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October 21, 2016 MARKET TREND: The competition for executive talent remains high. Various approaches for tying executive compensation to a company’s value can offer effective tools for both enhancing company performance and attracting and retaining talent. Companies, however, need to decide whether they want to use actual equity or “synthetic” equity arrangements to accomplish their goals as they differ in effect and implementation. SYNOPSIS: Stock options and restricted stock have been common compensation tools for several decades and can be effective in attracting, retaining, and motivating employees to render the desired performance. These approaches, however, may have unexpected tax consequences for the employees and may cause the company to give up an unacceptable degree of control. Synthetic equity programs are more recent developments that can address many of the concerns presented by stock options and restricted stock. TAKE AWAYS: Equity-based incentive compensation is important for companies and executives alike. This compensation can be provided through the delivery of actual equity, in the form of stock options or restricted stock, or through the use of synthetic equity arrangements. The keys to successful compensation planning using equity- based compensation are to understand the advantages and disadvantages of each approach and to choose the one that, on balance, will best accomplish the company’s objectives. It is widely recognized that paying “equity-based” compensation, which is tied to the value of the employer’s equity, can provide a valuable incentive for improving the performance of employees (particularly among executives) and a meaningful reward for enhancing the employer’s value. Often, this compensation is provided in the form of actual equity through arrangements like stock options and restricted stock. Alternatively, this compensation may be provided through a “phantom” or “synthetic” equity arrangement. This WRMarketplace provides an overview of the tax and practical considerations of each arrangement, while Part II of this series will take a closer look at the use of some of these approaches in practice. STOCK OPTIONS Overview: A stock option is a contract allowing an individual to purchase stock of the issuing company during a specified period for a fixed exercise price. Upon payment of the exercise price, the participant becomes a shareholder in the issuing company. There are generally two types of option – “nonqualified stock options” (“NSOs”) and “incentive stock options” (“ISOs”). Tax Treatment: In reviewing the tax treatment of stock options, there are two key actions that can trigger tax recognition: (1) the exercise of the option (“option exercise”) and (2) the subsequent disposition of the stock received from the option exercise (“stock disposition”). NSOs – Tax on Option Exercise: With NSOs (typically the majority of stock options), the participant (optionee) generally recognizes ordinary income as of the option exercise in an amount equal to the excess of the fair market value (“FMV”) of the stock at the date of option exercise over the exercise price paid for the stock. The exercise price must at least equal the stock’s FMV on the date of the NSO’s grant. The optionee and the issuing corporation also may pay Social Security and Medicare taxes based on the option exercise. ISOs – Tax on Stock Disposition: With ISOs, however, the optionee recognizes capital gain upon stock disposition rather than ordinary income at option exercise, assuming that the stock is held until the later of the second anniversary of the ISO’s grant or the one-year anniversary of the option exercise. Social Security and Medicare taxes also are not payable upon the option exercise. Practical Result – Little Difference: Although ISOs seem to offer more favorable tax treatment than NSOs, the practical result for the optionee is similar in both cases because of the alternative minimum tax (“AMT”). The difference between the stock’s FMV at option exercise and the exercise price (which must at least equal the stock’s FMV at the option grant) is an adjustment item in calculating the optionee’s AMT liability for the year of exercise. Thus, both NSOs and ISO may create complicated tax situations for the optionee, unless the option exercise and stock disposition occur simultaneously or within a short period of each other. Otherwise, the optionee may owe income tax when he or she does not have the liquidity to pay that tax. Practical Considerations Award Based on Company’s Future Performance: The employer should consider whether stock options will provide the desired incentive for the employee. Based on the tax rules noted above, stock options must be granted with an exercise price at least equal to the stock’s FMV on the date of the option grant. Accordingly, stock options only provide economic value to the optionee if the company’s value increases after option grant. While that may incentivize an employee’s future actions, the employer also may want to award employee compensation based on the company’s current value. As stock options only capture future appreciation, they don’t address this goal. Employee Becomes Shareholder: Employers also must recognize that the award of stock options allows the optionee to become a shareholder of the company – with all the attendant legal rights – upon option exercise. The existence of minority shareholders can prevent the original owners from conducting business without interference. For example, minority shareholders may have the right to examine the company’s books and records. Perhaps more importantly, in the event of a sale of the company, potential buyers may not want to deal with minority shareholders (or even holders of outstanding options to acquire employer stock), since minority shareholders may be able to assert dissenter’s rights under state law and hold up or derail a proposed transaction. Liquidity Needs: In addition to any tax liability, the employee may need to have available cash to pay the exercise price upon option exercise. RESTRICTED STOCK Overview: Restricted stock is typically an award of employer stock, subject to the requirement that the individual forfeit the shares back to the employer if the criteria established by the issuer are not satisfied. These “vesting” criteria typically obligate the employee to remain employed for a specified period but also may require the employee to achieve specified performance objectives to allow the stock to vest (i.e., remove the stock restrictions and forfeiture requirements). Tax Treatment: For tax purposes, the key actions for restricted stock are the vesting of the stock in the employee (“vesting date”) and the award or grant of the restricted stock to the employee (“grant date”). Tax Based on Vesting Date: Unless the employee has made an “83(b) election” as discussed below, upon vesting of the stock, the employee recognizes ordinary taxable income on the stock’s FMV as of the vesting date. Social Security and Medicare taxes are also owed based on the time of vesting. Thus, as with stock options, if the restricted stock vests at a time when there is no liquid market for the employer’s stock, the employee may have a tax liability without having sufficient cash available to pay that liability. Tax Based on Grant Date: 83(b) Election: Alternatively, an employee can elect to be taxed on the restricted stock’s FMV as of the grant date by making what is referred to as an “83(b) election.” This election potentially enables the employee to pay less ordinary income tax by basing the tax on the presumably lower value of the stock as of the grant date rather than the vesting date. It also allows the employee to anticipate more accurately the liquidity needs generated by the tax liability. The employee, however, cannot recover the taxes paid if the restricted stock decreases in value after the grant and may not be able to recover the taxes if the stock is forfeited back to the employer before it vests. Practical Considerations: Unlike stock options, restricted stock awards can compensate an employee based on the then full value of the company and do not require the employee to come up with cash to acquire the stock. But restricted stock creates the same issues as stock options in terms of giving the employee full rights as a shareholder of the employer – in this case from the time of the grant date of the restricted stock award, even if the stock is not vested. “PHANTOM” OR “SYNTHETIC” EQUITY Overview: Unlike stock options or restricted stock plans, phantom or synthetic equity plans do not promise to deliver shares of the employer. Instead, they promise a payment in cash based on the value of the employer’s shares at the time of payment (though plans can be structured to allow payment in shares if that medium of payment is desirable at the time of payment). The value to be paid with respect to a synthetic equity award can be based on the full value of a share or the appreciation in the value of a share since the time of award. Tax Treatment: A participant in a synthetic equity plan is not taxed until he or she actually receives payment. In all cases, the tax payable will be at ordinary income rates; there is no way of obtaining capital gains tax treatment for a synthetic equity award. Generally, a synthetic equity plan is structured to pay out on a liquidity event and often pays out in cash. As a result, the potential exposure to tax liability when there is no cash available to pay the tax does not exist. In addition, the employer is similarly not obligated to make a payment when it cannot afford to do so. Practical Considerations: In recent years, the use of synthetic equity plans has increased in frequency because they generally provide solutions to the problems described above with respect to stock options or restricted stock. Because these