Many entities have arrangements that allow their employees to defer some or all of their earned compensation (i.e., salary or bonus). Sometimes the employer uses a “rabbi trust”4 to hold assets from which nonqualified deferred compensation payments will be made. ASC 710 provides guidance on deferred compensation arrangements in which assets equal to compensation amounts earned by employees are placed in a rabbi trust. Such arrangements often permit employees to diversify their accounts by investing in cash, the employer’s stock, nonemployer securities, or a combination of these options. In all cases, the employer consolidates the rabbi trust in the employer’s financial statements.
The guidance in ASC 710 refers to four types of deferred compensation arrangements involving rabbi trusts. These four arrangement types, known as plans A, B, C, and D, differ on the basis of whether the plan permits diversification, whether the employee has elected to diversify, and the allowable forms of settlement:
Rabbi trusts are generally used as funding vehicles to provide for the deferral of taxation to the employee receiving the compensation. That is, in a nonqualified deferred compensation plan, employees defer the receipt of compensation amounts earned by placing the amounts earned in a rabbi trust. By deferring receipt of the amounts earned, the employees are also deferring the taxability of those amounts. The employees will be subsequently taxed upon receiving the amounts that have been placed in the rabbi trust.