July 30, 2020
Federal tax law provides favorable tax treatment for various “qualified” retirement plans by deferring income tax on contributions made by workers. The Internal Revenue Code (IRC) limits the annual amount that workers can contribute to qualified plans. Executives at large corporations have another option for retirement savings that allows them to make far greater contributions thanks to loopholes in the IRC. A bill introduced in the U.S. Senate earlier this year, the CEO and Worker Pension Fairness Act (CWPFA), would close these loopholes, resulting in higher taxes for executives.
What Is an Executive Retirement Plan?
The term “executive retirement plan” refers to certain deferred compensation plans that are not “qualified” under the IRC. They are not eligible for deferred taxation in the same way as qualified plans like individual retirement accounts (IRAs) or 401(k) plans, but large corporations have found ways to take advantage of tax deferrals.
Workers with qualified retirement accounts have an annual limit on contributions. Tax deferrals on contributions to 401(k) plans, for example, are limited to $19,500 per year. Some executive retirement plans, however, may allow unlimited contributions. A report by the Government Accountability Office (GAO), entitled Private Pensions: IRS and DOL Should Strengthen Oversight of Executive Retirement Plans, found that 2,300 corporate executives maintain around $13 billion in this type of account. Many of them contribute to these accounts after they reach their annual limit on qualified plan contributions.
How Are Contributions to Executive Retirement Plans Taxed?
Under current law, a nonqualified deferred compensation plan may be eligible for tax deferrals on contributions if it is “an ‘unfunded and unsecured’ company promise to pay benefits in the future.” The GAO report describes how corporations may be able to create a particular type of trust “to ‘informally fund’ executive retirement plans.”
The report expresses concern that “little is known about certain key aspects of these arrangements.” It makes four recommendations:
1. Improved instructions for IRS examiners;
2. Review of Department of Labor (DOL) reporting requirements;
3. Development of procedures for the DOL “to help companies prevent the inclusion of rank-and-file employees in executive retirement plans”; and
4. Creation of “specific instructions for companies to follow to correct eligibility errors” resulting from “rank-and-file employee” participation in these plans.
What Would the CWPFA Change About Tax Law?
The CWPFA would amend the IRC and the Employee Retirement Income Security Act (ERISA) to implement the GAO’s recommendations. The provisions about preventing “rank-and-file employee” participation are intended to protect those employees’ retirement compensation. The bill would require the inclusion of contributions to executive retirement plans in taxable income when they vest, instead of when they are distributed.
According to the bill’s sponsors, closing this loophole could result in $15 billion in additional revenue over ten years. The CWPFA directs the IRS to transfer the additional revenue to the Pension Benefit Guaranty Corporation, for the purpose of providing additional capital for the estimated 1.7 million workers in “troubled multiemployer pension plans.”
Does the CWDFA Have a Chance of Passing?
The bill’s sponsors are Senators Bernie Sanders (I-VT) and Chris Van Hollen (D-MD). The bill was referred to the Senate Committee on Finance in late February 2020. With the Senate in Republican hands, that is where the bill is likely to stay.
If you need help with questions related to taxes, the tax advisors at the Enterprise Consultants Group are available to answer your questions and discuss your rights and options. Please contact us today online or at (800) 575-9284 to schedule a consultation to see how we can help you.