A church established a nonqualified deferred compensation plan for the benefit of ordained ministers and lay employees. The church contributes a stated percentage of a participating employee’s compensation based on whether the employee is a minister or lay employee. Participants may also elect to defer a stated percentage of their compensation per year under the plan. No contributions can be made by a participant on an “after-tax” basis. All amounts contributed with respect to a participant are fully vested and nonforfeitable.
Under the plan, a bookkeeping reserve account (the “account”) is established for the employee. The account is used solely as a device for the measurement and determination of the amount to be paid to the employee in the future under the terms of the plan. Participants have the right to suggest an investment option in which the balance of their account will be deemed to be invested. At the time a participant first becomes eligible to participate in the plan, the participant elects the form and timing that amounts will be distributed to the participant from the options provided in the plan. The church is not required to set aside any assets with respect to the plan. Any assets actually held by the church with reference to the plan remain the sole property of the church and are subject to the claims of the church’s creditors. Benefits under the plan are not subject in any manner to transfer or assignment of any kind.
The IRS was asked to evaluate the tax implications of this plan, and it reached the following conclusions: (1) Section 457 of the tax code, which sets forth the rules governing deferred compensation plans, does not apply to churches. (2) “Under the economic benefit and constructive receipt doctrines of sections 61 and 451 of the code, the crediting of amounts to a participant’s account, whether such amounts reflect the deferral of current compensation by participants, church contributions or the deemed accumulation of income in the participant’s accounts shall not result in taxable income for the participant or the participant’s beneficiaries under the cash receipts and disbursements method of accounting until the taxable year in which the benefits are actually paid or otherwise made available.” (3) The right of a participant to suggest how amounts credited to his account are deemed to be invested does not result in taxable income for the participant or the participant’s beneficiary under the constructive receipt doctrine. IRS Letter Ruling 2001105.
Key point. The tax rules governing nonqualified retirement plans are complex. Churches should not adopt such a plan without the assistance of a tax attorney. If your church has adopted a nonqualified retirement plan without the assistance of an attorney, you should immediately obtain a legal review to ensure compliance with the law.
This content originally appeared in Church Treasurer Alert, July 2001.