editing disabled

Deferred compensation refers to a process of delaying payment of income to a date after the income has been earned, often following retirement. Deferred compensation is also a method for delaying payment of taxes and/or reducing the value of the business in order to reduce estate taxes.

Characteristics of a nonqualified deferred compensation plan

Qualified deferred compensation plans (e.g., 401(k) plans in the U.S.) must include most nonowners. A nonqualified deferred compensation plan can be used to provide additional benefits to owners and/or key employees. Because the business cannot take a current tax deduction for money set aside to pay the benefit, many nonqualified plans are not currently funded and are essentially an agreement to pay the compensation at a later date. The employee who is the designated recipient of the deferred compensation may therefore be concerned about the employer's ability to pay the deferred compensation at a later date. A life insurance policy is often used to fund the benefit because this allows a tax-deferred build up of assets similar to a qualified plan. (Epstein, Nonqualified deferred compensation and your family business).

Deferred compensation to parents as part of ownership transition

If estate taxes are an issue in the transfer of the business, a deferred compensation plan for the parents reduces the value of the business and thus the potential estate taxes. (Walson, 2008).

Deferred compensation for key employees

Deferred compensation for a key employee can take the form of salary continuation for a defined number of years after retirement. This allows the employee to postpone taxes to a time when their total income may be less and thus their tax rate may be less. For younger key employees, a survivors' benefit provision can be included to better suit their current family needs. These approaches to deferred compensation generally have forfeiture provisions to incentivize key nonfamily employees to stay with the business, i.e., creating "golden handcuffs". (Epstein, Three problems facing family businesses).

Deferred compensation for children while parents own the company -- as a tool for transfering ownership to the children

When the family business is being transfered to the children via a grantor retained annuity trust (GRAT) or to a defective trust, a nonqualified defered compensation plan for the children can allow the children to receive the tax-free build up of the plan. When the stock of the company is transfered to the children, they can receive a tax deduction which offsets the taxable income. (Zwick and Jurinski, 1999).


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Categories: Compensation and benefits