Three games into the 2014 National Football League season, the Green Bay Packers had a 1-2 record. Fans were panicking. Many were questioning whether the Packers and its quarterback, Aaron Rodgers, were doomed to have a bad season. Rodgers responded with a simple message for fans: “R-E-L-A-X”. The Packers redoubled their efforts and made the playoffs that year, showing that the initial panic was rather silly. A similar scenario could be playing out with respect to the nonqualified deferred compensation and other executive compensation provisions of the recently proposed Tax Cuts and Jobs Act (the Proposed Act). Some of the initial commentary is expressing some concern that the proposed Act could spell the end of traditional deferred compensation arrangements. This reaction seems a bit premature. One reason is that the Proposed Act still has a number of hurdles to clear before becoming law, and the final law could have different terms from the current Proposed Act. Another reason is that even if the Proposed Act’s deferred compensation terms remain unchanged, employers will still have opportunities to create deferred compensation arrangements for key executives (although they may have to be more creative). So, let’s take a deep breath and explore the three main executive compensation changes in the Proposed Act.

Repeal of Code Section 409A … and replacement with Code Section 409B

One very significant change is that the Proposed Act would repeal Internal Revenue Code Section 409A, effective for services performed on and after Jan. 1, 2018, and add new Code Section 409B. The Proposed Act also would eliminate Code Section 457(b) for non-governmental tax-exempt employers and also Code Sections 457(f) and 457A, again effective for services performed on and after Jan. 1, 2018. The result would be that nonqualified deferred compensation arrangements, including common equity-based compensation awards such as stock options, restricted stock units/phantom stock and stock appreciation rights, would become fully taxable at vesting. In essence, Code Section 409B would impose on private for-profit organizations rules that are similar to what governmental and tax-exempt employers must follow for certain arrangements—deferred compensation that must be subject to a substantial risk of forfeiture. In some respects, new Code Section 409B would be stricter than Code Section 457(f) because the only valid risk of forfeiture would be a requirement to continue to perform services. For example, non-compete covenants generally would not create a substantial risk of forfeiture under the Proposed Act.

That is a significant change and what has led some people to worry that deferred compensation may be dead. We would remind everyone about two important points. First, as mentioned above, tax-exempt and governmental employers have been dealing with these rules for decades, and these employers still manage to provide deferred compensation to their executives. In some ways, tax-exempt employers have less flexibility to design these types of plans than for-profit employers, but in other ways, tax-exempt employers think quite clearly and strategically about the mix of incentive-based pay and supplemental retirement benefits. Second, the Proposed Act will not be the final word on these types of arrangements. Even if the Proposed Act’s terms remain in a final bill that becomes enacted (a big if), the Proposed Act directs the Treasury Department to issue regulations that define certain terms and carve out exceptions.

In that regard, the Proposed Act implements a transition period. Deferred compensation arrangements that were in place for services performed before Jan. 1, 2018, generally would continue to be governed under pre-409B law until the last tax year beginning before 2026 (i.e., Dec. 31, 2025, for calendar year taxpayers). After that period, such arrangements would become subject to Code Section 409B, and thus any vested amounts would become immediately includable in taxable income. Transitional relief also would allow employers to amend existing arrangements to accelerate payment and not violate Code Section 409A. It will be interesting to see how much of an enforcement priority the IRS places on Code Section 409A, and whether it changes any other deferred compensation plan guidance, during this eight year period.

Repeal of performance-based compensation exception to 162(m)

In addition to the changes to nonqualified plan rules, the Proposed Act eliminates the exceptions to the $1 million deduction limitation on compensation paid to “covered employees” of publicly traded companies. Relatedly, the Proposed Act conforms the definition of “covered employee” under Code Section 162(m) to the SEC definition by including as a covered employee anyone who served as the CEO or CFO during the tax year, and the three highest compensated employees at the close of the tax year as listed in the proxy statement. Additionally, anyone who was a covered employee for any tax year beginning after Dec. 31, 2016, would continue to be treated as a covered employee.

Imposition of 162(m) and 280G rules on tax-exempt organizations

The final significant change is that a tax-exempt organization would be subject to a 20 percent excise tax on annual compensation in excess of $1 million paid to any of its five highest paid employees for the tax year. The excise tax would also apply to excess parachute payments, which generally would include payments contingent upon the employee’s separation from service with an aggregate present value of at least three times the employee’s base compensation. In essence, it would subject tax-exempt organizations to rules that are similar to Code Section 280G’s parachute payment excise taxes that private for-profit employers are governed by and Code Section 162(m)’s $1 million annual compensation deduction limitation.


Would these changes mean the death of executive and deferred compensation? As we have hinted at in this blog, various types of employers have been subject to one or more of these proposed changes in one form or another already, and they still offer deferred and incentive compensation to key executives. It is true that the nature of common relationships would change. It also is true, however, that with some planning, employers could still provide incentive and supplemental retirement benefits to key executives that go beyond what qualified plans offer. Again, the Proposed Act is just that—proposed! Everyone would do well to follow the advice that Aaron Rodgers gave to Packers fans a few years ago: R-E-L-A-X (but also double check your executive compensation plans).