Non-qualified Deferred Compensation Plans of Tax-exempt and Governmental Entities

Background

Non-qualified deferred compensation plans maintained by tax-exempt or state or local governmental entities, other than certain “eligible” deferred compensation plans, are subject to special, and often surprising, federal income tax rules under Internal Revenue Code (“Code”) section 457(f). These plans, commonly known as “ineligible 457(f) plans,” or just “457(f) plans,” offer tax-exempt and governmental employers the ability to compensate their senior officers and high level management employees on a basis that is generally unrestricted in terms of who is covered by such plans and the amount of compensation provided.

Compensation deferred under a 457(f) plan is includible in the plan participant’s taxable income on the later of the date when the participant obtains a legally binding right to the compensation or the date the right to receive the compensation is no longer subject to a “substantial risk of forfeiture.”  Thus, depending on the terms of the 457(f) plan or arrangement, amounts may be taxable to the participant in a taxable year prior to the taxable year in which the amount is paid.