The American Jobs Creation Act of 2004 makes substantial changes to the tax
rules for nonqualified deferred compensation plans. The new rules are effective
January 1, 2005.
The types of plans that may be affected by the law are:
- Nonqualified deferred compensation plans
- SERPs (supplemental executive retirement plans)
- Excess benefit plans
- Discounted stock options
- Restricted stock units
- Phantom stock
- Stock appreciation rights
- Certain severance agreements
The types of plans not affected by the new law include:
- Qualified employer plans
- Qualified retirement plans such as pensions, 401(k)s, and profit sharing
- SIMPLE (savings incentive match plans for employees) plans
A participant must now elect to defer compensation prior to the year in which
that compensation is earned. There are two exceptions to this rule:
1. Performance-based compensation; and
2. When an individual first becomes eligible to defer, he or she has 30 days
to elect deferral.
A participant can only collect the money early under certain circumstances
such as: disability, death, separation from the job, change in control of the
employer, financial hardship of the participant caused by an unforeseen emergency,
or on a date specified at the time of election.
Participants can no longer collect their money early by forfeiting a certain
percentage of the total amount, which has traditionally been allowed. The forfeited
amount was customarily 10 percent of the principal.
The penalties for violating these rules are strict. They consist of:
- Including the deferred compensation in the participant's current income;
- Paying interest at the underpayment rate plus 1 percent from the time the
amounts were first deferred; and
- Paying an additional tax of 20 percent.