There has been a lot of noise lately about government regulation.

On one side, the tea party yells, “All regulation is bad!” On the other side, the Occupy movement screams, “Big business is bad!” and therefore more regulation is required.

I’d like to whisper a novel idea into the noise: appropriate regulation. In my view, appropriate regulation sets and enforces ground rules, treats all players fairly – but does not micromanage.

Nowhere are the strengths and weaknesses of regulation more evident than in the tax code’s treatment of executive deferred compensation.

In its simplest form, deferred compensation is an incentive arrangement under which, for work currently performed, a business promises to pay its executive at some future date. Until that date, the business retains control of the promised funds and the executive is not taxed until the funds are received.

Two contrasting code provisions (among others) regulate deferred compensation – Sections 451 and 409A.


The regulations under Section 451 define “constructive receipt.” Dating back to the 1913 Tax Code, “constructive receipt” means that an individual is taxed on income she controls, whether or not she actually receives it.

In a straightforward example, the business gives the executive her bonus on Dec. 30, 2011, but the executive asks the business to hold the check until Jan. 3, 2012. Under the doctrine of constructive receipt, the executive is taxed on that paycheck in 2011, because she controlled the money as of Dec. 30.

Constructive receipt is appropriate regulation. It prevents an executive from gaming the system, it applies evenhandedly to all taxpayers, and it does not micromanage the relationship between the business and the executive. It merely taxes the income once the executive controls it.

Section 409A is constructive receipt on steroids.

Effective in 2005, it attempts to prevent executives from gaming the system, but it does so with a labyrinth of requirements regarding when and how income can be deferred and paid.

Specifically, 409A only allows payments of deferred compensation on six permitted events: death, disability, separation from service, unforeseen emergency, fixed date or schedule, or change in control (of the business). Moreover, it provides specific and often difficult definitions for these events.


For example, to meet the definition of “disability,” an executive must be totally and permanently disabled. Section 409A does not allow payments when a person is merely disabled with respect to his current position. Section 409A will not permit payment upon the sale of a division of the business (unless it comprises 40 percent or more of the assets of the company) – even if it is the division the executive has worked hard to build. Section 409A does not permit payment when the executive’s children start college. In sum, Section 409A will not permit payment at any time mutually agreed upon by the business and the executive unless it meets the definition for one of the six permitted events.

This is micromanagement.

As with many micromanaging regulatory schemes, Section 409A is especially burdensome to small businesses.

Small businesses typically lack the budget and infrastructure to maintain complicated deferred-compensation arrangements. Prior to 409A, I saw one-page arrangements that were perfectly adequate. Now, a similar arrangement could require 10 pages or more of definitions, formulas and legalese.

To survive and thrive, businesses need a regulatory system that is predictable and fair, but does not micromanage. Constructive receipt is a time-tested doctrine that accomplishes those ends. By contrast, Section 409A is neither predictable nor fair, and micromanages the relationship between businesses and their executives.

Section 409A should be repealed.

Steven R. Gerlach is an attorney in Bernstein Shur’s Tax, Trusts and Estates Practice Group and Labor and Employment Practice Group. Reach him at 228-7128 or

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