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myNQDC.com Alert: Insights & Updates, April 12, 2012

We continue to enrich our content with crucial updates and practical new articles and FAQs about key NQDC topics. Below are selected additions and updates from the past few months.

New Articles From NQDC Experts

  • Added Protections To Look For In Your Company’s Nonqualified Deferred Compensation Plan, by Michael Melbinger, Partner, Winston & Strawn. Participating in your company’s NQDC plan can be an excellent way to defer taxes and save for retirement, among other benefits. However, as compensation and benefits attorney Michael Melbinger explains, you need to know the protections you should look for in your NQDC plan and related documents, and you should know what additional protections can be included.
  • How Bankruptcy Affects Your Nonqualified Deferred Compensation, by Chad R. DeGroot, Staff Attorney, Laner Muchin. One of the biggest risks you face with nonqualified deferred compensation (NQDC) is the possibility of your company’s bankruptcy. Unlike 401(k) plans, NQDC plans do not receive ERISA protections, and the funds in the plans are at risk of being included in a company’s bankruptcy estate. This article, by attorney Chad DeGroot, addresses some key issues that participants in these plans should know about corporate bankruptcy.
  • Ten Key Features Of Nonqualified Deferred Compensation, by Kenneth A. Dayton, Regional Director, The Newport Group. For retirement savings, a nonqualified deferred compensation (NQDC) plan is one of the few choices for meaningful tax-deferred investing. When properly designed, financed, and administered, NQDC plans can also give your company a cost-effective way to retain and attract talented executives who maximize shareholder value. This article, by consultant and lawyer Kenneth Dayton, encapsulates 10 compelling reasons in favor of NQDC plans, for both participants and companies.

409A Developments

Our readable collection of FAQs on the rules of Section 409A reflect the types of questions participants care about. The rules we explain also permeate all aspects of nonqualified deferred compensation. The following 409A developments will be of interest to both professionals and participants.

1. W-2 reporting for NQDC. As we explain in our FAQ on this topic, the amount of income deferred during the year may be indicated in Box 12 of the W-2 using Code Y once the IRS has issued more guidance on the point. (For income from a 409A violation, Code Z is currently used.) This guidance—and thus the required W-2 reporting—is not expected for some time, according to Bloomberg BNA’s Compensation Planning Journal. It seems that the IRS is currently preoccupied with other proposed and final rules, including the Income Inclusion Regulations that relate to 409A and the penalty calculations

2. IRS audits. According to the newsletter HRS Insight by PricewaterhouseCoopers (Mar. 14, 2012), the IRS is “now stepping up its enforcement activity” in 409A compliance for nonqualified plans. Participants will get stuck with substantial penalties if plans do not comply. Areas of IRS attention include:

  • incorrect reliance by companies on the short-term deferral rule to avoid 409A consequences
  • inappropriate identification of specified employees, a point that matters for various purposes, such as the six-month delay in payouts after employment termination
  • documents that do not clearly specify the time and form of payment for deferred amounts, as with an employment agreement’s severance provision allowing an employee to elect a lump-sum or installment distribution at termination

Bankruptcy & Nonqualified Plans

Although bankruptcy is the biggest risk with NQDC plans, there are ways to manage and limit it, as we explain in a thorough FAQ and article. Below we present updates on two real-world examples of NQDC treatment in corporate bankruptcy.

1. Kodak. Soon after Kodak filed for Chapter 11 bankruptcy on Jan. 19, 2012, we issued a special alert on what could happen to executives’ interests in its elective nonqualified deferred compensation plan and its excess benefit pension plans, and on what actions the company and its executives have been taking in relation to the plans during the past several years. Since we published that alert, we have learned that the bankruptcy court has told Kodak to form a retirees’ committee for purposes of working out of its large legacy costs, including some $1.2 billion in retiree health care and survivor welfare benefits, and an estimated $200 million in nonqualified deferred compensation plans. The committee is expected to have about 15 members selected by the trustee from the names submitted to it by Kodak and the independent Eastman Kodak Retirees Association (EKRA).

We have heard that the former executives, as unsecured general creditors through their unfunded pensions and elective deferred compensation plans, are concerned that the extremely large health care costs for 30,000 retirees will overshadow the obligations due to 1,000 executives in the nonqualified plans. The bankruptcy court will probably allow only one retirees’ committee, so the positioning for influence on it is intense. The retirees’ committee will be formed in addition to the official unsecured creditors’ committee that was put together shortly after Jan. 19, including the Pension Benefit Guaranty Corporation but excluding any representation of retirees’ interests.

While the number of executives and the amounts of NQDC at risk are relatively small by contrast with Kodak’s overall legacy costs, the deferred compensation participants were the first to feel the sting of reorganization (their payments stopped on Jan. 19 without advance notice or a hearing). For some participants, the loss of deferred compensation payments was around 70% of monthly income. On the other hand, Kodak’s motion to eliminate its health care contributions for Medicare eligible retirees was recently rejected by the court over the objections of the unsecured creditors’ committee—the scramble is just beginning for remaining assets, which may prove to be elusive after all lenders and other secured lien holders have been satisfied.

John Lawson, VP of Executive Compensation at Tompkins Financial Advisors and a member of the myNQDC.com Advisory Board, provided input on the Kodak update above.

2. General Motors. The court case Tate v. General Motors reveals some details about the way the company’s executive retirement plan (ERP) was handled when the company faced financial difficulties. At GM, if a participant’s combined yearly benefit under its qualified pension plan, plus nonqualified plan, was over $100,000, the benefit under the ERP was reduced by two thirds. Calling it “implausible,” the court rejected the executives’ interpretation that only ERP benefits should be considered in reaching the $100,000 threshold.

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