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CCH® PENSION AND BENEFITS — 8/7/07

IRS to define severance pay plan, substantial risk of forfeiture under Code Sec. 457

The IRS has announced that it intends to issue guidance, applicable to nonqualified deferred compensation plans of state and local governments and tax exempt entities under Code Sec. 457, which will define the terms “bona fide severance pay plan” and “substantial risk of forfeiture.”

The rules of Code Sec. 457 do not apply to certain types of plans, including a bona fide severance pay plan. The IRS anticipates that its guidance will state that an arrangement is a bona fide severance pay plan under Code Sec. 457(e)(11), and thus is not subject to the requirements of Code Sec. 457, if:

• the benefit is payable only upon involuntary severance from employment,
• the amount payable does not exceed two times the employee’s annual rate of pay, and
• the plan provides that the payments must be completed by the end of the employee’s second taxable year following the year in which the employee separates from service.

Substantial risk of forfeiture

Code Sec. 457(f)(1) provides that compensation under a nonqualified deferred compensation plan subject to Code Sec. 457(f) is included in the gross income of the participant or beneficiary for the first taxable year in which there is no substantial risk of forfeiture of the rights to such compensation. The IRS anticipates that its guidance defining a substantial risk of forfeiture for purposes of Code Sec. 457(f)(3)(B) will be similar to the rules under Reg. §1.409A-1(d). Those rules provide that a right to an amount of compensation is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services or the occurrence of a condition that is related to a purpose of the compensation and the possibility of forfeiture is substantial. Under those rules, an amount is not subject to a substantial risk of forfeiture merely because the right to the amount is conditioned, directly or indirectly, upon refraining from the performance of services.

Salary deferral election amounts generally cannot be made subject to a substantial risk of forfeiture under the rules of Code Sec. 409A beyond the date or time the salary would otherwise have been received. The IRS reasons that a rational recipient would not agree to accept future payment of compensation currently earned and payable if there were a real possibility of forfeiture, and would only be subjecting the amount to the purported risk of forfeiture as a means of avoiding taxation.

Use of definitions

The IRS cautions that the anticipated guidance, when issued, will likely be prospective and may modify the definitions of bona severance pay plan and substantial risk of forfeiture contained within this notice. However, pending the issuance of the anticipated guidance, taxpayers may rely on the definitions of those terms contained within this notice.

Comments requested

Written comments on the definitions of a bona fide severance pay plan for purposes of Code Sec. 457(e) and substantial risk of forfeiture for purposes of Code Sec. 457(f) should be submitted by October 15, 2007 and forwarded to CC:PA:LPD:PR, (Notice 2007-62), Room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044, or electronically at notice.comments@irscounsel.treas.gov (Notice 2007-62).

For more information on this and related topics, consult the CCH Pension Plan Guide.

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