synthetic plans are not stock options, the tax laws governing the determination of FMV do not apply, giving synthetic plans greater flexibility in establishing the amount that will be paid to the employee and less administrative cost and burden than option plans. Also, because the synthetic equity plan generally does not grant shares of stock to employees, the plan participants do not acquire potential troubling or burdensome shareholder rights. Although synthetic equity plans address many of the concerns presented by stock options and restricted stock, they are not without their own issues. For example, the motivational value of the award may be diminished if an employee wants actual equity in the employer. But more importantly, a synthetic equity plan may be a “deferred compensation plan” subject to the requirements and restrictions of IRC §409A, which imposes strict limitations on the operation of a deferred compensation plan, severely limits the ability to change provisions relating to payments under such a plan, requires the specification of payment provisions at the time the award of deferred compensation is made, and subjects an employee to current taxation with interest plus a 20% tax penalty if the requirements of IRC §409A are violated. Accordingly, careful consideration of the terms and conditions of these arrangements must be undertaken before they can be implemented. Part II of this series will describe in more detail the planning issues involved in setting up a synthetic equity program. COMPARING EQUITY-BASED COMPENSATION PROGRAMS – A SUMMARY Program Advantages/Disadvantages TAKE-AWAYS Equity-based incentive compensation is important for companies and executives alike. This compensation can be provided through the delivery of actual equity, in the form of stock options or restricted stock, or through the use of synthetic equity arrangements. The keys to successful compensation planning using equity-based compensation are to understand the advantages and disadvantages of each approach and to choose the one that, on balance, will best accomplish the company’s objectives. For more information on using equity-based compensation in your executive benefit plan, please contact Mezrah Consulting. Source: AALU

Incentivizing executives to meet business objectives is one of the most important factors in designing executive benefit packages. A sound plan depends on good governance and well-established compensation practices that are aligned with the organization’s overall goals. There are several types of executive benefit plans and each one compensates differently according to the needs of the organization’s industry. To be assured you are maximizing your efforts, consult with your third party administrator to determine which package will suit your company best. When you are ready to move forward it is important to consider the following elements: 1) Define the eligible group. Who do you want to impact? Unlike qualified plans, which must be offered to a non-discriminatory group of employees, a non-qualified plan may be offered to a select group based on certain job titles and/or level of compensation and responsibilities. 2) Outline the purpose. Understand that the executive benefits package is designed to attract and retain select talent, reward performance and years of service. These benefits help you attract the key executives who will contribute to your company’s growth and profitability. 3) Determine competitiveness. There is tremendous competition to retain valuable, high-performing executives. Know your industry’s peer group and what other organizations are providing to their executives. A balanced benefit package that incentivizes performance can also improve recruitment and retention efforts, positioning your company to achieve its set business goals. 4) Identify benefit types. There are many factors beyond compensation that you will need to consider when assembling an executive benefit package. Voluntary plans, company contributions, make up contribution plans due to government limitations in qualified plans, and enhancements to existing group benefit plans (life insurance, disability, and long-term care) are all components that will need to carefully be addressed. 5) Create a solid framework. In designing the overall executive benefits package, make sure each component is well defined and documented. Important factors include – defined contribution, defined benefit, wealth building, wealth preservation, personal risk mitigation or elimination, personal asset protection and credit exposure to the organization. 6) Understand plan costs. It is critical to the financial well-being of the organization to understand the total costs associated with the executive benefits package. Be sure to review your organization’s corporate financial sensitivity to cash flow and profit and loss (P&L), economic costs, as well as tax costs to the executives you are compensating. 7) Verify proxy disclosure. How sensitive is your company to disclosure of benefits? In this climate of intense scrutiny, some organizations must not only understand their executive benefit packages and where they fit into the total compensation picture, but they must also be prepared to defend the plans in proxy statements. There is a lot of work involved with developing solid executive benefit packages that keep your organization competitive, integrates goals and contains performance measurements that tie back to compensation. These packages can be structured in many different ways. To maximize organizational performance, it is important to work with your plan administrator who can see to it that your organization’s executives have been properly incentivized and your company’s goals are aligned.

Target date funds (also known as lifecycle funds) have become increasingly popular in retirement plans. Close to 70% of 401(k) and profit sharing plans offered target date funds in 2014, according to the most recent survey by the Plan Sponsor Council of America.* Are target date funds a good fit for your plan? What criteria are important when choosing to use them in a plan? Understanding What They Are Target date funds automatically rebalance their asset allocations and generally become more conservative as the target date gets closer. The change in asset allocation is referred to as the glide path. The U.S. Department of Labor (DOL) has emphasized the need for plan sponsors to understand a fund’s glide path, which can be either “to retirement” or “through retirement.” With “to retirement” target date funds, the equity portion of the fund’s asset allocation is reduced to its most conservative point at the target retirement date. “Through retirement” funds reach their most conservative asset allocation some years after the retirement target date. Important Differences Glide paths of funds with the same target dates may vary from fund to fund. For example, funds may differ in the percentage originally allocated to equity. They may also differ in when they start reducing their equity exposure and the rate at which it’s reduced. Another difference is that the asset allocation may follow an established glide path or be actively managed based on market conditions. Underlying funds may be actively managed, passively managed, or a combination of both. Fees for active management are generally higher than for passive management, which is designed to track the performance of benchmark indices. Guidance for Choosing Target Date Funds In February 2013, the DOL’s Employee Benefits Security Administration issued guidance to employers and other fiduciaries of retirement plans for selecting and monitoring target date funds. The DOL emphasized that there are considerable differences among target date fund — even among those with the same target date. When selecting target date funds, the DOL suggests the plan fiduciaries take several steps. These include: Establishing a process for comparing and choosing target date funds. Information to consider should include investment returns, fees, and expenses and also how well the target date fund’s characteristics align with the ages of eligible employees and the dates they are likely to retire. Creating a plan to regularly review the funds. Be aware of any significant changes in strategy, management, or other criteria since the last review. Understanding the target date fund’s asset allocation, as well as the risks, strategies, and the glide path of the fund. Review fees and investment expenses. Some target date funds invest directly in individual stocks and bonds, but if the target date fund is a “fund of funds” that invests in other mutual funds, the plan sponsor should be aware of the fees and expenses for both the target date fund and the underlying funds. Creating effective plan participant communications, including required regulatory disclosures. Employees should understand what target date funds are, what the glide path is, and how it works. Documenting the selection and ongoing review of target date funds for the plan. Know Your Plan Participants Since different target date funds have different asset allocations over their glide paths, having an understanding of the demographics of your plan participants and their asset allocations may help you choose target date funds for your plan. This is especially important if you use target date funds as your plan’s qualified default investment alternative, as many plan sponsors do. If your plan already has a target date fund option, it may be beneficial to review how participants are using the funds. Although target date funds are designed as a sole investment option, participants often invest in a target date fund and other options. Participants may also be invested in multiple target date funds. There may be a need to provide additional education to help participants better understand the target date concept. Communication Is Critical Providing information to your participants to clear up any misconceptions is vitally important to getting the maximum benefit of having target date funds in your plan. Points of emphasis can include that target date funds aren’t guaranteed against losses and that reaching a target date doesn’t necessarily mean that investors have saved enough to meet their retirement goals. If you offer funds that don’t reach their most conservative allocation until after the target date, participants should understand the risks involved with having greater exposure to more volatile investments as they approach their retirement date and eventually retire. According to the DOL, such funds may be most appropriate for participants who expect to take their money out of the plan gradually after they retire rather that withdraw all their plan savings at retirement. Having accurate expectations of target date funds should not only improve the participants’ investing experience but your overall plan experience as well. Source: Pension Investors Corporation * 58th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America, 2015 November 2016

