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What is a 457a?

Ron Davis
Ron Davis

457A is a provision of United States tax code. It was passed in 2008 as part of the Emergency Economic Stabilization Act of 2008. The primary intended effect of the original bill passed by the House of Representatives was to change the ability of managers of off-shore hedge funds to defer taxes on certain kinds of conditional income. This provision modifies section 409A of the tax code, but many of the definitions of 409A are carried into 457A. Section 409A provided an IRA-like income tax deferral for very high income earners.

To be eligible for the deferment, the compensation must meet three requirements. First, it concerns compensation for work done or services rendered, and the contractor or employee must agree to be paid in a future year other than when the work has been completed, often at the time of retirement. Section 457a does include phantom units, which are equity units that have appreciated in value. It does not, however, include any compensation that will be billed within the next 12 months if there is no risk that the compensation will not be paid.

Woman holding a book
Woman holding a book

The employer must meet both requirements for a nonqualified entity. First, the employer is a foreign company that does not receive the majority of its income as a result of a connection to a U.S. trade or business, and is also does not pay comprehensive foreign income taxes. Second, the corporate partnership must not pay a majority of its income to either foreign individuals who pay comprehensive foreign income taxes or to organization who do not pay federal income taxes.

Finally, there must not be a credible risk that the employee or contractor will not be compensated. There are two exceptions to this rule. First, gains from any investment assets do not qualify as a risk of non-compensation. An investment asset is defined as a single asset, not a fund of any kind, that the entity does not participate in active management, and income is distributed to investors. The rule also does not apply under this provision if the income can be deducted under federal tax code section 882.

The IRS will take the view that any 457A/409A income is constructively received in the current tax year and taxes are owed in that year. To further complicate 457A, the Senate chose to rewrite the original House bill. The resulting language change makes the rescission of tax deferral possibly apply to some domestic situations, including private investment funds and venture capital funds.

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