risk, i.e., subject to forfeiture if the employee leaves IBM. The company is thereby assured the continued services of valued employees, which is one of the major purposes of deferred compensation plans. To the extent that voluntary deferral is elected by the employee, this "holding power" benefit to the corporation is maximized by being extended beyond the initial period of mandatory deferral to cover the entire period of voluntary deferral. The added benefit to the Corporation is thus directly proportional to the period of added deferral. Under the proposed regulations, in order to achieve this same "holding power" potential, the Plan would have to require a longer mandatory deferral period, which would deny needed flexibility to those employees having greater present cash needs. 3. Because it offers added benefit to the Corporation, the voluntary deferral feature is also a favorable feature from a stockholder viewpoint. The interest of stockholders in retaining key employees is equal to that of the Corporation. Most large publicly held corporations submit these plans to stockholders for approval-IBM did so in 1973—and the plan deescription in the proxy statement, as required by SEC rules, would include the material features of the plan, including the voluntary deferral feature. It is likely, therefore, that this feature would have been a favorable factor in securing stockholder approval. If the proposed regulations were adopted, these non-tax benefits would be virtually eliminated. Few if any employees would elect voluntary deferral since any such election would require the employee to pay tax immediately on an amount which would not be received until much later, if at all, considering the risk of forfeiture. Treasury officials have stated publicly that deferred compensation plans such as these do not respect the principle of nondiscrimination, and therefore must be penalized. The argument is specious. There is no universal principle demanding that all compensation plans must be nondiscriminatory, particularly where no extraordinary tax benefit is sought. The fact that ERISA specifically exempted excess benefit plans for executives is ample evidence of Congressional recognition of this fact. Certain plans, e.g., qualified retirement plans, enjoy special tax benefits, such as immediate deductibility for the employer despite postponement of taxation to the employee, for which an assurance of nondiscirimination is extracted. Unfunded deferred compensation plans enjoy no such privilege. They seek merely to grant the employee a degree of flexibility, for which the employer foregoes a current tax deduction. Moreover, since IBM's Plan, and most other industry plans, provide for compensation over and above base salary (see, e.g., enclosed pages from IBM's 1978 proxy statement), there is little or no opportunity afforded for abuse, such as deferral of 100% of compensation. Finally, there is little or no revenue loss to the Treasury from permitting voluntary deferral since deferred compensation is now subject to the maximum tax by virtue of the 1976 Tax Reform Act, and since, by accelerating the imposition of tax on the employee, the proposals would also accelerate the corporation's offsetting tax deduction. The foregoing discussion suggests the hazards for business which the proposals present. We can only guess at the impact on the financial and estate plans of all those individuals employed in private industry who have relied on the established law in this area. This is an area where stability, indeed permanence, is desirable. It is not a fitting subject for will-o'-the-wisp tax policy, the more so since the changes will not, could not, produce any significant revenue for the Federal Government. For the foregoing reasons, we strongly urge IRS to withdraw the proposals.. If IRS nevertheless insists that some change in the law in this area is warranted, it should propose specific legislative measures to Congress which can then consider them in the broader context of all forms of deferred compensation. Very truly yours, Enclosure. E. T. BUHL, Corporate Counsel. 1 For 1976 performance, stock awards shown above in shares were made in 1977 by the Executive Compensation Committee of the board of directors to 20 officers. These stock awards which are restricted from being sold, transferred, or assigned until mandatory retirement, were in addition to previously reported awards for 1976. The aggregate value of these stock awards, in the amount of $1,370,292, has been charged against the available 1976 variable compensation fund. Total awards for 1976, including the value of the stock awards, was $6,345,339. The total fund available was $18,847,740. VARIABLE COMPENSATION PLAN Under the IBM Variable Compensation Plan adopted by stockholders, certain executives, designated as participants by the Executive Compensation Committee of the Board of Directors, are eligible to receive, in addition to a fixed salary, annual awards based upon their performance and that of the