Deferred-Pay-Plan Proposal Still Leaves Some Loopholes

Until recently, executive deferred-compensation plans largely escaped scrutiny by regulators. That changed after Enron Corp. filed for bankruptcy late last year, and court documents showed that some Enron executives had withdrawn millions of dollars from their accounts just before the Chapter 11 filing.

In response, Rep. Robert Matsui, a California Democrat, is sponsoring legislation that would make it harder for executives to withdraw money from their deferral accounts. Bill Thomas, a California Republican, subsequently made a similar proposal. The legislation, however, wouldn't put a stop to most withdrawals.

Executives at many large companies are allowed to defer large chunks of compensation, enabling them to postpone paying income tax on the money. The tax doctrine of "constructive receipt" dictates that income can be deferred as long as an executive's access to the money is restricted. For that reason companies usually impose penalties for early withdrawals.

Rep. Matsui drafted the legislation because he thinks companies don't go far enough. The proposal would prohibit withdrawals at will before an executive retires or leaves the company. "Recently we have seen many corporate executives abuse deferred-compensation schemes that allow them to reap substantial retirement benefits outside of their company's retirement plan," says Rep. Matsui. Because companies are spending disproportionately on executives, Rep. Matsui says, "This practice actually provides a disincentive for companies to set up generous, or even adequate, plans for their workers."

Rep. Matsui says that companies have had so much leeway in setting up the deferral plans that they are essentially giving executives all the tax benefits of 401(k) plans without the restrictions, such as a limit on how much can be contributed annually.

The lawmakers also believe that some companies may be flouting another tax doctrine by putting the executive's money into a secure account designed to keep the cash beyond the reach of creditors or claimants in lawsuits. Tax rules say that in order for an executive to avoid paying taxes on compensation, he cannot have received it. Nor can it be held for him in a secure arrangement. The legislation would remove tax breaks if companies broke those rules.

Still, the proposed legislation would only go part way toward curbing the ability of executives to make early withdrawals. It would exempt from its provisions billions of dollars deferred before the bill is adopted. The legislation also only would apply to top officials, not midlevel executives who often participate in these plans. Finally, executives would still be allowed to withdraw their money early, as long as they set up a schedule of distributions beforehand.

A staffer for Rep. Matsui says that although the legislation is limited to the top executives, it is estimated to raise $4.2 billion in tax revenue in the first five years. "This gives you a clue to how rich the plans are, and how most of the money is concentrated at the top," he says.