SERP Tax Deduction
The Serb tax deduction is the name given to a business tax deduction involving the funding of a SERP, or Supplemental Executive Retirement Plan.
Supplemental Executive Retirement Plans (SERP) have been a highly controversial subject in recent years. On one side, they have been seen as an important part of the overall compensation and benefit package necessary to hire and retain top executives. On the other side is increased competition that makes bottom line profit ever more important. In addition to this, there is an increasing sense that top executives are already being too highly compensated. The SERP is called a supplemental plan because it is designed to allow retirement savings that go beyond the contribution limits allowed for other qualified retirement plans like 401K’s. The SERP tax deduction situation does not favor their use either.
The question is based on the necessity of the SERP as a legitimate business expense that is both necessary and ordinary. From the executives point of view the retirement plan is unqualified and therefore is not restricted by the requirements of the IRS. This allows considerable laxity in the operation of the plan. Although they do not have the same tax deferment benefits as a qualified plan, such provisions as penalty free early withdrawal can be part of the package. Of course, the plan is usually totally funded by the employer and therefore is really a form of compensation.
However, the Company offering the SERP is also accruing the funds. They are being retained or invested to fund the program. The funds, basically, remain within the company and therefore are not a business deduction until such a time as they are actually distributed to the retired employee. Even then distribution plans that provide yearly distributions will make the life span of the retired executive an issue. Some top executives have been known to cancel their own SERPS because of the negative impact on company profit margins.
One such plan is the Insured Security Option Plan or ISOP. This plan has been specifically developed to replace the SERP as a high level executive incentive. It is really more of an investment type Insurance policy that provides retirement income as well as a death benefit for selected beneficiaries in case of death. The ISOP is funded by the company in the same way as the SERP, but is protected by ERISA regulations that allow it to be taxed more along the lines as company provided insurance.
SERP plans and ISOP plans are part of the competitive packages put together to lure or retain important employees and top executives to a company. The SERP plan is not a qualified plan for tax purposes and is structured to ‘supplement” the qualified retirement plans.