Deferred Compensation is generally compensation to an employee that is paid at a later date. One use of deferred compensation is incentive pay arrangements. The most common form of such incentive payments is discretionary cash bonuses. However, a company can develop a plan to pay compensation based on performance or benchmarks.
Internal Revenue Code (IRC) § 409A covers the taxation of nonqualified deferred compensation plans. In contrast, qualified deferred compensation plans are plans which meet certain requirements under law and therefore qualify for special tax treatment. Specifically, qualified plans allow an employer to deduct the payments at the time they are made, and taxation is deferred on the benefits until they are received by the employee at retirement. Such plans are also subject to a myriad of regulations related to protection of the benefits, nondiscrimination of the provision of such plans, and fiduciary obligations of providers.
Qualified plans are generally not as useful to companies for providing incentive compensation because of the various rules and regulations applicable to such plans. Often, a company needs to provide incentives to specific employees in order to encourage their specific performance in support of the company, and/or to maintain the likelihood of their remaining with the company over a long period of time.
Next up, Funded versus Unfunded Plans