Senate Finance Committee leaders are working on a plan to resurrect legislation to cap deferred compensation, which they could reintroduce next month as part of a bill that would extend popular education tax breaks.
WASHINGTON — Senate Finance Committee leaders are working on a plan to resurrect legislation to cap deferred compensation, which they could reintroduce next month as part of a bill that would extend popular education tax breaks.
Like previous legislation approved by the Senate — but not the House — this year, the new proposal would set a limit of $1 million on annual compensation deferral. If more than that amount were deferred, executives would face immediate taxation on the excess, plus a 20% penalty.
However, the proposal might drop a previous prohibition on deferrals that exceeded the previous five-year average of an individual’s compensation, which would have hit many executives. Dropping that provision is “definitely on the table,” according to a Senate Finance Committee aide, who asked not to be identified.
The proposal also would exclude earnings on non-qualified pensions and other deferred-compensation plans, as long as the earnings were based on market returns.
“That’s certainly something we’re talking about,” the aide said. “I can’t say exactly how it’s going to play out; that gets to be a fairly complicated area.”
Financial advisers who have clients with deferred-compensation plans were cheered to hear of the possible revisions to the earlier proposal.
The earlier Senate legislation could have affected several clients at Integrated Financial Group Inc. because of the five-year average, according to Donald Patrick, a certified financial planner and managing director at the Atlanta-based firm.
In addition, one major concern about the legislation has been that as earnings in non-qualified pensions accumulated, they would bump executives over the $1 million cap, he said. Excluding earnings based on market rates could prevent his clients from exceeding the cap, Mr. Patrick said.
However, he said, he has problems with the proposal on philosophical grounds.
‘Emotional issue’
“In general, I don’t like the government messing around with compensation,” Mr. Patrick said. “That should be the [purview of the] company’s board of directors [and] stockholders.”
Other advisers balked at what they view as class warfare by Congress.
"Congress deals with this more as an emotional issue,” said Dick Drew, a CFP who is director of financial planning at Hayden Financial Group LLC in Westport, Conn.
“It costs a lot of money to live in the more metropolitan areas of the country,” Mr. Drew said. “They tend to overlook that.”
The deferred-compensation plan Mr. Drew accumulated during more than 30 years working as a corporate executive “is what keeps me going,” and helped finance his transition into financial planning, he said.
Proponents of the deferred-compensation cap also aren’t accounting for the fact that companies can’t take deductions for deferred amounts, he said. “I don’t think they’re tying the two of those together,” Mr. Drew said.
The deferred-compensation cap was sponsored by Senate Finance Committee Chairman Max Baucus, D-Mont., and Sen. Charles Grassley, R-Iowa. the panel’s ranking minority member. Most rank-and-file workers must pay income taxes for the year in which income is earned, and it is inequitable to allow high-income executives to defer their taxes, the senators argued.
Under the changes being discussed, the deferred-compensation ban wouldn’t hit nearly as many executives as the previous proposal, which was killed by the House this year, according to executive-compensation experts.
The earlier proposal was part of legislation approved by the Senate to raise the federal minimum wage. Congress passed the minimum-wage bill, stripped of the Senate deferred-compensation cap, in May.
The effort to tie earnings to market rates of return is an attempt to prevent companies and executives from claiming unrealistic rates as a way to defer more money.
“What they wanted to get at is plans’ coming up with some crazy, fictitious earnings as a way to put money aside,” said Edward Ferrigno, vice president of Washington affairs for the Profit Sharing/401(k) Council of America in Chicago. “Some plans could assume a 20% earnings rate,” which isn’t realistic, he said.
But it will be difficult to define what constitutes a market rate of return, executive-compensation experts said.
For example, rates of return could be based on hedge fund returns, said William Sweetnam, a principal with Groom Law Group Chartered in Washington.
“It could be hard to determine the return on the hedge funds,” said Mr. Sweetnam, who was benefits tax counsel at the Department of the Treasury from 2001 to 2005.
Coming up with a system for identifying market-based rates is “not an easy thing to do,” he said. “It seems easy at the beginning, but as you drill down, you find it’s difficult.”
The difficulty of implementing deferred-compensation rules was highlighted last week when 92 major law firms asked the Internal Revenue Service to delay for a year, until 2009, implementation of complicated new regulations that would govern deferred-compensation plans.
“Every company in America has to review every single compensation plan and every single employment agreement for compliance with these very complicated regulations,” said Regina Olshan, a partner with New York law firm Skadden Arps Slate Meagher & Flom LLP, who signed the letter to acting IRS Commissioner Kevin Brown. “It’s a very formidable task.”
