawyers to follow rules, help people, make the justice system better, and learn more about law.

Source: https://www.floridabar.org/the-florida-bar-journal/tax-and-erisa-considerations-associated-with-nonqualified-severance-benefit-plans-sponsored-by-professional-c-corporations/