Be Careful With Deferred Comp

The backlash from the collapse of Enron appears to be never-ending. Between Sarbanes-Oxley headaches and audit committee members who practically have to put their lives on the line, can the rules get any tighter?

Yes, they can.

Now deferred compensation rules have been tightened because, no surprise, the execs at Enron took advantage of them too.

"Deferred compensation was an unregulated environment and things had gone too far," says Tom Long, a tax analyst at RIA, a Thomson business providing tax information and software to tax professionals.

So back in October 2004, the American Jobs Creation Act introduced stringent rules to prevent abuses. If you are eligible for deferred compensation, you'd better heed the warnings or you could actually end up with less money than when you started.

Deferred compensation is an arrangement with your employer in which a portion of your income is paid at a date after which it is actually earned. The primary benefit is the deferral of tax. You don't pay tax on the deferred compensation until you get the money, even though you have technically earned it.

There are two types of deferred compensation -- qualified and nonqualified. Qualified can be a pension or retirement plan. Nonqualified is mainly used for upper management. Examples of nonqualified deferred compensation include perks like stock appreciation rights agreements and nonqualified stock options for the CEO that wants to extend his salary beyond his working years.

Nonqualified deferred compensation plans must have restrictions or "substantial risks of forfeiture" in place to qualify. (Qualified plans do not need these restrictions.) For instance, one company's "substantial risk of forfeiture" might be that you need to stay with the company for five years to qualify for your bonus, says Mark Luscombe, a principal federal tax analyst with CCH, a provider of tax and business law information. Another risk could be that you must meet certain performance goals to get the money.

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