April 20, 2017 Since the Tax Reform Act of 1986 corporations have looked to non-qualified plans to allow themselves to better attract and retain executive talent and provide for retirement and wealth accumulation plans beyond the limitations imposed by the federal government as it relates to qualified pension plans (e.g. 401(k) plans, profit sharing plans, etc.). Non-qualified plans are employer-sponsored plans that are not subject to the rules, regulations, and limitations inherent in qualified pension plans. As a result, there are effectively no limitations on what executives can defer, or what corporations can provide in terms of supplemental retirement income. The only requirement is that companies only make eligible highly compensated (i.e. compensation of $120,000 or more) and/or management employees. In addition, these plans also have an element of substantial risk of forfeiture, which means that the benefits of the plan are general obligations of the company. Moreover, any assets set aside to informally fund these plans are general assets of the corporation and are subject to claims of creditors. Given the recent increase in income tax rates (note: top income tax bracket is now 40.5% not including state tax) there has been a resurgence in the participation in and offering of deferred compensation plans. In addition, with executive perks being closely monitored, companies have been looking for executive benefit opportunities that have little to no impact on the company’s profit and loss statement. The below graphic illustrates why companies look to implement executive benefit plans. While the rationale may vary, the common theme is the idea that highly compensated employees have been reversely discriminated resulting in an executive’s inability to retire with the same percentage of their income as a non-highly compensated employee. Source: 2008 PLANSPONSOR NQDC Survey The survey provided takes into consideration small, medium and large companies in Tampa Bay and focuses on a variety of executive benefit plans including deferred compensation plans, supplemental executive retirement plans (SERP), executive life insurance and executive disability income plans. In summary, deferred compensation plans allow a select group of executives to voluntarily defer their income (salary, bonus, commissions and incentive compensation) to a future date and accumulate wealth on a tax-favored basis. The dollars deferred can be structured to be paid at a specified date, upon separation of service or a retirement. SERP’s can take the form of a defined contribution plan or defined benefit plan whose benefits are paid for by the company and paid to the executive at retirement age. An executive life insurance plan is a plan whereby the company pays a premium for a life insurance policy whose death benefit is typically equal to some multiple of the executive’s salary (e.g. 3x salary). These benefits can be structured to be income tax-free when paid to the beneficiary of the participant. An executive disability income plan is a plan typically provided as a supplement to an existing group long term disability plan to provide supplemental monthly income to the executive upon not being able to perform the material duties of their own occupation. Monthly benefit amounts are often increased, plan provisions are enhanced and additional forms of compensation are often covered including equity forms of compensation. The survey below depicts a comparison between what companies are providing their executives nationally to what companies are providing their executives in the Tampa Bay area. While this survey is focused on publicly traded companies with $60+ million in revenue due to the prevalence of available information, privately held companies also utilize non-qualified executive benefit plans as tools to better attract and retain executive talent. It is important to note that based on the private company’s structure (C corp, S corp, etc.) the economics and value of these plans to the majority shareholders of a private company, as a plan participant, may vary based on plan design. Source: 2008 PLANSPONSOR NQDC Survey As expected, the prevalence of executive benefits within larger companies was more diverse with all executive benefit types being provided at various levels. More that 50% of the larger companies surveyed ($1 billion or more in revenue) are providing deferred compensation plans and, moreover, 92% of the surveyed group provides at least one or more type of executive benefit plan. 50% of the companies between $400 million and $1 billion provided executive life insurance benefits and less than 25% of the smaller companies provided either a SERP, executive life insurance plan or executive disability income plan. No smaller companies surveyed provided a deferred compensation plan. Compared to the national survey, the larger companies in Tampa Bay are competitive as it relates to providing executive life insurance and disability benefits but lagged the market competitively as it relates to providing deferred compensation plans and SERP opportunities. Many companies in Tampa Bay compete for talent nationally. Often times we find out that providing an executive benefit (e.g. deferred compensation plan) as part of the total compensation package can lure an executive to move for an opportunity. Alternatively, retaining talent is just as vital to the success of the business. The cost of losing an executive often times far outweighs the cost of providing an executive with a supplemental benefits platform. Disclaimer: This material is intended for informational purposes only and should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney, tax advisor or plan provider.

The fall season can be one of the best times of the year. It’s the start of football season, pumpkin flavored coffees, cooler weather and of course, one of HR’s busiest times of the year – open enrollment. For a variety of reasons, benefit options often change and with that come new demands on employees and employers during open enrollment. This can often times lead to stress and anxiety not only for the HR professionals, but for the employees trying to compare benefit plans, understand various changes in their policies, and how it will impact their families throughout the following year. To make the enrollment process as smooth as possible, it is important that employers educate and communicate to their employees effectively. The following four tips can help HR professionals meet their annual open enrollment challenges and in turn provide their employees with important information to make informed benefit decisions. Organize a Focus Group: One of the best strategies to boost engagement during open enrollment begins long before benefits season. Set up meetings with finance and your third party administrator to discuss how best to improve, communicate, and deliver a successful enrollment experience. By involving everyone early on in the process, you increase your chance of improving engagement come open enrollment time. Plan Ahead Using Thoughtful Content: Content and word choice are an important part of a successful enrollment season. Think about how you can best convey your message and lean on your team to help guide your decisions. Discuss any plan design enhancements and include them in the materials. Thoughtful execution allows you to influence what information your employees see and read first. Get Creative with Communications: Simple is better. Benefits can be confusing, so all communications should be presented in a clear format. Identify new imagery including photos, graphics, and financial examples. Simple charts and engaging videos help to make difficult benefit decisions easier for the average participant. Think about the creativity you have available, but keep the key message and “what you need to do for enrollment” information central to the enrollment materials. Improve the process: In order to improve this year’s open enrollment experience, it is important to review what worked well last year and identify what can be improved. This exercise is an important step to providing clear direction while setting executable goals. Know what you want to measure and how you are going to measure it. Eighty percent of employees believe their overall benefits packages influence their engagement on the job and with their organizations, according to the 2014 Aflac WorkForces Report. The report goes on to say that only nine percent believe their HR departments have effectively communicated health care reform and subsequent changes to their benefits packages. By working with both your internal resources and the Mezrah Consulting Team, you can be assured your open enrollment season will provide your employees with a personalized and informative experience.

