Thursday, September 07, 2006

Cool Running Mon, Nu?

I never cease to be amazed at the wealth of resources on the web. In preparation for the hearings before the Senate Committee on Finance, the staff of the Joint Committee on Taxation released a background paper on Present Law and Background Relating to Executive Compensation.

The hearings were directed toward the supposed cause and effect relationship between the $1 Million cap on executive compensation imposed by IRC Section 162(m) and the stock option backdating scandal. The argument in favor of the repeal of Section 162(m) goes like this: Section 162(m) imposes a penalty tax on executive compensation in excess of $1 Million a year, except compensation that is "performance-based." This has caused a growth in such performance-based compensation mechanisms as stock options which, in turn, have lead to such abuses as backdating of the options.

While I have some doubt as to the wisdom of Section 162(m), the option backdating scandal hardly provides a basis for repeal of the section any more than Bonnie and Clyde provided a justification for outlawing banks. (Although, I suppose that argument would have been a good excuse for a catchy slogan: "Unless banks are outlawed, only outlaws will have banks.")

The report, however, is a gem from a teaching perspective. In 45 concise pages, it presents a useable outline of the various types of deferred compensation arrangements and how they work. I have lectured on the topic, but I had not previously seen such a readable summary.

And the title of this posting? It's derived from the report's discussion of rabbi trusts. Rabbi trusts are deferred compensation arrangements where money or stock is placed in an irrevocable trust rather than being paid to the employee. The compensaton is deferred because (i) the employee cannot draw upon the assets in the trust at will and (ii) the assets in the trust remain subject to the claims of the creditors of the employer in the event of the employer's bankruptcy. (The arrangement got its name because the first letter ruling approving its use was sought by a synagogue for its key employee.)

Even though a rabbi trust has to be subject to the claims of the employer's creditors to allow the compensation to the employee to be deferred, planners have sought to minimize the risk that creditors will actually seize the assets in the trust by organizing the trust under the laws of a foreign jurisdiction. Funds placed in such trusts are now no longer deferred due to the enactment of IRC Section 409A in 2004. However, footnote 33 of the report notes that offshore rabbi trusts have been referred to as a "Rastafarian" rabbi trusts. Somehow, I can't picture Bob Marley wearing tallit.

No comments: