News Analysis: The Thin End of the Wedge on Deferred Compensation

Tax Notes contributing editor Lee A. Sheppard looks at some questionable deferred compensation practices, some of which lawmakers are investigating in the wake of the recent corporate scandals.

Document Type: News Stories

Tax Analysts Document Number: Doc 2002-21063 (12 original pages) [PDF]

Tax Analysts Electronic Citation: 2002 TNT 180-9

Citations: (13 Sep 2002)

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Tax Notes contributing editor Lee A. Sheppard looks at some questionable deferred compensation practices, some of which lawmakers are investigating in the wake of the recent corporate scandals.

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Bulls make money, bears make money, and hogs get slaughtered.

Corporate types have been telling anyone who will listen that lawmakers should not "overreact" to the Enron situation, which is why the recent accounting reform legislation was wimpy. "Overreacting" in this context means upsetting the apple carts of corporations and managers who were engaged in similar manipulations of the tax, accounting, and reporting rules.

Thankfully, legislators have not been heeding everything the corporate apologists are telling them. Even pro-business Republicans have become disgusted by what investigations into corporate machinations have revealed.

Blame Enron. Last November, just before Enron's December 2 bankruptcy filing, some top Enron executives caused themselves to be paid an estimated $32 million in deferred compensation pursuant to contractual clauses accelerating payment in the case of a bankruptcy filing. They had some of the money wired to their own bank accounts so that it reached them within 24 hours.

About 150 other lower-ranking executives with rabbi trust promises were not so lucky; their requests for withdrawals were denied by the one executive who was in charge of the deferred compensation plans. So their deferred compensation remained part of the bankruptcy estate, as the rabbi trust fiction dictates. Not surprisingly, Enron's creditors have raised the question whether the deferred compensation payments were voidable preferences under the bankruptcy law. (Associated Press, Feb. 15, 2002, and Aug. 3, 2002; The Wall Street Journal, June 17, 2002.)

Similarly, Global Crossing Ltd. made lump-sum pension payments under a supplemental plan to 65 of 80 top executives on the eve of its bankruptcy filing, even waiving the withdrawal penalty for those executives. Global Crossing's deferred compensation plan had a provision triggering immediate payment on a bankruptcy filing; the supplemental pension plan was changed at the eleventh hour to match that. Top executives also had millions of dollars in company loans forgiven before the bankruptcy filing. (The Wall Street Journal, Feb. 21, 2002, p. B1.)

Corporate scandals have usefully exposed the longstanding dirty little secret of nonqualified deferred compensation -- that it really is funded, and it really is set aside for the employee out of reach of the corporation's general creditors. That the law has tolerated this nonsense for so long is just further evidence, as if more were necessary, that the law serves primarily to protect the property rights of the haves.

The Senate is even thinking about reviving the doctrine of constructive receipt -- which Congress ordered the IRS off so long ago that some of our readers probably could not pass a quiz on it. In reporting out S. 1971, the National Employee Savings and Trust Equity Guarantee (NESTEG) Act -- we don't make up the names of these things -- last July, the Senate Finance Committee stated its intention to allow the tax administrator to revive the doctrine of constructive receipt. (For the bill as reported out of the Finance Committee, see 2002 TNT 157-14 .)

On the House side, the Ways and Means Committee chairman's corporate inversion bill contains some remedies that would rattle the cozy world of executive compensation if enacted. The American Competitiveness and Corporate Accountability Act, H.R. 5095, sponsored by House Ways and Means Committee Chairman William M. Thomas, R- Calif., would call a halt to some of the more egregious rabbi trust practices. (For the Thomas bill, see 2002 TNT 135-57 .)

Egregious behavior has gotten rather expensive for the fisc; the Joint Committee on Taxation staff estimated that the deferred compensation part of the Thomas bill would raise $5.2 billion over 10 years. (2002 TNT 137-7 .)

The Thomas bill provisions had their origin in suggestions made by a Democrat, House Ways and Means Committee member Robert T. Matsui, D-Calif., in a display of bipartisanship that is highly unusual on the House side of the Capitol. But the high-level disgust with executive greed is making for strange bedfellows.

