Deferred Compensation Plans for Pass-Through Businesses

The owners and key executives of pass-through businesses can benefit from the use of nonqualified deferred compensation plans when their NQDC plans are well-designed and appropriate for pass-throughs.

A business owner’s company can play an important part in providing added retirement income for both the owner and key employees of the business. Although pass-through entities are one of the most common tax structures in the U.S. today, many owners of pass-through businesses do not realize that their companies can take advantage of deferred compensation plans as a strategy for helping to build retirement readiness.

A pass-through business may be structured as an S corporation, a partnership, a limited liability partnership (LLP), or a limited liability corporation (LLC). Because these businesses have chosen to be taxed as a pass-through, they have specific considerations in retirement planning for the business owners and the key employees. A nonqualified deferred compensation (NQDC) plan can help a pass-through business with many of the challenges to retirement savings that all organizations face and the specific challenges unique to pass-through structures.

How Deferred Compensation Plans for Pass-Through Businesses May Benefit Employees and Employers

Deferred compensation plans can be a valued benefit for key employees of a pass-through business. The appeal of these plans can help inspire retention and the employee’s loyalty to the company. And contributions with vesting schedules based on service or performance reward key employees and can potentially advance company success.

Knowing When to Use Deferred Comp for Pass-Throughs

Not all deferred compensation plan structures for pass-through businesses benefit employers.

Pass-through entity owners may decide not to take advantage of deferred comp benefits for any of the following reasons.

• Deferred comp benefits are tax deductible only when paid, so any increase in taxable income due to owner deferrals at the entity level flows directly through to the owner. Any decrease in personal income (W-2) due to the deferral is wholly offset by the increase in business income (K-1).
• In multi-owner scenarios, deferred comp can cause a disproportionate taxable income effect if owners defer amounts not proportionate to their ownership interest. See: Tax Information for Partnerships

Key Takeaway

Owners of pass-through businesses should evaluate the potential benefits nonqualified deferred compensation plans can offer them and their key employees. In addition to their tax and legal advisors, they will want to work with knowledgeable executive benefits consultants, who can help them structure a plan that optimally serves their needs and the needs of their key employees and the organization.   

Read the full report: Deferred Compensation for Pass-Through Businesses here.