Deferred-compensation plans are an important part of the employee compensation package. Under a deferred-compensation plan, part of the employee�s compensation over the employee�s service-providing years is deferred until a later period, such as the employee�s retirement. This deferral meets two goals. First, the deferred compensation will provide income for the employee during his or her retirement. Second, the deferred-compensation plan can realize a tax-planning objective since taxation of properly designed deferred compensation is deferred until the income is received.

Deferred-compensation plans can be categorized as either qualified or nonqualified. Qualified plans must meet a plethora of federal nondiscrimination and administrative compliance standards. These standards, of course, increase the cost of such plans since a broad base of employees must be included and significant administrative fees must be paid. However, the corporation gets an immediate income tax deduction for contributions to the plan while the employee�s tax on plan benefits is deferred until the benefits are received. For the purpose of this discussion, qualified plans will include pension plans, IRAs, profit-sharing plans, and Sec. 403(b) plans.

Nonqualified plans provide a similar deferral of the employee�s receipt of ordinary income. However, nonqualified plans also cause a deferral of the employer�s tax deduction until such benefits are paid. Because closely held corporations often want to maximize the benefits for shareholder-employees, the goal of their retirement plans is to discriminate in favor of shareholder-employees and key executives to the fullest extent of the nondiscrimination rules. Since discrimination is permitted in nonqualified arrangements, these plans are often more favorable to the closely held corporation.