company as a whole or a business unit thereof. Special supplemental awards for extraordinary achievement may be made to any employee. The Executive Compensation Committee is composed of directors who are not eligible to participate in this plan. Awards may be in cash, capital stock of the Corporation, or both. The awards in aggregate may not exceed 1.5% of the Corporation's adjusted net earnings (i.e., consolidated net earnings after taxes less 10% of stockholders' equity at the end of the preceding year) for the year with respect to which awards are made. For this purpose shares of stock awarded are valued at the average closing price on the New York Stock Exchange for the 30 calendar days prior to the award date. Cash awards are payable in annual installments over a period not exceeding five years, beginning in the year following the year for which the award is made; or, the executive may irrevocably defer payments to later years, to be paid with interest, currently at 5% compounded annually. Stock awards may be restricted against sale for varying periods. Payment of unpaid amounts, whether cash or stock, is subject to the proviso that the executive remain with IBM or, upon retirement, render consulting services to the Corporation and not enter the employ of a competitor. The amounts shown in the Variable Compensation Plan Awards cash column in the preceding table, are awards made with respect to 1977. The aggregate amount of such awards was $4,981,477. The limitation of the fund available for 1977 awards is $21,667,281. Additional awards in the form of capital stock, which have not been determined at the date hereof, may be made later in 1978. The aggregate compensation earned under the Variable Compensation Plan for the five years, 1973 through 1977, by the following persons was: Mr. Cary, $1.389.323 and 700 shares; Mr. Opel, $979,935 and 600 shares; Mr. Beitzel, $760.050 and 500 shares; Mr. Rizzo, $719,460 and 500 shares; Mr. Katzenbach, $575,900 and 500 shares; by present directors and officers as a group, $12,632,352 and 7,000 shares; and by all participants as a group, $20,763,148 and 8,150 shares. Some company subsidiaries and divisional units also have incentive compensation plans under which certain executives are eligible to receive, in additon to a fixed salary, annual awards based upon performance. The total amounts awarded under these plans were approximately the following: 1973, $2.4 million; 1974, $2.9 million; 1975, $3.5 million; 1976, $2.2 million; 1977, $3.0 million. RETIREMENT PLAN The Corporation has had a formal Retirement Plan for U.S. employees since 1945, which has been amended from time to time. The Plan, under which benefits normally begin at age 65, is noncontributory by the employee and the com pany's contributions are not allocated to the account of any particular employee. The Plan provides benefits based on service and earnings with a reduction in the benefit formula for employees electing early retirement from age 55 through 59. Officers participate in the Plan on the same basis as the approximately 173,000 other employees of the Corporation and its domestic subsidiaries who are covered by the Plan, which is a qualified plan under the Internal Revenue Code. However, officers are required to retire upon reaching age 60. The maximum annual retirement benefit to any employee is $120,000. To the extent that retirement income exceeds the limit established by the Employee Retirement Income Security Act for payments from qualified trust funds, the difference will be paid from the general operating funds of the Corporation. SAFFER & ASSOCIATES, INC., Re: Hearings on S. 1587 and on the deferral from iincome of certain amounts deferred under non-qualified deferred compensation plans; and, Tax Reform Proposals Mr. MICHAEL STERN, Staff Director, Committee on Finance, Subcommittee on Private Pension Plans and Employee Fringe Benefits, Dirksen Senate Office Building, Washington, D.C. DEAR MR. STERN: As a member of The National Association of Pension Consultants and Administrators, Inc., The American College of Life Underwriters and The National Association of Life Underwriters, I am in complete accord with the stand adopted by The National Association of Pension Consultants and Administrators, Inc., as defined in their letter to you dated March 13, 1978 (copy attached). I urge you to give full consideration to these issues, as put forth in that letter, and the letter from NAPCA to the Honorable Al Ullman, Chairman of the Ways and Means Committee on Tax Reform Proposals (copy enclosed). Yours truly, Enclosure. RONALD G. SAFFER, CLU, President. THE NATIONAL ASSOCIATION OF PENSION Re: Hearings on S. 1587 and on the deferral from income of certain amounts deferred under nonqualified deferred compensation plans Mr. MICHAEL STERN, Staff Director, Committee on Finance, Subcommittee on Private Pension Plans and Employee Fringe Benefits, Dirksen Senate Office Building, Washington, D.C. DEAR MR. STERN: In Press Release #15, Senator Bentsen