• Immediate taxation
• 20% penalty
• Interest from the year of deferral (at the underpayment rate plus one percent).

That’s old news, right?  Not exactly.  Although plans should be in compliance at this point, we are finding that some employers never updated their plans for 409A, are not administering their plans correctly, or both.  Fortunately, the IRS has provided limited relief on both counts.

For certain operational failures that are both inadvertent and unintentional, the IRS relief varies based on how soon after the failure the correction occurs and on the status of the participant who needs the relief.  For correcting certain unintentional document failures, reporting of the correction and limited penalties may apply.

Example

The correction procedures are too complicated to effectively summarize in a blog post, but consider the following operational failure we recently encountered to get a sense of what can be involved.

A plan had been updated for 409A, but the plan has not been administered correctly.  The plan provides for vesting at age 65, with an annual benefit of $100,000 payable for five years.  The participant is the employer’s chief executive officer.  However, the parties decide when the participant attains age 65 to defer payment to age 68.  409A does not allow for this type of flexibility.  (Payment dates can be extended under 409A, but the extension must be for at least five years and must be made in writing at least one year before the date of entitlement.)  This year, when the CEO attained age 67, the employer tried to resolve the 409A violation.

The correction procedure for an insider (i.e., the CEO) who fails to receive scheduled payments under the plan, and who corrects the mistake by the end of the second year after the error, is as follows:

• the employer in 2012 pays the CEO $100,000 for 2010 and $100,000 for 2011;
• gains in the plan are removed, and the employer cannot pay any interest or other payment to the CEO;
• the employer and the CEO would need to amend their prior tax returns to include the payments and required taxes;
• the CEO would pay a penalty amount of $20,000 [i.e., 20% of $100,000] for 2010 and $20,000 for 2011; and
• the employer and CEO would need to file an information statement with their original, timely returns (contains list of affected employees, name of plan, description of failure and circumstances, describes steps taken to avoid recurrence, and a statement of eligibility).

The employer would then pay the remaining three annual installments in a timely manner under the terms of the plan.

So where does this leave us?  Employers with plans that have never been updated for 409A or that are not being administered correctly should take advantage of the correction procedures and start complying with 409A.  Various types of corrections can be made without penalty, but early correction is the key.

• (c) Subject to any limitations or restrictions that the department or a federal regulator may impose by regulation, rule, policy, or guidance, a credit union may purchase and hold life insurance as follows:
• (1) Life insurance purchased or held in connection with employee compensation or benefit plans approved by the credit union’s board of directors.
• (2) Life insurance purchased or held to recover the cost of providing preretirement or postretirement employee benefits approved by the credit union’s board of directors.
• (3) Life insurance on the lives of borrowers.
• (4) Life insurance held as security for a loan.
• (5) Life insurance that a federal credit union may purchase or hold under 12 C.F.R. 701.19(c).

We understand that the Credit Union Division will still require credit union boards to strictly adhere to the guidance contained in the Interagency Statement on the Purchase and Risk Management of Life Insurance that is applicable to banks and savings associations. Among other things, Indiana boards must:

• Limit the investment to 25% of capital, unless the credit union’s board approves a higher level. Credit unions exceeding this level should expect close scrutiny on examination.
• Review policy performance at least yearly.
• Use vendors (brokers, consultants, agents) and insurers that have a long-term commitment to the industry.

FY2011 marked the end of the three-year phase-in of the redesigned Form 990. [T]his means the lead-up time is over, and the redesign has begun to pay off by providing us with more information about exempt organizations. This allows us to use data analytics and build risk models that will guide our work and greatly improve our ability to support high standards of transparency and stewardship among exempt organizations.

Consistent with this statement, Form 990 for reporting 2011 activities has few changes in its compensation reporting requirements compared to 2010. Here is a comparison of the 2010 and 2011 forms.

Defined Benefit Retirement Plan

W–2 Compensation

Short Deferrals

Benefit Reporting Table

Governance:

Has the organization provided a copy of this Form 990 to all members of its governing body before filing the form?

As nonqualified deferral plans for credit unions normally use cliff vesting to qualify for tax deferral under 457(f), and supplemental employer contributions rather than elective deferrals, the new rules should require few if any changes to credit union plans.

The guidance is also expected to address what qualifies as a bona fide severance benefit for purposes of 457(f). Compensation paid under a bona fide severance plan will be taxed as received. Compensation in excess of the bona fide severance limits will be taxed in a lump sum at termination. We expect the bona fide  plan limit to be two times the lesser of (i) the executive’s annual compensation, or (ii) the qualified plan compensation limit ($250,000 in 2012).

As with deferred compensation, we expect that few changes will be required to comply with the new rules, and certainly there is no expectation that severance will actually have to be limited to the two-times limit.

As we wait for the proposed 457(f) regulations to be issued, credit union boards and management should consider:

1. Does the credit union have any nonqualified deferral plans that use noncompetes or elective deferrals?
2. Has the credit union established severance arrangements (contained in employment agreements or in separate arrangements) that exceed the expected bona fide limits?

If so, you should be prepared to update your plans when the new rules come out. If not, it will still be important to verify that no other changes to your plans are required.

1. Continued Employer Protection.

It may surprise some, but boards really do value noncompete restrictions. In a nonqualified plan, they protect against unfair competition much more effectively than injunctive noncompetes in employment agreements. Enforcing the noncompete in a deferral plan involves doing nothing—not writing the check. Enforcing injunctive noncompetes often involves lawyers, Latin words and long-lasting litigation. We expect many employers to continue to include noncompete restrictions in their plans, just not rely on them to defer taxes.

Example:  The Deferral Plan provides an annual employer contribution of $10,000. Each year’s contribution vests three years after it is made. Upon vesting, the contribution is taxable and the employer distributes enough to pay the taxes due, but retains the balance. It distributes the balance two years after the executive terminates employment, provided the executive does not compete with the employer during the two-year period.

2. Section 83.

So far, the IRS comments about the anticipated guidance indicate it will apply only to 457(f) plans, and not to Section 83 plans. Section 83 governs the taxation of property that is transferred to an employee. Like 457(f), Section 83 recognizes bona fide noncompete restrictions as SRFs that defer taxes. Therefore, it appears that noncompete restrictions will continue to defer taxation under Section 83 arrangements even after the IRS publishes the 457(f) guidance.

Example:  The employer transfers ownership of a life insurance policy to a key physician. The physician must return the policy to the employer if the physician terminates employment prior to age 62 and competes with the employer. The life insurance is property, so its transfer is governed by Section 83. Therefore, assuming the anticipated guidance is limited to 457(f), the physician will not be taxed on the value of the policy until remaining employed to age 62 or satisfying the noncompete restrictions.

If the anticipated guidance concludes noncompete restrictions are not SRFs, we fully expect that well-intentioned advisers will use phrases such as “Noncompete restrictions in deferral plans are illegal.”  They will not be illegal. They could not be used to defer taxation in 457(f) arrangements, but they can be used to protect against unfair competition. Depending on the scope of the guidance, they may also continue to defer taxation under Section 83 arrangements, and possibly under some 457(f) arrangements if the IRS decides to grandfather any prior plans.

Consistent with prior practice, the IRS just published another private letter ruling concluding that a reduction in the benefit formula is not a change in the formula that forfeits great-grandfathering.

Given the limited (and dwindling) number of great-grandfathered plans, the more important impact of the ruling is its confirmation that reducing benefits is generally not treated as a change in benefits. This is important for law and regulatory changes that, like the Tax Reform Act of 1986, are not express about the issue. For example, the 2003 split dollar regulations give nearly no guidance on what constitutes a “material modification” that forfeits grandfathering. This new private ruling gives additional analogous support for reducing split dollar benefits without forfeiting grandfathering and subjecting the plan to the new regulations. (Compare 409A, which specifically states that a reduction in benefits is not a material modification that forfeits grandfathering.)

From: bna.com

If the final regulations look like the proposed rules, few, if any, changes to current plans will be required. 457(b) plans designed to meet the 409A requirements could remove the 409A restrictions (such as annual deferral elections and five-year postponements for changing the time and form of benefit payments). Even now, new plans can be installed with greater confidence in the 457(b)/457(f) approach.

• The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457(b) plans, and the federal government’s Thrift Savings Plan is increased from $16,500 to $17,000.
• The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.
• The limitation on the annual benefit under a defined benefit plan under Section 415(b)(1)(A) is increased from $195,000 to $200,000.
• The limitation for defined contribution plans under Section 415(c)(1)(A) is increased from $49,000 to $50,000.
• The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) is increased from $110,000 to $115,000.
• The annual compensation limit under Section 401(a)(17) is increased from $245,000 to $250,000.

Source

I love lists, and this one made sense to me in what can sometimes be a mess of fuzzy guidelines.

Read the entire post here: http://blog.nafcuservices.com/2011/09/18/10-best-practices-of-compensation-oversight-by-your-credit-union-board/