February 2018 The Tax Cuts and Jobs Act (“Tax Law”), which became effective on January 1, 2018, includes several provisions that impact life insurance companies and the products they offer. The Joint Committee on Taxation estimates the 10-year cost for the industry to be $23 billion. While a lower corporate tax rate (21% under the Tax Law, down from 35%) will offset some of the impact, there are a number of implications to consider. The good news is that for products with strong cash values—including current assumption Variable Universal Life (VUL), Universal Life (UL), and Private Placement Life Insurance (PPLI)—the impact for many product structures is neutral or better as the reduction in the corporate rate offsets the insurance-related tax increases. In addition to the reduction in the corporate rate (a positive for the industry), the primary provisions of the Tax Law that impact life insurance products include: The DAC tax amortization rate has been increased to 9.20% from 7.70% and the amortization period has increased to 15 years from 10 (Negative) The changes in the DAC tax parameters increase the cost of the DAC tax, which essentially operates as a no-interest loan to the federal government. Therefore, the change in the parameters essentially increases the amount and duration of this loan. In many products, the cost of the DAC tax is charged to the policy as a percentage of premium charge, approximating the present value of the cost to the company for essentially loaning the government money at 0% interest for 15 years (corporate hurdle rate on DAC balance over the amortization period). While the cost to insurers will increase, this cost appears to be offset by the lower corporate tax rate. Therefore, it is not anticipated that insurers will raise the DAC tax charge for in-force policies. For new products, insurers may choose to reflect a higher DAC tax cost, while applying the benefits of the lower corporate tax rate in other elements. Computation of life insurance tax reserves (sec. 13517 of the Senate amendment and sec. 807 of the Code) (Negative) – For insurance companies, increases in reserves are tax deductible expenses and, conversely, decreases in reserves are taxable income. This provision, which limits the deductibility of reserves to 92.81% of the change in reserves that are in excess of cash surrender values, could have a substantial negative impact on many insurance products. While the actual impact will vary based on how the product and reserves are structured within a product, the products most likely to be impacted are those with no or low cash surrender values (such as Term, NLG, or products with NLG-like features) and products with large surrender charges. In some Term and NLG products, which have a certain amount of capital leveraging, small changes in the reserving can have a potentially substantial impact on premium (estimated at 10% to 20%). High cash value products like VUL and PPLI may not incur any adverse impact. There is additional uncertainty as insurers are still evaluating the 2017 CSO transition and Principles Based Reserve (PBR) changes, which are especially difficult since the IRS has not ruled on the tax deductibility of the components that comprise the new PBR reserve. The Dividend Received Deduction sets the proration for Company Share to 70% and Policyholder Share to 30% (Positive or Negative depending on an insurer’s past practices). Proration is the amount of dividend income which a corporation is allowed to use for the Dividend Received Deduction. This provision primarily impacts separate account business. Insurers that have been reflecting 100% company share proration in their pricing may see a negative impact. However, companies that have not recognized proration in their pricing may now be willing to include this in their pricing. The impact can be a 10 to 30 basis point change in long-term policy IRRs. In general, the Tax Bill will make products more capital intensive, a result of the DAC Tax change and the limit on the deductibility of life insurance tax reserves. Since tax-deductible reserves are still able to use a cash value floor, products where the reserves equal cash values (PPLI and VUL) will feel less of an impact. Products without cash values (Term and NLG) will feel more of an impact. There may be insurer specific situations where the interplay with other sections of the Tax Law (e.g., limits on deducting interest expense, foreign reinsurance transactions, etc.) will come into play. At this time, M Carriers have not indicated that any provisions of the Tax Act will directly affect the pricing of their products. Going forward, it is likely the industry will identify product designs that take advantage of the lower corporate rate and minimize the negative impact of these other changes. These products would be introduced over the next couple of years as insurers continue revising product portfolios for the transition to 2017 CSO and PBR. As always, please do not hesitate to contact Mezrah Consulting if you would like to discuss your specific situation in more detail. Source: M Financial Group

August 8, 2016 The IRS recently issued proposed regulations supplementing the existing regulations and guidance on the application of Code Section 409A to nonqualified deferred compensation arrangements. As a whole, the proposed regulations clarify existing rules rather than making substantive changes to Section 409A. The proposed regulations will become effective when they are published as final regulations. RELEVANCE: Section 409A is a tax minefield laid for those employers who sponsor employee benefit plans with deferred compensation elements and for the participants in these plans. If an employer provides benefits to an employee that are subject to Section 409A but under a noncompliant plan, the participating employee will be subject to federal income tax results sooner than expected or desired, and will also be liable for a twenty percent federal penalty tax. Under its regulations, Section 409A potentially applies to any employment-related benefit payment that may be received in a future year, other than “short- term” deferrals including: Salary or bonus deferral plans, whether short or long term, Nonqualified retirement payments or benefits (including Section 457(f) plans), Severance arrangements, Employment agreements, Incentive compensation or retention arrangements, Split dollar plans providing for future roll out of policy equity or forgiveness of indebtedness, and Independent contractor agreements providing for deferred compensation. Life insurance professionals sometimes recommend deferred compensation arrangements, informally financed with life insurance, to business owners looking to provide a valuable benefit to one or more key employees. It is absolutely essential that employers, their counsel and life insurance agents active in the deferred compensation market have an in-depth knowledge of these proposed regulations and an understanding of their scope. FACTS: The IRS recently issued proposed regulations supplementing the existing regulations and guidance on the application of Code Section 409A to nonqualified deferred compensation arrangements. The general rule of Code Section 409A essentially requires that all amounts deferred under a nonqualified deferred compensation arrangement be included currently in the covered employee’s gross income (to the extent vested and not previously included in gross income). Such amounts will also be subject to an additional 20% penalty tax. However, these two levels of tax will not be imposed and federal income tax on these amounts will be deferred – IF strict requirements are satisfied regarding (among other things) deferral elections and the time and form of permissible distributions. The new proposed regulations address certain specific provisions of the existing 409A regulations and are not intended to constitute a general revision or substantial change of existing regulations and guidance. The proposed changes are intended to be applicable on or after the date on which they are finalized. However, taxpayers may rely on the proposed regulations until final regulations are published. The proposed regulations clarify existing regulations and guidance in the following significant ways: 1. Joint Application of Sections 409A and 457. The proposed regulations clarify that the 409A rules apply separately and in addition to the rules under 457A and 457(f) applicable to nonqualified deferred compensation arrangements sponsored by tax-exempt organizations. Long awaited proposed regulations under Section 457 were issued the same day as the 409A proposed regulations June 21, 2016 (and are discussed in a separate Blog entry). The proposed regulations clarify that the inclusion of an amount in income under 457(f) by reason of vesting will be treated as a payment for all purposes under 409A. However, it is still possible for amounts to be considered subject to a “substantial risk of forfeiture” under 457(f) and not under Section 409A, for example, because payment is conditioned upon compliance with a noncompetition agreement which may be recognized as a substantial risk of forfeiture under 457(f) but not under 409A. Therefore, the proposed regulations clarify that in such cases, the amount payable at the end of the noncompetition agreement may not qualify for exemption from 409A as a short-term deferral, resulting in the application of both sections to the applicable payment. 2. Clarification of Short-Term Deferral Rules to Allow For Legally Required Delays. Payments are exempt from Code Section 409A to the extent that they are made no later than the 15th day of the third month following the later of the end of the calendar year or the service recipient’s taxable year in which the right to payment is no longer subject to a substantial risk of forfeiture (a “short-term deferral”). The proposed regulations clarify that payments that otherwise qualify as short-term deferrals will continue to qualify for exemption from 409A even if the service recipient (e.g. the employer) delays making the payment because “payment would violate Federal securities laws or other applicable law.” Delay in payments subject to 409A is already permitted for this reason but proposed regulations expand existing regulations to include this as a basis for delay of short-term deferral payments without loss of exemption. 