Special rules apply to compensation arrangements of tax-exempt entities. If the arrangement does not comply with the rules, then the amount of compensation subject to the arrangement is taxed to the employee as soon as it is vested (even if the employee won’t receive the money in that year). The IRS just published proposed regulations modifying some of these special rules. The proposed guidance will impact paid time off arrangements, death and disability plans, severance policies, bonus plans, employment agreements, and deferred compensation arrangements of tax-exempt entities.
Here are a couple examples of how the modified rules may affect a tax-exempt entity’s compensation arrangements:
- Bonuses are often paid after the end of the entity’s fiscal year. If the timing of bonus payments and documentation of the bonus plan do not meet the new rules, the amount of the bonus may become taxable to the employee in a year before it is actually paid to the employee.
- If severance may be paid on both involuntary and voluntary terminations or does not meet certain limits on timing and amount, the value of the severance may be taxable to the employee before the year in which it is actually paid to the employee.
- Plans that provide benefits upon an employee’s “own occupation” disability (rather than total disability) may result in taxable income to the employee before the employee becomes disabled.
To ensure compliance with the new rules (and avoid unintentional tax consequences for employees):
- Review employment agreements with bonuses, severance, disability payments, or special vacation arrangements.
- If severance is offered:
- Make sure a severance plan/policy is in place that meets the applicable payment timing requirements
- Reconsider or redesign any severance plan that allows payment on voluntary terminations
- Review and possibly tweak (or more clearly document) bonus plans to ensure it is clear they meet the rules
- Review any supplemental retirement plan or incentive plan, and, if necessary, redesign the plan to meet the new requirements.
- Review disability plans that provide for “own occupation” disability benefits
The new rules will be effective after the final regulations are published. We expect the rules to be effective beginning in January 1, 2018, and they will apply to new arrangements and to current arrangements that continue after the effective date.
Every tax-exempt entity should review its employment agreements and any deferred compensation arrangements as soon as possible; modifying these arrangements can take a significant amount of time due to the required approval process. We also recommend budgeting for the review and modification of other affected arrangements (such as paid time off arrangements, death and disability plans, severance policies, bonus plans, and deferred compensation arrangements) in the next year. We can help with this process by providing customized estimates – please don’t hesitate to ask.
We’re happy to provide more information on the new rules and how they might impact specific plans.
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