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Court rules on deferred compensation plan case

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Tax Hot Topics newsletterThe Sixth Circuit Court of Appeals held in Wilson v. Safelite Group (No. 18-3408) that a nonqualified deferred compensation plan which allowed for the deferral of an employee’s bonuses and other compensation constituted an employee pension benefit plan under the Employee Retirement Income Security Act (ERISA).

Under ERISA, an employee pension benefit plan is a plan, fund, or program that, by its terms or as a result of surrounding circumstances, either (i) provides retirement income to employees, or (ii) results in a deferral of income by employees for periods extending to the termination of covered employment or beyond. However, the Department of Labor regulations provide an exception for certain bonus plans. Under the Labor rules, employee pension benefit plans do not include payments made to employees as bonuses for work performed, unless such payments are systematically deferred to the termination of covered employment or beyond, or so as to provide retirement income to employees.

In 2005, Safelite Group, Inc. created a transaction incentive plan (TIP) that provided for substantial bonus payments to participating company executives if they secured a strategic buyer for the company. The company’s president and CEO from 2003 to 2008 participated in the TIP. The following year, the he entered into a nonqualified deferred compensation plan (the Safelite plan) to defer any TIP bonus payments to be awarded to him and thereby avoid certain tax consequences. The Safelite plan allowed eligible executive employees to defer their base annual salary, annual or long-term bonuses and any TIP bonuses. Participants were required to submit completed election forms each year to indicate what income to defer.

In 2007, Safelite was purchased by another company, generating substantial payments to the TIP participants. By 2014, the president and CEO had deferred over $9 million in compensation under the Safelite plan. That same year, the IRS audited his tax returns and determined that some of his elections to defer income failed to comply with Section 409A. Accordingly, he owed income taxes and incurred substantial tax penalties for violating the Section 409A requirements. In 2016, he sued Safelite under applicable state law for breach of contract and negligent misrepresentation arising from the company’s alleged mismanagement of the Safelite plan. He also argued that the plan did not constitute an employee pension benefit plan under ERISA because it met Labor’s bonus plan exception.

The district court examined the Safelite plan’s provisions in the context of ERISA and DOL regulations and held that it was an employee pension benefit plan under ERISA. The Sixth Circuit affirmed the district court’s findings and analysis, clarifying that the Safelite plan was not designed as a bonus plan because it did not provide financial incentives for employee performance or retention. The mere fact that the Safelite plan allowed for the deferral of bonuses awarded under a separate plan did not transform the deferred compensation plan into a bonus plan.

The court ultimately dismissed the president and CEO’s state law claims on the ground that they were pre-empted by ERISA, which generally preempts state causes of action that duplicate, supplement or supplant the remedies otherwise available under ERISA (for example, benefit claims and breach-of-fiduciary-duty claims).

Contacts:
Jeff Martin
Partner
Washington National Tax Office
T +1 202 521 1526

Keith Mong
Managing Director
Washington National Tax Office
T +1 202 521 1554

James Sanchez
Senior Associate
Washington National Tax Office
T +1 202 861 4107

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