Nonprofits Grapple With Shifting 457(f) Landscape

The Wagner Law Group presented a detailed panel discussion on the evolving topic of nonprofit executive compensation arrangements, with a particular focus on the tax treatment of 457(f) deferred compensation plans.

As the panel explained, 457(f) plans are often contrasted with the more familiar 457(b) plans. In the simplest terms, 457(b) plans are subject to contribution limits, while 457(f) plans allow for unlimited compensation deferrals. These deferrals remain untaxed only so long as the amounts remain subject to a “substantial risk of forfeiture.”

According to the panel, which featured Wagner Law Group attorneys Dan Brandenburg and Mark Poerio, as well as James Wynn, principal with Quatt Associates, there are a number of rules and restrictions that nonprofit employers must follow to offer such benefits successfully. Much of what nonprofits have to worry about can be tied to two major sections of the Internal Revenue Code—409A and 457. Due to changes in the wider benefits and compensation landscape, the experts agreed, now is a fine time for nonprofit employers to reconsider their offerings and whether they can do more to attract and retain top executive talent. 

The panel highlighted that the Republican’s federal tax cut package from 2017 included a compensation provision that could have an indirect effect on 457(f) plans. Under the new tax regime, a 21% percent excise tax will apply to the top-five highest-paid employees (or former employees) of a tax-exempt or governmental entity each year on any compensation that exceeds $1 million per employee. According to the panel, there may be an indirect impact on nonprofit employers due to the type of compensation that counts for determining the excise tax. Under the new tax laws, performance-based compensation and commission exceptions have been eliminated.

The panel said 457(f) deferred compensation that is no longer subject to a substantial risk of forfeiture will now count toward the $1 million threshold. If an employee or former employee subject to the excise tax vests in a 457(f) an amount that exceeds $1 million, the employer would then become responsible for the excise tax on the amount in excess of $1 million. The panel stressed that this $1 million figure is a collective amount looking across all the types of compensation a given executive may receive in a given year.

The speakers said nonprofits must be very careful and strategic about how they manage executive compensation. If they do make a mistake it must be addressed quickly, as uncorrected issues can result in an employer excise tax of up to 200% of the amount of excess compensation in question.