3. Definition of Service Recipient Stock Clarified. The exemption for stock options and stock appreciation rights under 409A is limited to “common stock” of the service recipient. Although “common stock” does not include any stock that is subject to a mandatory repurchase obligation or permanent put or call right at less than fair market value, the proposed regulations clarify that a service recipient’s right to repurchase shares upon termination for cause or violation of a noncompetition or nondisclosure agreement will not prevent the shares qualifying as “common stock” for purposes of exemption from 409A. The proposed regulations also clarify that stock options issued to a person in anticipation of providing services to an entity within 12 months prior to commencement of service may qualify as service recipient stock as long as vesting is conditioned upon services commencing within that period. 4. Modification of Rules Following Death. The proposed regulations expand the category of permissible payment events to include the death, disability, or unforeseeable emergency of a beneficiary who becomes entitled to payments due to the service provider’s death, and also allow the acceleration of payments which have already commenced in the event of such an occurrence. The proposed rules also provide that an amount payable following the death of a participant or beneficiary may be paid at any time between death and the last day of the calendar year following the calendar year in which death occurs. The proposed regulations further permit a plan providing for payments during this discretionary payment period following death to be amended to provide for payments during any other period within this discretionary payment period, without complying with the 409A change rules. For example, a plan providing for death benefits to be paid within 60 days after death may be amended to provide for payment at any time prior to December 31st of the calendar year following the calendar year in which death occurs, without waiting 12 months for the change to become effective. 5. Plan Termination Rules Clarified. Some commentators had interpreted the 409A plan termination rules under 1.409A-3(j)(4)(ix)(C) to require termination of only those plans in which the applicable service recipient participates. The proposed regulations clarify that the termination and acceleration of benefits pursuant to subsection (C) is permitted only if the service recipient terminates and liquidates all plans of the same category sponsored by the service recipient, not merely all plans of the same category in which a particular service provider actually participates, and that for a period of 3 years following such termination and liquidation, the service recipient cannot adopt a new plan in the same category, regardless of which service providers participate in the new plan. The proposed regulations also clarify the termination rules applicable to termination in connection with bankruptcy. 6. Corrections Applicable to Unvested Amounts. Section 409A income inclusion rules effectively permit the correction of plan failures applicable to amounts that are not vested or paid as of the end of the calendar year in which the correction is made. However, an anti-abuse rule provides that amounts will not be considered unvested to the extent that there is a pattern or practice of permitting impermissible changes in the time and form of payment with respect to unvested deferred amounts. The proposed regulations indicate that while these rules permit the correction of certain plan provisions while amounts are unvested without including amounts in income or incurring additional tax, they were not intended to allow service recipients to change the time or form of payments that otherwise meet the requirements of 409A without compliance with applicable change rules. The new rules therefore treat as vested any unvested amounts impacted by a change in a plan provision otherwise not permitted by 409A that affects the time or form of payment – if there is no reasonable good faith basis for concluding (a) that the original provision failed to meet 409A requirements and (b) the change is necessary to bring the plan into compliance. Further, the proposed regulations give specific examples of patterns of practice of permitting impermissible changes and require that, if a correction method is proscribed in applicable correction procedures, one of the proscribed correction methods must be used (although it is not necessary that applicable penalties or reporting requirements be complied with for corrections with respect to unvested amounts). 7. Transaction-Based Compensation Rules Applicable to Exempt Stock Rights. Existing 409A regulations permit transaction based payments upon qualifying change in control events to be paid on the same schedule and terms as payments to shareholders generally if paid within five years after the change in control event. However, uncertainty has existed with respect to whether the provision for payments under an exempt stock option on the same basis as other shareholders would result in loss of the 409A exemption. Proposed regulations clarify that the special transaction-based payment rules apply to an exempt stock option or right so that payment in a manner consistent with these rules does not result in the stock right being treated as having a deferral feature violating 409A from the original grant date. 8. Termination of Service Clarified. Proposed regulations clarify that an employee who changes status to an independent contractor is treated as having separated from service if, at the time of the change in status, the level of services reasonably anticipated to be provided after the change as an independent contractor would result in a separation from service under the employee rules (i.e. less than 20%-50% of prior level of service). 9. Other Changes. Proposed regulations also include a number of other specific modifications or changes such as (i) clarification of the rules regarding recurring part-time compensation, (ii) the ability to accelerate the time of payment to comply with Federal debt collection laws, (iii) clarification that a service provider can be an entity, (iv) clarification of the separation pay plan definition where a service provider commences and terminates employment in the same year, and (v) providing that a right to reimbursement of reasonable attorney’s fees in connection with a bona fide legal claim against the employer does not provide for a deferral of compensation judgment. Mezrah Consulting will continue to keep you apprised of any further information relating to new and proposed IRS rules regarding 409A and non-qualified deferred compensation plans (NQDCP). However, please contact Mezrah Consulting if you have any questions regarding 409A regulations and compliance of your NQDCP. Your business and confidence are appreciated. Source: AALU & Marla Aspinwall of Loeb & Loeb, LLP.

August 9, 2016 On June 21, 2016, the Treasury Department issued long-awaited proposed regulations under Code Section 457(f) regarding nonqualified deferred compensation arrangements sponsored by governmental and tax-exempt entities. Section 457(f) essentially requires that nonqualified deferred compensation of such employers in excess of amounts permitted to be deferred under an “eligible Section 457(b) plan” will be included in income at the later of (1) contribution or (2) vesting. The proposed regulations address important issues about the application of Section 457(f), including 1) defining what constitutes bona fide severance pay, (2) death and disability plans excluded from compensation, (3) adding a short-term deferral exclusion, and (4) clarifying the meaning of the term, “substantial risk of forfeiture.” These proposed regulations will become effective when published as final regulations. RELEVANCE: As with nonqualified deferred compensation arrangements in for-profit companies, Section 457(f) plan sponsors often use permanent life insurance to help informally finance the future payment obligation to key employees and/or their beneficiaries. Together with the Section 409A proposed regulations discussed in a recent Blog entry, familiarity with the proposed regulations is essential for those involved in selling or implementing nonqualified deferred compensation plans to non-profit or government entities under Section 457(f). Below is a synopsis of the proposed regulations. 1. Definitions of Excluded Compensation Clarified. Code Section 457 generally excludes “bona fide vacation leave, sick leave, compensatory times, severance plan, disability pay and death benefit plans” from compensation. The proposed regulations clarify the definitions of these various types of excluded compensation. a. Severance Pay Plan Defined. The proposed regulations provide that, to qualify as a bona fide “severance pay plan” excluded from compensation, (1) benefits may be payable only upon “involuntary” severance, or pursuant to a “window program” or an “early retirement incentive plan”, (2) benefits must not exceed two times the participant’s annualized compensation, and (3) the plan must require that all benefits be paid no later than the last day of the second calendar year following the year of severance. The second two criteria generally follow the definition of severance under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”); however, the definition of “involuntary” severance is a significant addition to the ERISA statutory definition, codifying less formal prior guidance. Under these proposed regulations, severance paid pursuant to an employee-initiated “good reason” departure may be treated as “involuntary” if certain requirements are met. Such requirements are similar to those under the Section 409A regulations and include a substantially identical safe-harbor definition of “good reason.” The definition of “window program” also generally follows the definition under the Section 409A regulations. “Early retirement incentive plans” are limited to retirement subsidies payable in coordination with a qualified defined benefit pension plan. b. Other Welfare Benefit Plan Definitions. The proposed regulations define bona fide death and disability plans similarly to the definitions under Section 409A regulations but provide significantly more detail on what constitutes a bona fide sick or vacation leave plan. c. New Short-Term Deferral Exclusion. Similar to the exclusion under Section 409A, the proposed regulations add a “short-term deferral” exclusion, under which a deferral of compensation does not occur with respect to any amount actually or constructively received on or before the 15th day of the third month following the later of the end of the calendar year or the employer’s fiscal year in which the payments vest. This new exclusion is significant because it will allow payments to be made after the vesting year without subjecting them to Section 457(f) (i.e. they do not have to be included in the service provider’s income at the time of vesting). 2. Rules Relating to “Substantial Risk of Forfeiture.” The definition of “substantial risk of forfeiture” under the proposed regulations is similar to that under the Section 409A regulations: An amount is subject to a substantial risk of forfeiture if entitlement to that amount is “conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation, if the possibility of forfeiture is “substantial.” Whether an amount is conditioned on future performance is based on the facts and circumstances, but the proposed regulations specify that the inquiry should examine whether the hours required to be performed during the relevant period are substantial in relation to the amount of the compensation. a. Non-Competes as Substantial Risk of Forfeiture. Unlike Section 409A regulations, these proposed regulations provide that a non-compete condition may be considered a substantial risk of forfeiture if (1) the condition is expressly proscribed in a written agreement that is enforceable under applicable law, (2) the employer consistently makes reasonable efforts to verify compliance with all of the noncompetition agreements to which it is a party, including the one at issue, and (3) the facts, circumstances, and timing indicate that the employer has a substantial and bona fide interest in preventing the employee from performing the prohibited service and that the employee has a bona fide interest in engaging, and the ability to engage, in the prohibited services. b. Conditions for Initial Deferrals and Extensions. The proposed regulations create special rules to determine whether initial deferrals of current compensation may be treated as subject to a substantial risk of forfeiture (so as to allow a voluntary deferral) and whether a substantial risk of forfeiture can be extended (i.e., rolled to a later year). First, the present value of the deferral amount payable on lapse of the new substantial risk of forfeiture period must be “materially greater” than the amount that would have been paid absent the initial election or extension. “Materially greater” here means more than 125% of the deferred amount measured as of the date that amount would otherwise have been paid (the proposed regulations specify these regulations cannot be used to interpret Section 1.409A-1(d)(1) even though the same “materially greater” language is used in that regulation). Second, for a voluntary deferral or extension to be treated as subject to a substantial risk of forfeiture, it must require the performance of substantial services or a limitation on competition (i.e., not merely a performance condition). Third, the additional period for which substantial services must be performed must be at least 2 years, absent an intervening event like death, disability, or involuntary severance. Finally, the agreement must be made in writing prior to the beginning of the calendar year in which services are performed (in the case of an initial deferral) or at least 90 days before the lapse of an existing substantial risk of forfeiture. Special rules apply for new employees but not newly eligible employees. The proposed regulations also add a substitution rule similar to the Section 409A regulations, which provides that if an amount is forfeited, the new risk of forfeiture will be ignored for purposes of 457(f). This means that the above requirements may not be circumvented by just canceling an existing right and replacing it with a new one having a later vesting date. 3. Calculation of Section 457(f) Inclusion. The proposed regulations provide that the amount to be included in income under an ineligible plan will be the present value of deferred compensation at the later of (1) the first date that there is a legally binding right to such compensation or (2) the date that the compensation is no longer subject to a substantial risk of forfeiture (i.e., the vesting date). The amount taken into income under ineligible plans will include any earnings as of the inclusion date. Earnings that accrue on deferred amounts after the inclusion date will be included in income when paid. Once amounts are “properly” taken into income, they are considered investment in the contract and are not taxable again at the time of distribution. a. Defined Benefit Plans. For a defined benefit plan, the present value of the ultimate benefit payable is calculated by multiplying the amount of a payment (or of each payment in a series of payments) by the probability that any contingencies will be satisfied, and then discounting that amount using an assumed rate of interest. The proposed regulations require that the present value be determined “using actuarial assumption and methods that, based on all the facts and circumstances, are reasonable as of the applicable date,” without regard to whether the present value is “reasonably ascertainable” under Section 31.3121(v) regulations. This calculation ignores the probabilities that payment will not be made or the payment will be reduced based on adverse financial conditions of the plan or of the employer. If the date of payment is conditioned upon separation from employment, severance is generally deemed to occur on the 5th anniversary of the applicable date, unless circumstances indicate that this assumption is not reasonable. If unreasonable assumptions are used to calculate present value, then the IRS will calculate present value using methods it determines to be reasonable. However, the IRS will apply the midterm Applicable Federal Rate (“AFR”). Note: Because the AFR is considerably lower than any reasonable discount rate, this will result in the maximum acceleration of tax. The proposed regulations do not address the result if an unreasonably low discount rate is used (e.g., if an employer uses a rate of zero to avoid present value calculations). A zero discount rate would likely be seen as unreasonable and the IRS might take the position that amounts included in income in excess of the amount computed using the mid-term AFR may not be treated as investment in the contract because they have not been “properly” included in income. b. Account Balance Plans. For an account balance plan that is credited at least annually based on a pre-determined actual investment or a reasonable interest rate, the amount included in gross income will be the account balance as of the applicable inclusion date (typically, the vesting date), taking into account both principle and earnings. However, if the amounts credited to the account are not reasonable and are not based on a predetermined actual investment, as defined by the Section 31.3121(v) regulations, then the includible amount will be increased by the present value of the excess of the earnings to be credited under the plan over the amount that would be credited using a reasonable rate of interest. Again, if the taxpayer does not make the determination applying reasonable crediting rates, the IRS will apply the mid-term AFR in making the determination. c. Coordination with Other Inclusion Sections. The proposed regulations clarify the application of Section 457(f) to amounts that were includible in income under other provisions of the Code, such as Section 83 or Section 401(b). Any amounts that have not yet been included in income by reason of the application of another such Code section will be included in income at the time Section 457(f) would otherwise apply. 4. Recurring Part-Year Compensation. The proposed Section 457(f) regulations coordinate with proposed Section 409A regulations to clarify that a plan or arrangement under which an employee receives recurring part-year compensation will not be considered a deferral of compensation under Section 457(f) if the arrangement does not defer payment beyond the last day of the 13th month following the first day of the service period for which the recurring part-year compensation is paid, and the amount of the recurring part-year compensation (not merely the amount deferred) does not exceed the annual compensation limit under Section 401(a)(17) (e.g., $265,000 for 2016) for the calendar year in which the service period commences. 5. Applicability Date. With limited exceptions, the proposed regulations will apply for calendar years beginning after the publication date of the final regulations to existing deferrals pursuant to a binding legal right which arose during a prior calendar year which have not previously been included in income. Note: This means that if the proposed regulations are finalized in their current form, all existing arrangements will need to be amended to the extent necessary to comply with the new rules no later than the end of the calendar year in which the regulations are finalized. Taxpayers may also rely on the proposed regulations prior to the final publication date. Mezrah Consulting will continue to keep you apprised of any further information relating to new and proposed IRS rules regarding 457(f) and non-qualified deferred compensation plans (NQDCP) sponsored by governmental and tax-exempt entities. However, please contact Mezrah Consulting if you have any questions regarding 457(f) regulations and compliance of your NQDCP. Your business and confidence are appreciated. Source: AALU & Marla Aspinwall of Loeb & Loeb, LLP.