Rabbi Trusts

A rabbi trust is better than a naked promise to pay compensation later because it is funded, even though the IRS and the Labor Department believe that it is "unfunded" in the pension trust sense because the corpus is reachable by the employer's creditors.

In the original rabbi trust ruling, letter ruling 8113107, a congregation formed an irrevocable grantor trust intended to benefit its rabbi. The rabbi received the trust income quarterly; the corpus was to be distributed to him on his death, disability, retirement, or termination. The IRS ruled that the contribution of the cash to a trust for the rabbi's benefit was not income to him, because the cash was not paid or made available to the rabbi in that year, given that it was subject to the claims of the congregation's creditors.

In the 20 years that rabbi trusts have been permitted, and the 10 years since they have been officially encouraged, taxpayers have gotten more aggressive about walking a line that was a thin one to begin with. They have stashed funds that are supposed to be reachable by the firm's general creditors out of the practical reach of those creditors. They have given executives not only investment discretion over their accounts, but also access to the funds by means of loans and withdrawal penalties. They have done all this with the apparent perception that the IRS will not enforce the law.

Most rabbi trusts are facially consistent with the IRS model; they state that the assets will be reachable by creditors and not reachable by employees before the stated time of payment. (The IRS model is delineated in Rev. Proc. 92-74, 1992-2 C.B. 422, modified by Notice 2000-56, 2000-2 C.B. 393.) But a rabbi trust is just a grantor trust that holds assets; it is not the vehicle for the employer's promises. The problems generally come in the nonqualified deferred compensation plan documents, which spell out the corporation's promises to participating executives. The plan, which is a contract, constitutes the substantial limitation that blocks the executive's access to the rabbi trust assets. Plan documents contain the haircuts, participation suspension periods, and payment triggers that the Congress is worried about.

Tax Havens

Section 83(a) provides that if property is transferred in connection with the performance of services, the excess of the fair market value of the property over the amount, if any, paid for it is taxable to the service provider when his rights in the property become transferable or are not subject to a substantial risk of forfeiture.

For something not to be considered "property" for purposes of section 83, it must be subject to the claims of the service recipient's creditors. Indeed, Rev. Proc. 92-64, 1992-2 C.B. 422, the model rabbi trust agreement, requires trust assets to remain subject to the claims of the service recipient's creditors. The IRS will not rule on rabbi trust provisions that deviate from the IRS model. If the assets representing deferred compensation are located in a bank secrecy jurisdiction, so that they are not, as a practical matter, reachable by the service recipient's creditors, then those assets should be considered "property" under section 83.

Large, legitimate, respectable corporations are increasingly moving rabbi trust assets offshore to keep them away from creditors. The countries used for this purpose are "asset protection havens," otherwise known as bank secrecy jurisdictions. Stashing deferred compensation assets offshore, where they are effectively beyond the reach of creditors, is a common practice of hedge funds. (For a discussion of hedge fund compensation practices, see Tax Notes, Aug. 27, 2001, p. 1140.) Hedge fund managers are thought to have deferred billions of dollars of income offshore, with some individual managers deferring $100 million or more. Institutional Investor, September 2002, p. 13.

Rabbi trusts in banking havens are only nominally subject to the claims of the service recipient's general creditors. As a practical matter, creditors will have a huge hassle reaching those assets. So offshore rabbi trusts purport to enable their beneficiaries to have a stash out of the reach of creditors while still within the letter of the law.

Omerta among executives and practitioners has made it difficult for Congress to find out about nonqualified compensation arrangements.

The April 18 Senate Finance Committee hearing on executive compensation saw a Chicago-based law professor, Prof. Kathryn Kennedy of John Marshall Law School, call offshore rabbi trusts a "potentially serious problem." She suggested that Congress explicitly require that rabbi trust assets reside in the United States, where they would be reachable by the employer's general creditors. (For coverage of the hearing, see 2002 TNT 76-2 .)

