Non-Qualified Deferred Compensation: The "Substantial Risk of Forfeiture" Requirement

         Income for tax purposes is defined in the broadest possible terms.  §61 states it as “income from whatever source derived.”[1]  The case law adds further clarification and detail.  Glenshaw Glass defined income as “undeniable accessions to wealth, clearly defined, and over which the taxpayers have complete dominion.”[2]  The latter term is central to a properly structured non-qualified deferred compensation (NQDC) plan.  If the taxpayer has any control over the plan’s income, he will have to include the total income in his annual income. 
Therefore, all money in a NDQC plan must be subject to a substantial risk of forfeiture.[3]  “[E]ntitlement to the amount [must be] conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial.”  The future services must be performance based, and they cannot include “any amount or portion of any amount that will be paid either regardless of performance, or based upon a level of performance that is substantially certain to be met at the time the criteria is established.”[4]  These two conditions further support the requirement that the NQDC contract must be in writing.[5]  They also strongly allude to an employment law component in which the service recipient and provider agree on a basic compensation level and an additional layer, which will be paid for through the NQDC plan. 
Finally, the “substantial risk of forfeiture” element can’t be met if the service provider is the sole owner of the company.  The underlying rationale is simple: he or she will not use their management position to not pay themselves – it’s simply not going to happen.  The examples in the Treasury Regulations imply that a 20% ownership stake is the maximum amount the service provider can own of the company and still benefit from the NQDC plan.  But this same section also says the ultimate determination is based on the “facts and circumstances.”[6]


[1] 26 U.S.C. §61

[2] Comm’r v. Glenshaw Glass, 348 U.S. 426 (1955)

[3] Treas. Reg. 1.409-1(a)(d)(1)

[4] Treas. Reg. 1.409A-1(e)(1)

[5] See also Treas. Reg. 1.409(A)-1(e)(“The term performance based compensation means compensation that amount of which, or the entitlement to which, is contingent on the satisfaction of preestablished organizational or individual performance criteria relating to a performance period of at least 12 consecutive months.”)



[6] Treas. Reg. 1.409(A)-1(d)(3)In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance Law, Captive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance Law, Captive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors.