The following important executive compensation developments occurred late last week:

I.  Senate Finance Committee Action.

A.  The Development.  Late Thursday night/early Friday morning, the Senate Finance Committee approved the conceptual outline of legislation that would materially impact almost all existing nonqualified deferred compensation plans.  (This was the outcome of the Committee Staff report suggesting "anti-Enron" laws that we discussed in our February 24, 2003 e-alert.)  In very general terms, the legislation, if enacted, would impose the following new rules on nonqualified plan employee and employer contributions made after 2003:

1.  Distributions may be made only on separation from service, Social Security disability, death, severe financial hardship or a specified date (not on any other specified events, such as change in control, children enrolling in college, etc.).

2.  Distribution acceleration provisions of all kinds (including so-called "haircut" or penalty distributions) are prohibited.

3.  Separation from service distributions to disqualified persons (as defined under the securities laws) cannot be made for at least six months after separation from service.

4.  Voluntary deferral elections must be made in the calendar year prior to the calendar year in which the deferred compensation is earned (or within 30 days of initial plan eligibility).

5.  Elections to delay previously elected distribution dates must be made 12 months prior to the previously elected date, must defer that date for at least five years, and may be made only one time.

6.  Amounts deferred into offshore trusts are immediately includible in income.

7.  Amounts deferred into plans with financial triggers are immediately includible in income.

8.  Participant investment direction menus are limited to investments available to rank and file employees under their qualified retirement plan.

9.  Annual Form W-2 reporting to the IRS of annual contributions/accruals will be required.

10.  Option exercise income and restricted stock vesting income may not be deferred into nonqualified plans.

11.  Impermissible provisions result in immediate taxation, plus interest at the IRS underpayment rate plus 1%.

B.  The Likely Effect.  The pundits who follow tax legislation have stated that this proposal "has legs", and is likely to be enacted without too many changes.  Apparently, both the cosmetic political effect of "doing something/anything" about the perceived Enron (and similar) abuses, plus the revenue raising estimate attached to the proposal, imbue it with high chances of enactment.

Naturally, this legislation would require revisions to virtually every nonqualified plan in America.  In a sense, these changes would drag nonqualified plans back to the way they were in the early 80s, before the various enhancements which the legislation targets became popular.  Fortunately, the prospective-only nature of the changes prove once again the value of "making hay while the sun shines" in the deferred compensation area.

(One troubling suggestion is that the proposed rules in their final form might treat the Section 457(b) plans of tax-exempt entities as "nonqualified plans" subject to the rules, although it appears that the Section 457(b) plans of governments will be exempt.)

C.  Advice to Employers.  Employers with nonqualified plans should monitor this breaking news very closely.  As we suggested in our earlier e-alert on this topic, advance communication with participants is particularly important.  Hopefully, the prospective-only proposed effective date for the new rules will hold, which will only require employers to change their plans for post-2003 deferrals.  However, this will require employers to maintain two accounts for each participant, one subject to the pre-2004 rules and one subject to the post-2003 rules.  In addition, if the legislation is enacted late in the year, some scrambling will be required to perform all of the necessary housekeeping by the effective date for the new rules.  Therefore, employers may wish to consider gearing-up for these likely changes now.

II.  New Proposed Split Dollar Regulations.

A.  The Development.  On Friday, the IRS issued additional proposed Split Dollar Life Insurance Regulations, outlining the post-Final Regulations tax treatment of Endorsement Split Dollar arrangements (i.e., those arrangements where the life insurance policy is owned by the employer and carries an endorsement assigning certain rights to the executive).  As presaged in the prior Proposed Regulations, these new Proposed Regulations state, very generally, that for Endorsement arrangements entered into after the date the Regulations are finalized, the executive will be taxed each year that the cash value of the policy exceeds the amount of the employer's interest in the cash value plus amounts previously taxed to the executive.

B.   The Likely Effect.  The likely effect of these most recent Proposed Regulations will be an acceleration of the implementation of pending Split Dollar arrangements, because arrangements entered into before the Regulations are finalized enjoy the much more flexible rules of Notice 2002-8 rather than the less-favorable rules of these most recent Proposed Regulations.

C.  Advice to Employers.  As we have reported in prior e-alerts, it is important for all employers sponsoring Split Dollar arrangements (whether Endorsement or Collateral Assignment) to review those arrangements carefully as soon as possible in 2003, in order to avoid losing the transition relief that is available until the earlier of December 31, 2003 or the date the Proposed Regulations are finalized.

III.  Forthcoming Section 457 Regulations.

A.  The Development.  At Friday's ABA meeting, IRS representatives suggested that the May 2002 Proposed Regulations under Section 457 would be finalized soon.  Although the representatives did not hint how the most controversial provision in those Regulations would be resolved (i.e., the provision concerning so-called mutual fund option plans), they did suggest that "because only one or two comments" (one from us on behalf of a client) were received on the question of the timing of taxation of earnings in Section 457(f) plans, taxpayers "apparently weren't too concerned with the position taken in the Proposed Regulations and therefore the finalized regulations might reflect the Proposed Regulation's position that pre-vesting date earnings on contributions are taxable on the contributions' vesting date.

B.  The Likely Effect.  If the final Section 457 Regulations provide that pre-vesting earnings in Section 457(f) plans are taxed on the vesting date, virtually all employers sponsoring 457(f) plans will need to revise their plan documents, plan administration systems, plan communication materials, tax reporting, and so on.  In addition, depending on the effective date of such a provision, back tax reporting might also be required.

C.  Advice to Employers.  Employers sponsoring Section 457(f) plans should monitor developments in this area, and should consider communicating with participants about the possibility of this forthcoming negative change in their tax treatment.

In light of the weight of these developments, all employers with executive compensation programs should carefully review their impact/potential impact on their executive compensation programs, have appropriate communications with executives, and consider appropriate pro-active responses.

Please let us know if we can be of assistance in your response to these developments.