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A collection of our articles on various tax aspects.  We cover Tax Representation subjects (collections, liens, levies, penalty abatement), individual tax situations, and business taxes.

DEFERRED COMPENSATION PLAN (INDIVIDUAL)

by | Sep 25, 2024 | Tax Basics

Maximizing Executive Compensation with Deferred Compensation Plans for Small Business Owners

Deferred Compensation Plans offer small business owners a strategic tool for managing executive compensation and tax planning. This article outlines the structure, advantages, and considerations of non-qualified Deferred Compensation Plans (NQDCs), focusing on their role in deferring income and reducing current tax liabilities.

Understanding Deferred Compensation Plans

Deferred Compensation Plans allow participants to defer a portion of their income to future years, reducing current taxable income and potentially deferring tax payments until the income is received. These plans are particularly appealing for high earners seeking to manage their tax burdens.

Types of Deferred Compensation Plans:

  1. Salary Deferral Arrangements: Employees elect to defer a portion of their salary or bonuses.
  2. Supplemental Executive Retirement Plans (SERPs): Custom compensation agreements that provide retirement benefits above and beyond standard retirement plans.
  3. Excess Plans: Provide benefits to employees whose contributions exceed the limits of qualified plans due to IRS caps.

Advantages of Deferred Compensation Plans:

  • Tax Deferral: Participants can defer taxes until the distribution phase, potentially reducing tax rates if they are in a lower bracket upon retirement.
  • Tailored Benefits: Plans can be customized to meet specific financial planning and retirement goals.
  • Recruitment and Retention: These plans are effective tools for attracting and retaining key executives by offering competitive compensation packages.

Key Considerations and Risks:

  • Unfunded Liabilities: Most NQDCs are unfunded to maintain tax advantages, which means the promised benefits are not set aside in a separate fund and are subject to the company’s creditors.
  • Timing of Distributions: The timing of compensation deferral and distribution must be planned carefully to align with the executive’s financial needs and tax planning strategies.
  • Compliance Requirements: NQDCs must comply with IRS rules under Section 409A to avoid penalties and immediate taxation.

Engaging a Tax Professional

Given the complexities and regulatory requirements of Deferred Compensation Plans, working with a tax professional, such as an Enrolled Agent, is crucial. They can help design the plan, ensure compliance with tax laws, and align the strategy with broader financial planning goals.

Summary

Deferred Compensation Plans are an excellent way for small business owners to manage compensation for their top executives while providing tax deferral advantages. These plans can be a key component of a competitive compensation strategy that aligns with long-term business goals.

Keywords: Deferred Compensation Plan, small business owners, tax deferral, executive compensation, Enrolled Agent.

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