Madam Speaker, today I am introducing the Offshore Deferred Compensation Reform Act of 2007, which would put an end to the practice of allowing unlimited amounts of income to be deferred offshore. Middle-class taxpayers that are saving for…
Madam Speaker, today I am introducing the Offshore Deferred Compensation Reform Act of 2007, which would put an end to the practice of allowing unlimited amounts of income to be deferred offshore. Middle-class taxpayers that are saving for college or their retirement can't avoid paying taxes by deferring millions offshore. Congress needs to reform the tax code to assure all Americans that, regardless of their income, they are on a level playing field. This legislation takes an important step toward achieving that goal.
Either through ``qualified'' or ``non-qualified'' deferral arrangements, taxpayers can defer paying taxes on their compensation. Most taxpayers make qualified deferrals, such as contributions to 401(k) plans and Individual Retirement Accounts (IRAs). Non-qualified deferred compensation arrangements are usually used by senior executives or other high-income taxpayers who want to defer amounts in excess of the qualified plan or IRA limits. In contrast to the contribution limitations that apply to 401(k) and IRA accounts, there are no limits on the amount that U.S. taxpayers can contribute to non- qualified deferred compensation arrangements.
U.S. companies that offer non-qualified deferred compensation plans to their employees
are unable to receive a tax deduction equal to the amount deferred until the compensation is received by the employee. This is a major financial drawback to these arrangements and constitutes a significant safeguard against their abuse. By contrast, foreign companies can locate in no-tax jurisdictions, provide deferred compensation to their U.S. employees, and suffer no economic loss, since the tax deduction is not relevant when the employer does not have any tax liability. Accordingly, there is a preference in the Code for U.S. taxpayers to defer compensation in certain offshore jurisdictions since it provides a significant tax benefit to the employee without any tax disincentive to their offshore employer.
There is a fundamental inequity between middle-class Americans who can defer up to $15,500 of income into qualified plans, like a 401(k), and $4,000 into their IRAs, and higher-income taxpayers who can defer unlimited amounts offshore. The Offshore Deferred Compensation Reform Act of 2007 seeks to rectify the inequity by eliminating the ability of U.S. taxpayers to defer non-qualified deferred compensation in offshore tax havens. Under this legislation, individuals who currently take advantage of such tax planning and who wish to make offshore deferrals would be limited to making deferrals under qualified arrangements which are subject to annual limitations. In this way, the legislation creates a level playing field for all U.S. taxpayers.
The legislation specifies that offshore non-qualified deferred compensation paid by a foreign corporation will be taxable income when there is no substantial risk of forfeiture to the compensation by the employee. A substantial risk of forfeiture exists where the receipt of compensation is conditioned upon the future performance of substantial services in order to receive that compensation. The Offshore Deferred Compensation Reform Act of 2007 is not intended to prohibit a foreign deferred compensation arrangement if the foreign corporation entering into the arrangement is subject to tax on substantially all of its income and denied an immediate deduction for compensation that is deferred. For purposes of the legislation, a foreign corporation would be any foreign corporation unless substantially all of its income is effectively connected to a trade or business in the United States or is subject to an income tax imposed by a foreign country that has a comprehensive tax treaty with the United States, and a deduction is allowed for compensation under rules that are substantially similar to the way in which the United States provides deductions for compensation. In addition, the Secretary of the Treasury is given authority to determine whether a foreign corporation that operates in a country without a formal tax treaty with the United States can qualify for the exemption.
There are many different ways to structure an offshore deferral arrangement. A prototypical structure would be an executive who elects to defer his or her year-end bonus in an offshore investment fund for a period of time--typically, five to ten years. Assuming it complies with the Code Section 409A requirements, the bonus and any associated earnings would not be taxable until the end of the term of the arrangement. These types of deferral arrangements comply with current law. But while they may be legal, they are not fair, and for this reason my legislation would change current law to make the offshore deferred compensation taxable immediately when the deferral arrangement is granted. However, because taxpayers should not be penalized for complying with current law, my legislation includes an effective date that only affects compensation earned, vested, and deferred after 2007.
Finally, the New York Times published a story on April 17, 2007, entitled ``Managers Use Hedge Funds as Big I.R.A.'s.'' The story described the ability of hedge fund managers to defer unlimited amounts offshore, and contrasted this with the ability of middle-class taxpayers to defer up to $20,000 in a qualified plan, like a 401(k), and an IRA. While the New York Times article focused on the ability of hedge fund managers to use offshore deferral arrangements, other types of industries could use foreign corporations based in no or low-tax countries as vehicles for offshore deferred compensation. For this reason, my legislation does not single out investment firms, and applies broadly to any industry that might use this type of arrangement.
I look forward to working with my colleagues, and specifically Senator Kerry who introduced the Senate version of this legislation, to address this issue.