announced the captioned hearings and solicited comments from the public. These comments are submitted with respect to Proposed Treasury Regulations § 1.61-16 which were published in the Federal Register on February 3, 1978, and which relate to the taxation of non-qualified deferred compensation arrangements. The attached comments are submitted on behalf of the National Association of Pension Consultants and Administrators, Inc. (NAPCA). We request that these comments be made part of the hearing record and that they receive the careful consideration of the Committee and its staff. We further request the Committee, in the exercise of its general oversight function regarding the Department of Treasury and the Internal Revenue Service, to urge the Department and the Service to withdraw the proposed regulations or, in the alternative, to take appropriate action to prohibit their publication. Respectfully submitted, STANLEY H. HACKETT, STATEMENT OF THE NATIONAL ASSOCIATION OF PENSION CONSULTANTS AND ADMINISTRATORS, INC. (NAPCA), REGARDING PROPOSED TREASURY REGULATION; SECTION 1.61-16 PRESENTED TO SUBCOMMITTEE ON PRIVATE PENSION PLANS AND EMPLOYEE FRINGE BENEFITS, COMMITTEE ON FINANCE, UNITED STATES SENATE, MARCH 15, 1978 NAPCA is a national organization of consultants and administrators of employee benefit plans of all types. NAPCA's members provide administrative and advisory services to literally thousands of plan sponsors and employee benefit plans. Most clients of NAPCA's members are small businesses and small plans. NAPCA's members frequently advise and assist with the installation and administration of non-qualified deferred compensation arrangements of the type considered in the proposed regulation. NAPCA strongly objects to the proposed regulation and urges that it be withdrawn. NAPCA's objection is based on policy as well as legal grounds. With respect to policy, NAPCA submits that in this period of increasing concern over the availability of adequate provision for retirement, it is sound tax policy to encourage all taxpayers to provide for income in their retirement years, and that actions should not be taken to discourage such provision. Furthermore, NAPCA submits that if any changes are to be made with respect to non-qualified deferred compensation arrangements, such changes should be made only after a careful and comprehensive study of the impact of such changes on the entire retirement sector. With respect to legality, NAPCA submits that the proposed regulation is so broadly drafted that it would deny tax deferral, in a number of situations, in direct conflict with long-established case law. OBJECTIONS ON POLICY GROUNDS a. Premature to act prior to study It is premature to fundamentally revise rules relating to non-qualified deferred compensation at a time when the entire area of employee benefit plans, both public and private, is scheduled for, and is in dire need of, a thorough re-examination. In recent months a plethora of proposed rules, regulations, legislation and policy statements in the employee plan area have been issued on an ad hoc basis by the Administration and the Congress. Many of these propose very fundamental changes in law and policy. However, it would appear that no one has examined the relationship of these proposals to one another or to the whole area of private qualified plans, private non-qualified plans, public plans and Social Security. We contend that such an examination is sorely needed prior to any further changes. The 1977 Social Security legislation provided for the establishment of a National Commission on Social Security which is charged, among other matters, with examining certain relationships of qualified plans with Social Security. The recently announced (and funded) Presidential Retirement Commission will examine the relationship of private and public plans with Social Security. The Congress is in the midst of hearings relating to Social Security and private plans and will shortly begin hearings relating to public plans. Legislation in both Houses of Congress (S. 1587; H.R. 10746) has been introduced which would require withdrawal of the subject proposed regulations as they relate to public employees. It is clear that the entire retirement and employee benefit sector is in a state of flux and is to be the subject of extensive study. We contend that any fundamental change in rules and regulations relating to employee and retirement plans in general, and specifically the proposed regulation relating to deferred compensation arrangements, must be postponed until the Administration, the Congress and the public have had the benefit of the recommendations of the various study commissions, and until the direction of this Country's policy relating to such plans has been determined. b. Administrative difficulty of enforcement The proposed regulation would be administratively difficult to monitor and enforce. The key inquiry of whether the deferral of income receipt was made at the taxpayer's individual option or was mandated by the employer would be vulnerable not only to abuse, but to honest differences of opinion and interpretation. The proposed regulation could well encourage contrived negotiations and documentation in an effort to literally comply with their requirements, and it would be extremely difficult to distinguish such contrived situations from legitimate ones. c. Discrimination against self-employed and small business In focusing on the exercise of individual taxpayer option, the proposed regulation would discriminate against the self-employed and individual taxpayeremployees who were not in a position to bargain collectively. As a practical matter, such individuals would simply be unable to participate in non-qualified deferred compensation arrangements. Small businesses would similarly have great difficulty in establishing such arrangements for key personnel due to questions of de facto control. For example, it would appear that under the proposed regulation, a stockholder or officer of a small, closely held corporation could never negotiate a non-qualified retirement arrangement. The inability to do this would severely disrupt orderly retirement and transition to younger owners and managers. On the other hand, mandatory arrangements in non-closely-held corporations would be permitted, since no individual taxpayer would have sufficient control to make a "tainted" election. Mandatory collectively-bargained arrangements would similarly avoid "tainted" individual elections. OBJECTIONS ON LEGAL GROUNDS The proposed regulation would not restate or clarify the existing law regarding taxation of deferred compensation. Rather, the proposed regulation would extend substantially beyond long-established law. We find it highly pertinent that the specific basis of the proposed regulation is not stated. Rather, the preamble simply cites cases and revenue rulings of longstanding, which the Service now deems incorrect. Publication of the proposed regulation under Section 61 of the Internal Revenue Code is, in our view, indicative of the Service's difficulty in locating authority for its position. Section 61 properly relates to the definition of income, not to the taxable year of inclusion in income. No one denies that compensation, deferred or otherwise, is income. However, we contend that the proper year of inclusion must be determined under applicable law, and that there is no law, statutory or court-related, which justifies the broad scope of the proposed regulation. The basic statutory provision for the proper year of inclusion is Section 451, which basically provides that an item of income shall be included in income "for the taxable year in which received by the taxpayer", unless the particular method of accounting used by the taxpayer requires inclusion in a different period. Taxpayers using the cash method of accounting are thus not required to include an item in income until the item is received, either actually or constructively. Treas. Reg. $ 1.451-2 specifically provides that "income is not constructively received if the taxpayer's control of its receipt is subject to substatial limitations or restrictions". The doctrine of constructive receipt has been part of the Treasury Regulations for a substantial number of years and under the theory of leigslative re-enactment, should not be altered by administrative fiat, but only by legislation. Section 83, which deals with the proper year of inclusion of property transferred in connection with the performance of services, has been specifically construed by the Service not to apply to "an unfunded and unsecured promise to pay deferred compensation". Prop. Treas. Reg. $1.83-3(e). The statutory language and the legislative history of Section 83 fully support this interpretation. Indeed, the fact that Congress found it necessary to deal with restricted property transfers by legislation in the form of Section 83 is convincing evidence that the Internal Revenue Service lacks the requisite statutory authority to deal administratively with other non-qualified deferred compensation arrangements in the manner contemplated by the proposed regulation. In other words, if the Internal Revenue Service has the present authority to issue the proposed regulations, then Section 83 was not needed to deal with restricted property transfers. It is our view, that there are but two theories on which the Service could base its position in the proposed regulation: the often overlapping theories of constructive receipt and economic benefit. However, the proposed regulation would go far beyond either of these theories. a. Constructive Receipt As a general matter, the Internal Revenue Service has attempted to tax currently amounts which, while not actually received, were "made available" to the taxpayer without "substantial restrictions". As interpreted by the courts, this constructive receipt takes place only where (1) the taxpayer is immediately entitled to the item of income, (2) the item is immediately available to the tax |