NYLEX News Premier Executive Beneﬁts Plan Services June, 2005 To our clients and friends NQDCs do not meet the requirements This issue of NYLEX News discusses the recently released Internal of Section 401(a) of the Internal Rev- Revenue Service Audit Technique Guides. These publications include enue Code. instructions to IRS Agents for the examination of nonqualiﬁed deferred compensation plans, executive fringe beneﬁts and split-dol- NQDC plans typically fall into four lar arrangements. The guides are intended to give agents basic infor- categories: mation about these topics and practical advice on how to conduct an 1. Salary reduction arrangements defer- examination. The guides also provide valuable insight to companies, ring the receipt of otherwise includi- executives and their advisors as to issues the IRS may address. Please ble compensation. send comments about this article, as well as suggestions for future 2. Bonus deferral plans deferring the issues, to our Stamford, CT ofﬁce. receipt of bonuses. 3. Supplemental Executive Retirement IRS Audit Technique Guides transfers of compensatory stock Plans (SERPs) primarily for a select I Executive beneﬁts are the focus of options to related persons; and (7) group of management or highly com- IRS examinations Code section 162(m) salary deduction pensated employees. limits. The Guides describe the topic, 4. Excess beneﬁt plans providing bene- I Understanding the rules and IRS’ discuss potential issues for the exam- ﬁts for employees whose beneﬁts are approach may help avoid IRS challenge iner to address and include practical limited by Section 415. suggestions as to how the examination could be conducted. NQDC plans by their nature are INTRODUCTION This issue of NYLEX News summa- unfunded, although employers usually The Internal Revenue Service recently rizes the ATGs that cover nonqualiﬁed set aside assets to meet their future published several Audit Technique deferred compensation plans, split dol- plan obligations. Employers often seek Guides (ATGs) that IRS agents will use lar life insurance arrangements and to acquire tax-favored investments such in conducting examinations of corpora- fringe beneﬁts. as corporate owned life insurance tions and executives. These ATGs dis- (COLI), in order to maximize the eco- cuss income and employment tax issues NONQUALIFIED DEFERRED nomic efﬁciency of these arrangements. for employers paying compensation COMPENSATION PLANS and the executives being compensated. Nonqualiﬁed deferred compensation The ATG advises IRS agents to The seven compensation-related plans (NQDCs) are deﬁned as any elec- focus on the following: areas for which there are now ATGs tive or nonelective plan, agreement, I When are the deferred amounts are: (1) split dollar life insurance; (2) method or arrangement between an includible in the employee’s gross nonqualiﬁed deferred compensation employer and employee to pay com- income? Agents should consider the plans; (3) fringe beneﬁts (including pensation some time in the future. issues of constructive receipt and life insurance); (4) golden parachutes; NQDCs do not afford employers the tax economic beneﬁt and look to see (5) stock based compensation; (6) beneﬁts of qualiﬁed plans, because the whether: NYL Executive Beneﬁts LLC 281 Tresser Boulevard, Suite 1110, Stamford, CT 06901 T 203 353-5800 • F 203 353-5844 • www.nylexbeneﬁts.com Afﬁliated Company • The employee has control over packages. Although the IRS for many SAFE HARBOR RULES the receipt of the deferred years provided little guidance regarding Notice 2002-8 includes special provi- amounts without being subject the use of these arrangements, begin- sions for split-dollar life insurance to substantial restrictions. ning in 2001 transitional guidance was arrangements that were entered into • Amounts have been set aside issued in the form of notices and pro- before January 28, 2002. Some of the for the exclusive beneﬁt of plan posed regulations. Final regulations safe harbors in Notice 2002-8 also participants or a preference is were issued and apply to split-dollar apply to split-dollar arrangements provided to participants over life insurance arrangements entered entered into after January 28, 2002 other general creditors. into or materially modiﬁed after Sep- but before the effective date of the I When are deferred amounts tember 17, 2003. ﬁnal regulations. deductible by the employer? Gener- ally amounts are deductible when In order to identify the existence of FINAL REGULATIONS the amounts are includible in split-dollar arrangements, agents are Under the ﬁnal regulations issued income by the employee. advised to review: September 17, 2003, it is critical for I When are deferred amounts taken I Annual 10-K ﬁling. the Agent to determine who owns the into income for employment tax I Board of Director and Compensation split-dollar policy. According to guid- purposes? Recognition generally is Committee minutes. ance offered in the ATG, if the execu- required at the later of when the I Executive employment contracts. tive owns the policy, the loan regime services are performed or when I Schedule M-1 for adjustments to tax- applies. The agent should make sure there is no substantial risk of forfei- able income for the payment of life the rate of interest being charged on ture as to the deferred amounts. insurance on executives. the loan is at least the applicable AFR I General ledger and accounts payable rate; otherwise, the executive will be GENERAL AUDIT STEPS journal for life insurance payments. taxed on the difference between the In addition to interviewing company AFR rate and the actual interest rate personnel who are most knowledge- INTERIM VALUATION RULES being charged. able about executive compensation Where the interim valuation rules If the employer is the owner of the practices, agents are advised to: apply, Agents should determine split-dollar policy, the employer’s pre- I Review deferral election forms. whether the taxpayer can use alter- mium payments are treated as provid- I Review disclosures in SEC ﬁlings and nate valuation rates furnished by the ing an economic beneﬁt to the execu- in the notes to the company’s ﬁnan- insurance provider, or whether Table tive. The agent should determine that cial statements. 2001 rates should be used. If the if alternate valuation rates are being I Determine whether the company insurer’s rates are being used, are used to value the economic beneﬁt, engaged a consulting ﬁrm to assist these published rates available to all they meet the applicable require- the executive in wealth management. persons who apply for insurance cov- ments, including covering standard I Review any distributions to covered erage from the insurer? risks and that the policy is for a one executives other than those for The Agent should check the insur- year period. death, disability or termination of er’s rate sheet for items such as “not The ﬁnal split-dollar regulations employment. for publication” or “internal use only”. apply to any split-dollar arrangement I Review tax return Schedule M-1 for The insurer’s Web site may indicate entered into after September 17, 2003, amounts that are expensed on the that they do not sell individual term which includes an arrangement that is company’s books but not deductible insurance but only corporate policies. materially modiﬁed after that date. on the tax return. Any of these factors could indicate The Agent should request information that the economic value of the term about any modiﬁcations or amend- SPLIT-DOLLAR LIFE INSURANCE coverage should be recomputed using ments made to the arrangement after ARRANGEMENTS Table 2001. September 17, 2003. Agents are advised that split-dollar life insurance arrangements can be a key feature of executive compensation NYL Executive Beneﬁts LLC (NYLEX Beneﬁts) is a subsidiary of New York Life Insurance Company. Securities offered through NYLIFE Securities LLC, Member NASD, SIPC. EXECUTIVE FRINGE BENEFITS I Loans — Loans to executives have professional. Agents are instructed The Audit Technique Guide deﬁnes been made under terms that indi- that the use of ﬁnancial planning executive fringe beneﬁts as any prop- cate the loans are really disguised services is a beneﬁt received in lieu erty or service an executive receives compensation. Agents should look of compensation and is a taxable in lieu of or in addition to regular tax- for (a) the existence of a promis- fringe beneﬁt. able wages. Regardless of its form, a sory note, (b) cash payments I Qualiﬁed retirement planning fringe beneﬁt provided in connection according to a speciﬁed schedule, — Retirement planning services with the performance of services must (c) interest being charged and (d) also represent taxable compensa- be treated as taxable compensation security for the loan. Loans should tion unless the expenses are “quali- unless there is a speciﬁc statutory be reviewed to make sure the terms ﬁed retirement planning services”. exclusion that applies to the beneﬁt. are being followed. Agents are These qualifying services are instructed to examine the underly- deﬁned as retirement planning Because the tax treatment of fringe ing intent of the arrangement. advice or information provided to beneﬁts can vary, agents are