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WASHINGTON-CUNA and NAFCU have written the Internal Revenue Service (IRS) in strong opposition to the changes in sections 457(f) and 83 of the Internal Revenue Code. New IRS guidance would require that deferred compensation be taxable to the employee in the first year in which the employee’s right to the deferred compensation is not subject to a substantial risk of forfeiture and eliminate tax deferment for the employee of a tax-exempt entity. “If taxable entities are allowed to provide their key employees options on a tax-deferred basis, tax-exempt entities should also be given this same treatment,” CUNA Associate General Counsel Mary Dunn wrote. “The practical effect of the proposed regulations is a tax increase on certain employees of tax-exempt entities. The proposed changes to the rules on option plans would probably end the use of nonqualified options by tax-exempt employers.” NAFCU concurred, as President and CEO Fred Becker wrote, “Under the current rule, credit unions may provide beneficial retirement plans structured under section 83 that are attractive to prospective and current employees. Attractive benefit plans are an essential competitive tool for credit unions to attract the best candidates and to retain current employees. The rule changes would eliminate this tool and create a divide between participating employees and non-participants.” Becker further explained, “The organization, structure, purpose and objective of credit unions make it more challenging for them to offer competitive compensation packages and attract the most qualified and desirable candidates. One way for them to effectively compete has been to offer competitive retirement benefits – specifically, discount option plans structured under section 83. The proposed changes by the IRS would take away the advantages of section 83 plans by `clarifying’ them out of existence.” CUNA noted that an increasing number of tax-exempt employers, including credit unions have been issuing nonqualified options at discounted prices to help retain talented employees. For example, CUNA provides a scenario where the employee would receive $50,000 worth of options that, by the time of exercise would be worth $100,000. By mandating that the options could not be exercised until a certain date, the employer can retain the executive until that time. “The format allows those executives to foresee the exact point in time at which they will take a tax `hit’ on the option. Many credit unions have found these types of option programs to be a good tool for retaining talented executives,” CUNA wrote. Dunn said they heard from several members on this issue, but is not sure how many credit union plans it would currently affect or those planning to use deferred compensation plans. Dunn also accused the IRS of dabbling in statutory changes. “The IRS has not provided an explanation as to why an employee of a tax-exempt entity should not be given the same benefit (via tax treatment) that is given to an employee of a taxable entity,” she wrote. “In our view, this action by the IRS appears to be overreaching, as the proposed regulations represent a fundamental change in tax law.” Prior to the proposed guidance, options were taxed under Section 83, while Section 457 says property taxed under 83 should not be also taxed under 457. Dunn explained that if the proposal were to be finalized as is, it would result in the promulgation of a matter not mandated under 457. “CUNA firmly believes that credit unions should continue to have this tool available for employee recruitment and retention,” she advocated. Both groups also said that the new guidance could create divisiveness between the `haves’ and the `have nots,’ due to the grandfather clause that would exempt options granted as of May 8, 2002. “The changes would therefore result in two classes of employees – those with the advantage and those without – creating unnecessary disparity and a potentially divisive situation between them. The proposed changes would eliminate the current value of section 83 plans as a valuable employee recruitment and retention tool and, at the same time, place credit unions at a competitive disadvantage,” NAFCU’s Becker wrote. CUNA agreed the situation could lead to “similarly situated employees having materially different compensation arrangements and has the potential for creating significant compensation management issues.” [email protected]

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