March 19, 2018 US corporations will be receiving a significant injection of cash by way of tax savings due to the recent Trump Tax legislation. As we are all aware, corporate tax rates have been dropped to 21%, the lowest corporate tax rate in the history of the United States since the early 1940’s. It is also important to note that there are 44 states with state income taxes ranging from 4% (North Carolina) to 12% (Iowa). How Would the Tax Proceeds Be Utilized? Source: 2017 BofAML Corporate Risk Management Survey Where will corporations deploy and allocate these dollars? There are a variety of options, of course, including share repurchases, dividends, M&A, and paying down debt. The conversation is all about where are the company and its shareholders going to get the most value. Another conversation taking place is the corporate tax rate savings not being permanent, a new Congress or President could effectively enact legislation that drives corporate tax rates back up. Setting a precedent for spending and allocating dollars can often send the wrong message to the capital markets and, more importantly, to employees and executives of those corporations. It is paramount that a company’s strategy be thoughtful and strategic when allocating these dollars. With this in mind, here are two thoughts: 1) What if the dollars allocated targeted strategic business units and the people that drive the profitability of those businesses? 2) What if the company addressed its balance sheet and repaired any mismatches that may actually drive a different behavior from key executives while improving P&L? While there are many options for uses of the tax savings and, arguably, dollars should be allocated to more than just one initiative, there are two that should be considered based on the thoughts noted above. Compensation and Benefits Increasing wages has a sense of permanency to it and can provide executives with unreasonable expectations moving forward. If tax rates increase in the future is the company going to decrease wages and would that be acceptable to the executive team? More than likely the answer is no and such actions could lead the company into a long-term adverse financial position, not to mention human resource challenges. Mezrah Consulting’s suggestion is to consider repositioning the cash to provide a long-term incentive based on company performance. This can be achieved by utilizing a non-qualified deferred compensation plan (NDCP). The contribution can be based on years of service and/or corporate performance and can vest over time. The vesting can even be based on achieving certain milestones (e.g. service and performance). This plan can be incredibly impactful, in line with corporate and shareholder interests, and does not have the air of permanency associated with it. If the company and the individual executives perform, the dollars allocated will be deserved. Creating an additional performance incentive for executives and key management to drive profitability as well as shareholder value is clearly a win-win. It also does not necessarily require a significant allocation of capital depending on how many executives you want to impact. Other things to consider when designing the Long-Term Incentive Plan are as follows: The company will just be repositioning cash on their balance sheet to the deferred compensation plan There is no P&L impact associated with the plan until one vests and performance metrics are achieved Vesting can be based on a variety of elements including years of service, company performance, or individual performance The company is not committing dollars to the plan every year unless performance thresholds are met There is no permanent aspect to the plan like a salary increase This executive benefit is an impactful way to motivate executives and create a tool for attracting other executive talent How Does Executive Behavior Drive Productive Output? Note: 300 senior executives were surveyed and asked to assess, based on their impressions of employee output, the relative productivity of dissatisfied, satisfied, engaged and inspired employees, where satisfied employees serving as the benchmark. For example, inspired employees (based on this scale) deliver an output equivalent to 2.25 satisfied employees. While a long-term incentive plan or supplemental executive retirement plan is an ideal way to better attract and retain talent, there are additional ways to allocate tax savings and reposition cash on the balance sheet without P&L impact. These other executive benefits can include split dollar plans and executive long-term care plans. The eligibility for these plans can be based on years of service or title. Balance Sheet Repair For companies that have unfunded or under-funded executive benefit plans, this is an opportunity to provide balance sheet parity. These are plans where the liabilities do not have corresponding offsetting assets. As a result, P&L impact is created every year and an executive’s benefits become further away from being secured. This can be the case with a non-qualified deferred compensation plan or a supplemental executive retirement plan (SERP). Fact patterns that may drive a need to fully fund are: 1) A deferred compensation plan was put in place that provided participants with the ability to select from a variety of investment funds but no offsetting assets were secured as the company did not think the impact of the plan was going to be material. 5 years later there is over $20 million in liabilities creating an annual $2 million hit to P&L on average. 2) A deferred compensation plan that credited a fixed guaranteed rate was implemented. Participation was initially low until the company merged with an entity of equal size. At that point, the plan was amended to allow for a variety of payout options and investment choices were expanded to include market rates of return. The plan liability doubled in 2 years and the P&L impact of the plan became a material item. 3) A legacy defined benefit SERP was partially funded and has not been funded in line with other corporate pension plans. In addition, a grantor trust was not established so the benefits are not secure given a change in control, a change of heart, or from the company’s inability to pay plan benefits. Funding executive benefit plans can provide the company with reduced P&L impact, the ability to recover the cash flow costs of the plan and provide benefit security for the plan participants. This not only can improve the financial position of the company but, moreover, can have a positive psychological impact on the executive team by setting aside cash in trust to better secure benefit payments. The most intriguing aspect of utilizing the tax savings for either one of these two initiatives is the company’s decision to do so will be incredibly impactful from a financial and personal executive perspective. Most importantly, the value and impact of this decision can be accomplished with a relatively low amount of capital creating a company’s return on investment that is both tangible and material. What better way to make use of these dollars than to benefit those that are driving the strategic vision and profitability of the company. The implications can be immeasurable in terms of shareholder value and executive goodwill.

May 9, 2018 The appropriate method for valuing company-paid life insurance benefits under final split dollar regulations is currently understood to be measured by Table 2001 or an insurance carrier’s published alternative term rates, which meet the specifications indicated in Notice 2002-8. Below is the basis for this industry practice: Final split dollar regulations provide that the value of current life insurance protection will be based on a premium factor designated in guidance published by the IRS. However, the IRS has not published any new valuation guidance since the issuance of final regulations in 2003. These regulations provide as follows: 1.61-22(d)(3)(ii) Cost of current life insurance protection. The cost of current life insurance protection provided to the non-owner for any year (or any portion thereof in the case of the first year or the last year of the arrangement) equals the amount of the current life insurance protection provided to the non-owner (determined under paragraph (d)(3)(i) of this section) multiplied by the life insurance premium factor designated or permitted in guidance published in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter). Since the issuance of final regulations, the industry has relied on the guidance provided in the IRS Notice, which is the most recent guidance available. Notice 2002-8 prescribes the use of either Table 2001 rates or alternative term rate with additional limitations beginning in 2004, which is designed to assure that the rates used reflect term policies actually sold. Notice 2002-8 states, in relevant part: For arrangements entered into before the effective date of future guidance, to the extent provided by Rev. Rul. 66-110, 1966-1 C.B. 12, as amplified by Rev. Rul. 67-154, 1967-1 C.B. 11, taxpayers may continue to determine the value of current life insurance protection by using the insurer’s lower published premium rates that are available to all standard risks for initial issue one-year term insurance. However, for arrangements entered into after January 28, 2002, and before the effective date of future guidance, for periods after December 31, 2003, the Service will not consider an insurer’s published premium rates to be available to all standard risks who apply for term insurance unless (i) the insurer generally makes the availability of such rates known to persons who apply for term insurance coverage from the insurer, and (ii) the insurer regularly sells term insurance at such rates to individuals who apply for term insurance coverage through the insurer’s normal distribution channels. IRS Notice 2002-59 notes the fact that proposed split dollar regulations are silent on the method of valuation and refers to Notice 2002-8 as the relevant authority until further guidance on the method of valuation has been issued. Final regulations are silent on the issue as quoted above and simply refer to IRS published guidance. While final split dollar regulations are silent on the issue of valuation, IRS audit guidelines for split dollar arrangements published after the issuance of final regulations indicate the IRS’ understanding that post-final regulation arrangements can continue to use Table 2001 or qualifying alternative term rates as indicated by Notice 2002-8. Regarding valuation of the split dollar life insurance policy, IRS Audit Guidance (03-2005) states the following: Interim Valuation Rules: Valuation of current life insurance protection—Determine whether one can use the alternate valuation rates furnished by the insurance provider or should they be using the new Table 2001 rates published in Notice 2002-8. Key factors to consider: If one is using the lower published premium rates instead of the PS 58 Tables or Table 2001, is the rate being used a published rate available to all persons who apply for term insurance coverage from the insurer? (See section III(3) of Notice 2002-8 for additional rules if the arrangement is entered into after January 28, 2002.) Is the alternate rate for a one-year standard term policy, all risks, or is the rate based on a policy with a renewal feature? Request a copy of the rate sheet. The rate sheet will describe the terms of the policy (renewal factor), policy applicability (standard risks, non-smoking), the dollar value of the policy, etc. Look on the rate sheet for items such as “not for publication” or “internal use only.” Check the company’s website—do they sell individual term insurance or do they only sell corporate policies? Any of these factors could indicate that the economic value of the term coverage should be recomputed using Table 2001. Final Regulations: Under the final regulations issued September 17, 2003, it is imperative to determine who owns the split-dollar policy. “…If the employer is the owner of the split-dollar policy, the employer’s premium payments are treated as providing taxable economic benefits to the executive. The economic benefits include the executive’s interest in the policy’s accessible cash value and current life insurance protection. Be certain that if alternate valuation rates are being used to value the current life insurance protection, they meet the aforementioned requirements of all standard risks, the policy is for one year, etc.” Since the issuance of final regulations in 2003, industry practice has been to follow the most recent IRS guidance available for valuation of the economic benefits provided by a split dollar life insurance arrangement in Notice 2002-8 as discussed above. Several relevant notices and guidance that discuss this standard as current industry practice are as follows: IRS Notice 2002-8 Split Dollar Arrangements, IRS Notice 2002-59 Split-Dollar Life Insurance Arrangements, and Split Dollar Life Insurance Audit Technique Guide (03-2005).