advised an employee and his or her spouse to follow a three-step analysis in Loans should be analyzed to deter- under a qualiﬁed plan, which can- examining this area: mine if they have below market inter- not discriminate in favor of highly I Identify the fringe beneﬁt and start est rates or no interest. Either situa- compensated employees. Such with the assumption that it is tax- tion would result in imputed income services must be provided on sub- able compensation to the employee. to the executive, who then is treated stantially the same terms to each I Check to see if there are any statu- as having paid interest back to the member of the group of employees tory provisions that exclude the employer. Different rules apply normally provided education and fringe beneﬁt from taxable income. depending on whether the loan is a information concerning the employ- I Value any portion of the beneﬁt demand loan or a term loan. Also, de er’s qualiﬁed plan. that is not excludible for inclusion minimis exceptions apply in some in the executive’s gross income. situations. Agents are advised to identify this The Sarbanes-Oxley Act of 2002 issue by seeking information about The ATG identiﬁes various fringe ben- prohibited personal loans to ofﬁcers services provided to executives for eﬁts that are most commonly encoun- and directors of public companies. income tax preparation, ﬁnancial tered, including: I Spousal/dependent life planning or other accounting services. I Awards and bonuses — All com- insurance — Group term life A review of executive employment pensation in whatever form is tax- insurance premiums to insure the agreements and beneﬁts also helps in able. Agents are advised to review life of a spouse or dependent of an identifying this issue, as will a review invoices for “ship to” addresses for executive are includible in the of outside accounting expense. large items that appear to be per- executive’s taxable income. sonal in nature. Employers sometimes attempt to SUMMARY I Club memberships — Club dues classify these payments as a de These Audit Technique Guides are are nondeductible by the employer minimis fringe beneﬁt, but agents intended to give practical suggestions unless they are included in the are advised that the IRS takes a to the IRS Agent conducting a corpo- employee’s taxable compensation. very narrow view of this provision. rate or executive tax examination. Agents are advised that club dues Also, split-dollar life insurance pro- Understanding the IRS’ approach in and fees often are disguised by vided for an executive’s spouse examining and analyzing these issues employers seeking a deduction. Also, should be examined. can help taxpayers and their advisors club memberships have been distrib- I Wealth management — Many avoid arrangements that will be chal- uted to departing executives and executives are provided either a lenged by an examining Agent and they should be reported as wages. sum of money for ﬁnancial plan- possibly result in additional income ning or the services of an outside and employment tax assessments. NYL Executive Beneﬁts LLC (NYLEX Beneﬁts) is a subsidiary of New York Life Insurance Company. Securities offered through NYLIFE Securities LLC, Member NASD, SIPC. ABOUT NYLEX BENEFITS NYL Executive Beneﬁts LLC (NYLEX Beneﬁts) provides supplemental execu- tive beneﬁt programs to a wide range of commercial clients. We focus on devel- oping cost effective executive beneﬁt solutions that are designed to attract, reward and retain key employees. Our services are designed to assist clients at all stages in the adoption and operation of executive beneﬁt programs, and include: I Initial assessment I Plan design I Funding I Plan implementation I Ongoing administration NYLEX Beneﬁts’ professional staff includes the following professional dis- ciplines, all dedicated to supporting our clients’ programs, processes, systems and services: I Accountants I Actuaries I Attorneys I Beneﬁt specialists I Insurance specialists We take great care to assure that client programs are practical and cost effective and that they are designed to achieve our clients’ strategic and oper- ational goals. SMRU000000CV(Exp.00/00) AR02884B(12/06) This material is provided by NYLEX Beneﬁts for general informational purposes only and should not be consid- ered as legal, accounting or tax advice. Readers should consult with their own professional advisors as to how this material may apply to their own speciﬁc circumstances. NYL Executive Beneﬁts LLC (NYLEX Beneﬁts) is a subsidiary of New York Life Insurance Company. Securities offered through NYLIFE SecuritiesLLC, Member NASD, SIPC.