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New deferred compensation statutes: will it ever end? Private equity fund sponsors need to watch out for section 457A, a new rule in the internal revenue code.

Article Excerpt
Hidden in the October 2008 bail-out bill was a new draconian rule that applies to traditional deferred compensation arrangements of partnerships and foreign corporations, and some performance and management fee arrangements of private equity and hedge funds. Deferred compensation that is subject to the new rule, [section]457A of the Internal Revenue Code, must be included in income when the compensation is no longer subject to a so-called "substantial risk of forfeiture" (meaning that the tax deferral will not be respected and the service provider may have phantom income). However, if the amount of the deferred compensation cannot be determined at that time because of future variable factors (such as the amount of future profits), the amount will continue to be deferred until the amount is determinable, at which time the service provider will include the amount in income and be subject to a 20% penalty tax, plus interest.

Private equity fund sponsors should already be in the process of determining whether this new rule applies to them or any of their portfolio companies and, if it does, should be formulating their compliance strategies.

Who, Me?

Section 457A applies to deferred compensation arrangements of "non-qualified entities." The first step in a private equity fund sponsor's inquiry will be to determine whether there...

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