Section 501 of the NESTEG Act would deem nonqualified deferred compensation funded with assets held in trusts outside the United States to be beyond the reach of the service recipient's general creditors for purposes of section 83. Technically, the bill would add a new section 83(c)(4), which would have the effect of treating offshore trust assets as property that is included in income when the right to compensation is no longer subject to a substantial risk of forfeiture. The proposed change would not apply when the services in question are performed in the foreign jurisdiction in which the assets reside.

The Joint Committee staff estimated that the offshore trust provision of S. 1971 would raise a piffling $290 million over 10 years. Why so little, if so much is stashed in offshore trusts? Because current law allows the tax administrator to go after it. (2002 TNT 134-8 .)

For all the kerfuffle about offshore rabbi trusts, they can be attacked under current law, and the tax administrator appears to be doing so. If the facts of the arrangement are inconsistent with the current law's requirement that the funds be available to general creditors, there is a case to be made that the law has been violated. This is substance -- practical unavailability -- over form -- nominal availability. But having Congress say that offshore trusts violate the law would make arguing this point easier.

Accelerated Funding Triggers

An equally serious problem, which is very difficult to attack except on audit, is the question of triggers that cause a rabbi trust to become funded -- so-called "springing" trusts.

The IRS has approved springing trusts in some circumstances, Kennedy testified. Springing trusts are rabbi trusts that automatically become funded on the happening of triggering events. The IRS has approved a change in control of the employer as an appropriate trigger for funding in letter ruling 9508014, which did involve a nonqualified deferred compensation plan.

But, Kennedy noted, employers commonly include triggers for liquidation and declines in the employer's creditworthiness. "Congress could explicitly provide that the events relating to the employer's financial health are triggering events that will result in constructive receipt for executives," Kennedy suggested.

In LTR 9508014, the IRS inadvertently blessed a nonqualified deferred compensation plan that would automatically terminate and pay all the benefits to the participants if the employer's net worth fell below $10 million. The letter ruling extensively discussed the propriety of a participant's election to defer compensation according to IRS interpretation of the constructive receipt doctrine. A careful reading of the letter ruling shows that the drafters simply missed the trigger issue.

A "rabbicular" trust is a form of springing trust. A rabbi trust -- assets of which are promised to employees and are reachable by the employer's general creditors -- terminates and pours its assets over to a "secular" funded trust -- not reachable by creditors -- on the happening of specified triggering events tied to the financial difficulty of the employer. At the time of the triggering event, employees have the right to get the assets and are taxed on them. The triggering event, the employer's financial difficulty, is exactly the sort of thing that arguably should make the trust corpus reachable by the employer's creditors under the rabbi trust rulings.

The IRS would not rule on rabbicular trusts. Under section 3 of the IRS model rabbi trust document contained in Rev. Proc. 92-64, a rabbi trust must cease making payments to its beneficiaries when the grantor becomes insolvent. In that event, the trustee holds the rabbi trust assets for the grantor's general creditors, among whom would be the trust beneficiaries. Because a rabbicular trust would put the assets beyond the reach of creditors on the occurrence of a triggering event, it would arguably violate the tenets of the law and the model that assets remain available to creditors. (For discussion, see Tax Notes, Jan. 22, 1996, p. 349.)

Bill Sweetnam, Treasury's benefits tax counsel, noted that springing trusts are difficult to attack before a triggering event has occurred, when the deal has been set up. At inception, the rabbi trust itself is kosher and within the model guidelines, even with the presence of the trigger. That is, future funding doesn't enter the rabbi trust analysis. The tax administrator cannot argue under current law that the mere presence of the trigger causes the trust to be funded. Once the trust becomes funded, then it is an audit issue and a bankruptcy issue. Sweetnam's position is that a change in the law is necessary to attack triggers before they go into effect.

Constructive Receipt

The big constructive receipt question is whether "haircuts" -- small forfeitures of promised benefits on withdrawal -- constitute substantial limitations on executive control of deferred compensation plan assets, so that the executive should not be in constructive receipt of those assets. Enron's deferred compensation plans had haircuts of 10 percent on withdrawals, which has become a common provision of these plans.

