BILL ANALYSIS �
Senate Appropriations Committee Fiscal Summary
Senator Kevin de Le�n, Chair
AB 1173 (Bocanegra) - Personal Income Tax: Nonqualified Deferred
Compensation Plan
Amended: March 21, 2013 Policy Vote: G&F 7-0
Urgency: No Mandate: No
Hearing Date: August 19, 2013
Consultant: Robert Ingenito
This bill meets the criteria for referral to the Suspense File.
Bill Summary: AB 1173 would reduce the penalty rate for
California tax on nonqualified deferred compensation
distributions from 20 percent to 5 percent.
Fiscal Impact: The Franchise Tax Board (FTB) indicates that the
bill would result in a General Fund revenue loss of $4.7 million
in 2013-14, $3.2 million in 2014-15 and $3.4 million in 2015-16.
The bill would increase the department's costs (modifying tax
forms, instructions and information systems) by an unknown
amount.
Background: In general, a deferred compensation arrangement
allows an owner or an employee to set aside a portion of their
income to be paid out at a future date. These arrangements are
broken down into two basic categories, "qualified" and
"nonqualified" deferred compensation arrangements
Qualified deferred compensation arrangements (also known as
"qualified plans") are plans that comply with the Employment
Retirement Income Security Act of 1974 (ERISA). ERISA imposes
specific rules on qualified plans, including nondiscrimination
requirements that prohibit an employer from providing
disproportionate benefits to its employees, and limitations on
the amount of contributions that can be made to the plan.
However, qualified plans also provide certain tax benefits:
employers are allowed to deduct contributions when they are
made, employees may make tax-deferred contributions, earnings of
the plan may be tax deferred until they are actually paid, and
distributions are generally eligible to be transferred to
another qualified plan, thereby allowing further tax deferral.
Qualified plans include IRC section 401(k) plans (for
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non-government organizations), IRC section 403(b) plans (for
public education employers), IRC section 501(c)(3) plans (for
non-profit organizations and ministers), and IRC section 457(b)
plans (for state and local government organizations).
Nonqualified deferred compensation arrangements (NQDCs) are not
subject to ERISA, and differ from qualified plans in many ways.
Employers are allowed to discriminate by only offering plans to
its key employees (e.g., senior management and
highly-compensated employees), employer contributions are not
limited, and employers may not deduct plan contributions until
they are paid.
In 2004, Congress added Section 409A to the Internal Revenue
Code to limit amounts deferred under NQDCs in response to the
Enron scandal, where executives enriched themselves at the
expense of the company and its creditors by taking substantial
withdrawals from NQDCs immediately before the firm declared
bankruptcy. The new federal law prohibits any acceleration or
change in NQDC payments, with some exceptions. Any payments
that violate the new federal law become taxable income at a
penalty rate 20 percentage points higher than the taxpayer's
applicable marginal rate.
California law automatically conforms without modification;
consequently, the State applies the same 20 percentage point
increase in the marginal rate on NQDC distributions that violate
the new federal law as a penalty, leading to a potential
combined federal and state tax that approaches 100 percent of
the income.
For instance, a taxpayer paying the top federal marginal rate
(39.6 percent) pays a federal tax of 59.6 percent of the NQDC
distribution with the penalty rate, plus a top state marginal
tax rate of 13.3 percent increased to 33.3 percent, or a total
rate of 92.9 percent.
Proposed Law: This bill would reduce the penalty rate for
California tax on NQDC distributions that violate federal rules
from 20 percent to 5 percent.
Staff Comments: Current federal tax law imposes a 10 percent
withdrawal penalty on early distributions made from certain
qualified deferred compensation plans such as 401(k) plans. The
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State imposes a similar penalty, but at a rate of 2.5 percent,
or 25 percent of the federal penalty. This bill's reducing the
penalty rate on NQDC distributions from 20 percent to 5 percent
would be in line with other current penalty practices.