Changes to 162(m) made by the Tax Act expand the $1 million deduction limit for covered employees at public companies. Nonqualified deferred compensation plans (NQDC) amounts accrued as of November 2, 2017 can escape these expanded deduction limits if the NQDC amounts meet certain grandfather requirements to remain covered by the pre-Tax Act 162(m) rules (“old 162(m)”). The Notice provides additional standards as to what can be covered by the grandfather rule and what could be a material modification that results in a loss of grandfathered treatment. Examples in the Notice include application of the grandfather rule to NQDC. While the new rules add some clarity about how the grandfather rule applies to NQDC, they also leave some questions unanswered. Background on Tax Act Changes to 162(m) Internal Revenue Code Section 162(m) (“162(m)”) provides a $1 million limit on the amount of compensation that certain companies can deduct for compensation paid to certain “covered employees.” The Tax Cuts and Jobs Act (the “Tax Act”) expands the scope of this deduction limit in a number of important respects beginning in 2018: The Tax Act provides that compensation payable under a written binding contract in effect on November 2, 2017, and which is not materially modified after that date, remains subject to the old 162(m) rules—i.e., the compensation is “grandfathered” under old 162(m). This grandfather rule can potentially apply to NQDC that was accrued on or before November 2, 2017, so that the previous tax treatment can be preserved on the payments of that NQDC in later years, without regard to the limitations of new 162(m). IRS Notice 2018-68 (the “Notice”), issued on August 21, 2018, provides guidance on the scope of the 162(m) grandfather rule.[2] The Notice applies a relatively unsurprising but narrow reading of the grandfather rule included in the statute. The Notice defines a “written binding contract” as an arrangement under which the company is “obligated under applicable law” to pay the compensation if the covered employee meets any vesting conditions included in the arrangement, such as continued employment. The Notice does not define what “obligated under applicable law” means — this will be a legal judgment based on the facts. The Notice clarifies, however, that if the company can unilaterally terminate or cancel the obligation without also having to terminate the covered employee’s employment, there is no legal obligation and thus no written binding contract. For a contract that can be unilaterally terminated by the company as of a given date without terminating the employee’s employment (such as an employment agreement with an automatic renewal date as of which the company can unilaterally choose with prior notice to not renew), the contract will no longer be grandfathered after that date, even if no action is taken. In other words, unfettered company discretion to reduce or terminate an obligation = no grandfather. The Notice provides that if an individual was employed with the company on November 2, 2017, and as of that date had a contractual right to begin participation in a plan or receive a grant at a later date, that contractual obligation to future compensation could be a written binding contract such that the future compensation would be covered by old 162(m) under the grandfather rule. But if that future participation or award is conditioned on any future discretionary act of the company, such as future board approval, that obligation would not be a written binding contract for purposes of the grandfather rules. Again, unfettered company discretion = no grandfather. The Notice explains that a “material modification” to a written binding contract occurs — thereby nullifying the 162(m) grandfather rule — if the contract is changed to increase the amount of compensation payable to the employee. The Notice states that it is not a material modification to adjust the amount of the compensation for an accelerated payment, if a reasonable discount is applied, or a further deferral, if the amount is adjusted for a reasonable rate of interest or deemed investment in a predetermined actual investment. The Notice cautions, though, that the material modification rules cannot be circumvented by supplementing a compensation arrangement or providing additional compensation on the same basis as the grandfathered compensation (other than an adjustment providing no more than a reasonable cost-of-living increase). Application of the 162(m) Grandfather Rule to NQDC — Four Examples from the Notice The Notice includes four examples that illustrate the application of the 162(m) grandfather rule to defined contribution NQDC: Implications of the Grandfather Rule and Unanswered Questions The Notice clarifies that account balance NQDC accrued as of November 2, 2017 should remain subject to old 162(m), which means that amounts could remain deductible when payable in the future either because the amounts are payable after the executive’s termination of employment or the executive otherwise occupies a position that would not have been a covered employee under old 162(m) in the year of payment. The same analysis should apply to an amount deferred as of November 2, 2017 that qualified as “performance-based compensation” under old 162(m) (assuming earnings are at no more than a reasonable interest rate or based on a predetermined actual investment). Whether amounts credited to the account after November 2, 2017 are grandfathered is less clear. This will require an inspection of the underlying plan or deferred compensation agreement. If, as is commonly the case, the company has reserved the right to terminate the plan at any time and pay out balances credited through the date of termination, the Notice appears to say that no future credits (earnings or otherwise) after November 2, 2017 would be considered grandfathered. Again, unfettered company discretion = no grandfather. But if the deferred compensation agreement cannot be terminated or changed without employee consent (i.e., not the company’s unilateral discretion), the grandfather may apply to future credits required by the agreement as in effect on November 2, 2017 (and assuming no subsequent material modification). In any event, companies should closely review with their legal counsel the specific terms of each potentially grandfathered NQDC arrangement. Assuming a portion of the NQDC account can be grandfathered, the company will need to separately account for this portion of the account to determine what is potentially deductible under old 162(m) when payment is later made. It is unclear under the Notice how this accounting would be applied if later payments are made other than in a lump sum. For example, if payments are made in installments from an account after termination of employment, a portion of which is grandfathered, will the first payments be considered the grandfathered amounts (and therefore deductible), or will the grandfathered portion have to be applied proportionately to each installment payment? The Notice also does not specifically address application of the grandfather rule to non-account balance NQDC, such as a final average pay defined benefit SERP. The same legal principles should apply, so that the amount accrued based on compensation and service through November 2, 2017, at a minimum, should be grandfathered. The extent to which the company retains the right to terminate or amend the arrangement should determine whether future accruals can be considered as grandfathered. It is unclear how actuarial adjustments to grandfathered accruals would be treated. The separate accounting of a grandfathered accrual may also present challenges when amounts are later paid, especially if payable as a lifetime annuity. The IRS has invited comments on the rules in the Notice and certain other aspects of new 162(m). Comments must be submitted by November 9, 2019. The IRS is then expected to issue formal regulations on new 162(m) at a later date. In the meantime, companies should be able to apply reasonable, good faith interpretations of these rules. Conclusion The Notice confirms certain aspects of the 162(m) grandfather rule as applied to NQDC, including the ways that old 162(m) can continue to apply from and after 2018 to amounts accrued as of November 2, 2017. But the Notice includes certain undefined standards — such as “obligated under applicable law” — that will require legal judgments and that will be highly dependent on the specific facts and circumstances of each case. Some actions that public companies with NQDC should consider now include: Create an inventory of all NQDC plans and agreements that were in place as of November 2, 2017; Review those plans and arrangements to determine the extent to which the company has unfettered discretion to terminate or reduce amounts deferred, in order to decide what amounts may be grandfathered; Begin to consider with NQDC recordkeepers how any 162(m) grandfathered amounts can be separately accounted; and Consider whether the company wants to file a comment letter with the IRS by the November 9, 2018 deadline. Please contact Mezrah Consulting if you have any questions about how the updated application of 162(m) will affect your company’s NQDC. Mezrah Consulting will continue to keep you apprised of any further developments relating to IRS rules regarding 162(m) and nonqualified deferred compensation plans. Your business and confidence are appreciated.

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