If a compensatory arrangement is outside of section 83 because there was either no transfer or no property, the service provider still may be in constructive receipt of the deferred income under reg. section 1.451-2 and the case law.

Reg. section 1.451-2(a), which describes constructive receipt, states:

Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.

Back in 1978, the IRS issued proposed regulation 1.61-16, which provided that if a payment of an amount of a taxpayer's compensation was, at the taxpayer's discretion, deferred to a later year than that in which it would have been payable but for his exercise of discretion, the deferred amount would be treated as received by the taxpayer in the earlier year. The congressional reaction was vehement and immediate. Section 132 of the Revenue Act of 1978 provides that the tax year of inclusion of any amount covered by a private deferred compensation plan is determined in accordance with the principles set forth in regulations, rulings, and judicial decisions in effect immediately before the proposed regulation was issued. Section 132 is still in effect.

Before the controversy erupted in 1978, after all, the tax administrator had been laying the groundwork for what became rabbi trusts in several revenue rulings stating that unfunded promises to pay do not result in constructive receipt of income. (Rev. Rul. 60- 31, 1960-1 C.B. 174; Rev. Rul. 69-650, 1969-2 C.B. 106; Rev. Rul. 75- 25, 1975-1 C.B. 127.)

Kennedy testified that the IRS has approved haircuts and periods of suspension from participation as constituting substantial burdens on the exercise of withdrawal rights. The IRS has approved haircuts in the low ranges of 5 percent to 10 percent, Kennedy testified, citing letter rulings 8123097 and 8107013, which involved qualified plans. The IRS has also approved suspension periods as short as six months, Kennedy testified, citing Rev. Rul. 55-423, 1955-2 C.B. 41, and Rev. Rul. 77-34, 1977-1 C.B. 276, which involved qualified plans. "Certainly Congress can question whether such penalties and suspension periods are too generous to the executive and decide to impose more restrictive provisions," Kennedy said.

The IRS has never explicitly approved any of these practices for nonqualified deferred compensation plans. The rulings that Kennedy cited are obsolete, inapplicable because they involved qualified plans, and predate these nonqualified plan practices, which are only about a decade old. Nonetheless, practitioners do rely on these obsolete qualified plan rulings, by analogy, to support these practices. A 10 percent haircut is widely accepted as constituting a substantial limitation on the executive's control of nonqualified plan assets. This is not only the qualified plan standard, but also appears to be the practical upper limit on what anxious executives will tolerate.

Qualified plans are different from nonqualified plans. Haircuts have been permitted for hardship withdrawals of otherwise unreachable funds in qualified plans. Hardship is not an issue for overpaid executives, while insolvency and getting out while the getting is good are issues. Moreover, qualified plan assets are never available to creditors, while nonqualified plan assets must remain available. Indeed, the IRS could argue, under Rev. Rul. 73-221, 1973-1 C.B. 298, which involved interest forfeiture on early withdrawal of a certificate of deposit, that only the forfeitable part of benefits subject to a haircut is subject to any substantial limitation. (Brisendine, "Haircuts and Other Substantial Limitations and Restrictions Under Section 451," 10 Benefits L.J. 3, p. 107 (Autumn 1997).)

Noting that the courts have been unsympathetic to the doctrine of constructive receipt, Sweetnam argued that repeal of section 132 of the Revenue Act of 1978 would allow the tax administrator to go after haircuts and their kissing cousins, further deferrals. He noted that the updating of Rev. Proc. 71-19, 1971-1 C.B. 698, has been on the business plan but that government lawyers see section 132 as a roadblock to issuing rulings and regulations on constructive receipt questions. Raising these issues after the fact, on audit, is possible but not productive.

Section 501 of the NESTEG Act would repeal section 132 of the Revenue Act of 1978. Repeal would not accomplish anything in and of itself. Repeal would merely free up the resource-strapped tax administrator to chase a privileged class of taxpayers that few in the upper echelons of tax enforcement have shown much appetite for chasing.

