The U.S. Treasury Department issued two proposed rules under Sections 409A and 457 of the Internal Revenue Code, both published in the Federal Register on June 22. The first proposed rule relates to deferred compensation plans of tax-exempt organizations such as health systems, universities, foundations and other nonprofit entities, while the second addresses deferred compensation plans of state and local governments.

In general, deferred compensation provided to employees of tax-exempt organizations and state and local governments is subject to taxation under Section 457(f)—unless provided through a "qualified" retirement plan under Section 401(a), 403(b) or 457(b). Under Section 457(f), deferred compensation is taxable to the employee when it is no longer subject to a substantial risk of forfeiture (SRF), i.e., it becomes vested. This is very different from the deferred compensation rules applicable to for-profit entities, where deferred compensation is subject to taxation only when it is actually or constructively received, even though it may have become vested at an earlier date.

Brian M. Pinheiro and Diane A. Thompson are attorneys in Ballard Spahr's employee benefits and executive compensation group.