One important reminder from the COVID-19 pandemic in 2020 is that, in the words of one scientist, “It is difficult to make predictions, especially about the future.” While that proverb has broader implications, it certainly describes deferred compensation in 2021.
Many employers who maintain nonqualified deferred compensation plans have allowed their employees to wait to make deferral elections for their bonuses and other incentive compensation until the middle of the year. This is allowed under an exception from the normal tax rule (Code Section 409A) that deferral elections must be made prior to the beginning of the year in which the compensation will be earned. The exception allows deferral elections for so-called “performance-based compensation” to be made as late as six months before the end of the performance period.
For many employers, the COVID-19 pandemic revealed significant limitations on the exception that permits midyear deferral elections for certain bonuses.
The exception applies only to “performance-based compensation” as defined in the tax rules. “Performance-based compensation” is compensation that is contingent on satisfying pre-established organizational or individual performance criteria relating to a performance period of at least 12 consecutive months. The performance criteria also must be established in writing no later than 90 days after the beginning of the performance period.
Compensation that meets these requirements may be deferred under a deferral election made up to six months before the end of the performance period (as long as the compensation has not become reasonably ascertainable by that time).
Compensation that does not meet these requirements can generally only be deferred if the deferral election is made prior to the beginning of the year (subject to other exceptions not discussed here).
The COVID-19 pandemic disrupted the usual midyear deferral election process in two ways: