The Practice and Tax Consequences of Nonqualified Deferred Compensation

Although nonqualified deferred compensation plans lack explicit tax preferences afforded qualified plans, it is well understood that nonqualified deferred compensation results in a joint tax advantage when employers earn a higher after‐tax return on deferred sums than employees could do on their own. Several commentators have proposed tax reform aimed at leveling the playing field between cash and nonqualified deferred compensation, but reform would not be easy or straightforward. This Article investigates nonqualified deferred compensation practices and shows that joint tax minimization often takes a backseat to accounting priorities and participant diversification concerns. In practice, the largest source of joint tax advantage likely stems from use of corporate owned life insurance (COLI) to informally fund nonqualified deferred compensation liabilities, suggesting that narrow reform aimed at COLI use might be a more attractive policy response than fundamental reform of the taxation of nonqualified deferred compensation.