The Senate Finance Committee report for S. 1971 states the committee's earnest desire that the Treasury write regulations "targeted to arrangements which result in improper deferral of income," unburdened by the command of the Revenue Act of 1978. What might constitute improper deferral? So-called substantial limitations on the right to receive income that are not in fact limiting, for one thing. This would include contracts that allow participants to withdraw funds on account of financial hardship, or subject to a relatively small financial sacrifice called a haircut. (For the report, see 2002 TNT 158-36 .)

Moreover, arrangements that purport not to be funded, but in fact are, should be addressed. "It is intended that the Secretary address arrangements in which assets, by the technical terms of the arrangements, appear to be subject to the claims of an employer's general creditors, but practically are unavailable to creditors," the Finance Committee stated. That would include not only offshore trusts but also third-party guarantees to fund compensation.

But elective deferral should continue. "It is not intended that the Secretary take the position (as taken in proposed Treasury regulation 1.61-16) that all elective nonqualified deferred compensation is currently includible in income," the Finance Committee stated. And no inference was intended either that the tax administrator had no power to address these questions now or that any existing guidance is invalid.

Cut the Comedy

The Thomas bill's nonqualified deferred compensation ideas came from a Democratic substitute to the Portman-Cardin pension bill, the Permanent Retirement Security and Pension Reform Act of 2002, H.R. 4931. In June, Matsui introduced a substitute that was designed to reenforce the fiction that deferred compensation promises are unfunded. The substitute was defeated. (2002 TNT 121-1 .)

The Matsui substitute would have required the executives to pick up their deferred compensation if it was promised by contractual arrangements that call for accelerated payment on sudden declines in share value and bankruptcy. It would also require executives to pick up unrealized gains on compensatory options if their companies inverted. In addition, there was a golden parachute excise tax on deferred compensation payable on sudden declines in share value and bankruptcy. (For description, see 2002 TNT 120-18 .) Matsui later introduced those ideas as a separate bill, H.R. 5088. (For the bill, see 2002 TNT 143-43 .)

Section 403 of the Thomas bill would install a special code section 409A dealing with funded deferred compensation of corporate insiders, who would be defined as anyone who is subject to the reporting requirements of section 16(a) of the Securities Exchange Act of 1934 or would be if the corporation was publicly traded.

Technically, the linchpin of the Thomas bill would be the definition of what it means for a deferred compensation plan to be "funded." Funding is a section 83 concept; the bill would use this concept to address constructive receipt questions now governed by sections 61 and 451. Purists might object that the contents of the Thomas bill's new section 409A should appear as amendments to sections 61, 83, and 451 instead, but the drafters preferred to put everything in one statute. The drafters wanted to reinforce the point that deferred compensation is supposed to be unfunded and that the recipient is supposed to be at risk. (We already have a generation of tax practitioners who cannot recognize section 446(b). Bill Thomas may yet create a generation who won't recognize section 451.)

According to the bill, a "funded" deferred compensation plan would be any plan unless the employee's rights are no greater than that of a general creditor, whose assets remain the sole property of the employer and are available to the employer's general creditors at all times.

Assets would be broadly defined as "amounts set aside (directly or indirectly)" and all the income from them. But, according to the Joint Committee on Taxation staff description, the drafters have no problem with the idea that deferred compensation be segregated or for book purposes. It is setting the money aside exclusively for payment of deferred compensation that causes the plan to be funded. (For the Joint Committee description, see 2002 TNT 141-20 .)

The requirements that the employee should have no greater rights than other creditors and that the assets be available to creditors "at all times (not merely after bankruptcy or insolvency)" are intended to preclude the payment trigger that is a feature in many plans. How would we know when an employee has rights greater than other creditors'? Again, the proposal would only exclude the complying class of transactions. An employee would be deemed to have greater rights unless compensation (assets or income) is payable only on separation from service, death, or at a specified time, and there is no provision for acceleration of payment.

According to the Joint Committee description, an event trigger would not qualify for the restriction that the compensation be payable only at a specified time. Surely there must be a less hair- splitting way to draft this to restrict payment to points in time rather than occurrences. Perhaps the drafters ought to limit the payment to separation from service, death, or attainment of Social Security retirement age.

If employer and employee modified the deal to accelerate payment, all previously deferred compensation would be included in income when there is no substantial risk of forfeiture, and deficiency interest would be owing. The modification clause would apply only to modifications that accelerate payment. Most modifications -- we're dealing with vastly overpaid people here -- further defer payment. Congress should reverse Veit v. Commissioner, 8 T.C.M. 919 (1949), in which the Tax Court permitted a second election to further defer compensation that had previously been deferred but had already been earned. Further deferral is an assertion of control that should put the employee in constructive receipt.

Well, how would we know that the employer's general creditors have full rights to the deferred compensation assets? They can't be on an island. The employee must have no beneficial interest in the assets. They must be available to general creditors at all times, not just in bankruptcy. And, most important, "there is no factor that would make it more difficult for general creditors to reach the assets in the trust than it would be if the trust assets were held directly by the employer in the United States." Just in case it isn't crystal clear, the proposal explains "except as provided in regulations prescribed by the Secretary, such a factor shall include the location of the trust outside the United States."

So, if the nonqualified deferred compensation plan is funded, and the employee is an insider, then the deferred compensation would be included in the employee's gross income for the first year that the rights to the compensation are subject to no substantial risk of forfeiture. Note the drafting. The proposal would speak of "no substantial risk of forfeiture of the rights to such compensation." It would deem a substantial risk of forfeiture to be present when the right to compensation is "conditioned upon the future performance of substantial services by any individual."

Sweetnam commented that the combination of the Thomas bill's definitions of funded deferred compensation plan and insider "would end rabbi trusts for the top five people" in a company. The Thomas bill, he commented, is a "broad assertion of constructive receipt doctrine." What he meant was that the Thomas bill would cause income inclusion in cases when it might not be appropriate, such as when an employee had a choice of distribution modes in a nonqualified excess benefit plan. He argued that the emphasis should be on situations when the assets are protected from creditors. The Bush administration has not taken a formal position on either the Finance bill or the Thomas bill.

The haste with which the Matsui ideas were incorporated into the Thomas bill is obvious. There is some sloppy drafting here. Why does the Thomas bill use the words "corporation" and "employer" and "employee" instead of "service provider" and "service recipient," the terms used in section 83? Hedge fund managers are engaged in the same deferred compensation mischief, but they are not employees, and hedge funds are not corporations. Use of the same terms as section 83 would cause the proposed section 409A to cover them; as drafted, it may not cover them. The final version will need to correct this problem.

Moreover, if employer and employee agree to modify the plan, and the employee becomes taxable on all the deferred compensation when there is no substantial risk of forfeiture, the proposal says that "the taxpayer" has to pay deficiency interest at the underpayment rate. The taxpayer is presumably the employee here, but corporations get themselves into Old Colony Trust pickles all the time, so it would be good to clear up just which party would owe interest on the deficiency.

The Enron Window

Even though it exemplifies the type of targeted abuse shutdown drafting that has gotten the government nowhere against aggressive planning, the Thomas bill is the most practical approach in that it contains clear and enforceable directives for the tax administrator. The smart money believes that the Thomas approach will ultimately prevail and that this version will energize the Senate Democrats. The Thomas bill is thought to have 75 to 80 votes in the Senate. There will be a new Senate version of deferred compensation changes later this week. (2002 TNT 176-1 .)

It's embarrassing when a Republican from Bakersfield looks more progressive than you do. Senate Democrats who are looking for new ideas might think about section 3121(v), which lets executives have it both ways. Nonqualified deferred compensation is not taxed currently as income. But section 3121(v)(2)(A)(i) treats deferred compensation promises as wages for purposes of the Social Security taxable wage base when the services are performed. Since every executive's current pay exceeds that limit, this means that deferred compensation will never be subjected to Social Security tax, either when promised or when paid out, as section 3121(v)(B) ensures. Section 3121(v) should be changed to subject deferred compensation to Social Security tax when it is paid out.

The Thomas bill would take away a lot of the tax administrator's discretion. Sweetnam commented that the Finance version left the tax administrator room to make appropriate judgment calls. For example, a 10 percent haircut might be a substantial limitation when the assets set aside for the executive are in six figures, Sweetnam suggested, but not when they are in nine figures. The trouble is that the generous exercise of discretion in the compensation area by Sweetnam's predecessors got the system in the present pickle, in which executives defer whatever and however they want.

In its deferred compensation provisions, the NESTEG Act is vintage Senate product. The senators know what the problem is, in an impressive level of detail. They earnestly want to address it. But they want someone else to be the heavy for taking away the candy from a lot of overpaid executives who can write campaign checks. So they have drafted a bill that entrusts that the tax administrator will want to challenge practices that have gone unchallenged for a decade. It is undoubtedly for this reason that the Joint Committee on Taxation staff scored the constructive receipt provision of the NESTEG Act as having a negligible revenue pickup. (2002 TNT 134-8 .)

In its report, the Finance Committee accepts the existence of rabbi trusts so long as they comply with the IRS model, which most do because the problematic clauses are in plan documents. Once something has been given away administratively and that giveaway has been ratified by Congress, even Congress will not take it back. Sweetnam was not particularly troubled by the implication that Congress might legislatively ratify the decision to permit rabbi trusts, since, in his view, a 20-year-old administrative decision is impossible to revisit as a practical matter.

Congress should not enact the Finance Committee's legislative history and ratify the administrative mistake that was made in permitting rabbi trusts. In hindsight, the 1992 model rabbi trust that the committee is so enamored of was an unsuccessful attempt to put the genie back in the bottle. If the Senate version prevails, the legislative history should contain no inference that rabbi trusts and their accompanying nonqualified plans will continue to be tolerated. Otherwise, the Finance Committee would not be taking full advantage of the Enron window of opportunity to correct past mistakes.

In the longer term, the Enron implosion will have given policymakers a unique opportunity to get legislators' attention for deferred compensation reforms that should have been made years ago.

All of the proposed legislation should open a useful debate about the propriety of nonqualified deferred compensation. The law contains a comprehensive, if imperfect, set of rules governing qualified deferred compensation. These rules have dollar limits set by Congress and nondiscrimination rules intended to achieve some small measure of workplace equity. Why should anyone be able to achieve deferral for more money for a smaller class of recipients by going outside these legislatively considered limits? This small overpaid class of recipients now looks to nonqualified plans for 70 percent to 80 percent of their hefty retirement compensation, meaning that they have little stake in the qualified plans that cover their workers.

Executives who think this will all blow over should think again. As this article was being written, William McDonough, the president of the Federal Reserve Bank of New York and a card-carrying member of the establishment, chastised executives for their excessive compensation. The recent increases in compensation represent "terribly bad social policy and perhaps even bad morals," McDonough said at a September 11 Trinity Church commemoration ceremony. "CEOs and their boards should simply reach the conclusion that executive pay is excessive and adjust it to more reasonable and justifiable levels," he said, adding that the present levels of compensation could not be justified by any economic theory. (The Wall Street Journal, Sept. 12, 2002, p. A2.)

Indeed, former GE chief Jack Welch, a hero to many executives, is inadvertently ensuring that this does not blow over. If you're an overpaid executive with a lavish company-supported lifestyle that you would rather the public not know about, don't get divorced. Divorce court is public, and his estranged wife has alleged some serious stuff about Welch's lavish company-supported lifestyle, many of the details of which appear not to have been reported to either the SEC or the IRS. (The New York Times, Sept. 9, 2002, p. C1.)

Code Section: Section 83 -- Property Transferred for Services; Section 451 -- Year of Inclusion; Section 61 -- Gross Income Defined
Geographic Identifier: United States
Subject Area: Accounting periods and methods
Corporate taxation
Fraud, civil and criminal
Legislative tax issues
Magazine Citation: Tax Notes, Sept. 16, 2002, p. 1549; 96 Tax Notes 1549 (Sept. 16, 2002)
Cross Reference:
Author: Sheppard, Lee A.
Institutional Author: Tax Analysts