Senate Finance Committee Votes to Limit Deferred Compensation

The Senate Finance Committee approved the Small Business and Work Opportunity Act of 2007. If adopted as written, the Act would cap nonqualified deferred compensation deferrals to the lesser of $1 million or your average taxable compensation for the previous five years. The provision applies to taxable years beginning after December 31, 2006 i.e. this year. Earlier years will be taken into account for purposes of computing the five-year average. So if your deferral for 2007 will exceed your average compensation for the past five years, you could have a problem.

Summaries of this proposal have emphasized the $1 million upper limit, but the proposal would limit deferrals for all executives even those who are deferring substantially less than $1 million.

Failure to comply will result in ordinary income tax on the entire deferral, not just the amount over the cap. Furthermore, the executive would be subject to the same penalties that apply for a failure to comply with Section 409(A) -- interest at the underpayment rate plus one percentage point on the "underpayments" that would have occurred had the compensation been included in income when first deferred, or if later, when not subject to a substantial risk of forfeiture. The amount required to be included in income would also be subject to a 20 percent penalty.