Code Section 457(f) nonqualified deferred compensation traps ... even for the wary. (Nonqualified Plans).

Internal Revenue Code (Code) Section 457(f) governs the tax treatment of nonqualified deferred compensation for employees of tax-exempt organizations, states, state political subdivisions, and agencies or instrumentalities of a state (referred to hereafter as exempt entities). Due to the often unique tax circumstances under which exempt entities operate, Code Section 457 imposes a different approach to deferred compensation for such entities. Code Section 457(b) plans, often referred to as "eligible plans," allow for the deferral of compensation income until it is paid or otherwise made available to the participant. Unfortunately, the total amount of such a deferral is limited to $12,000 in 2003 (which will increase in later years). If an exempt entity wishes to provide for nonqualified deferred compensation in excess of this limit (assuming that the entity also maximizes other tax-qualified benefits), the exempt entity is primarily limited to Code Section 457(f) arrangements.

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Generally, Code Section 457(f) governs all deferred compensation offered by an exempt entity that is not provided pursuant to an eligible plan (or an otherwise tax-qualified plan under Code Sections 403(b) and/or 401(a)). As such, Code Section 457(f) is a "catch-all" provision. Barring other minor exceptions such as governmental excess benefit plans and property transfer under Code Section 83, Code Section 457(f) appears to apply to all nonqualified deferred compensation provided by Exempt Entities. It is important to note that the legislative history contains suggestions that Code Section 457(f) was only intended to govern elective deferrals. However, pursuant to Notice 87-13, 1987-1 C.B. 432, it is clear that the Internal Revenue Service (IRS) does not believe that Code Section 457(f) is limited to elective deferrals.

Code Section 457(f) allows for the deferral of income until the deferred amounts are no longer subject to a substantial risk of forfeiture. This is similar to one of the two basic standards under Code Section 83. In fact, Code Section 83 is often looked to for guidance as to how to …