IRS Notice 88-99: Rabbi Trusts, 409A Funding Triggers, and Top Hat Filing

A rabbi trust must be built on the IRS model trust language in Revenue Procedure 92-64 and must operate inside the guardrails of Section 409A of the Internal Revenue Code. The core rabbi trust requirements are that trust assets remain reachable by the employer’s general creditors if the company becomes insolvent, that an independent trustee holds the assets, that the trust be a grantor trust of the employer, and that the underlying nonqualified deferred compensation plan follow Section 409A’s rules on funding, deferral elections, and distributions. Get any of that wrong and the executive faces immediate income taxation of the entire deferred balance, a 20% additional tax, and interest running back to the year the compensation was first deferred.

Why Creditor Access Is the Central Requirement

Every specific provision the IRS insists on in a rabbi trust exists to keep the arrangement out of two tax traps. The first is constructive receipt: income becomes taxable when it is credited to your account, set apart for you, or otherwise available to draw on, even if you have not taken the cash. Real restrictions on access defeat that doctrine.¹

The second is the economic benefit doctrine. When an employer irrevocably sets aside assets for an executive’s sole benefit and places them beyond the reach of the company’s creditors, the executive has received a taxable economic benefit right now under Section 83, even without any cash changing hands.² A trust that fully insulates assets from the employer’s financial trouble triggers immediate taxation for exactly this reason.

A rabbi trust threads the gap. Assets sit in a segregated trust account, but the trust document says openly that those assets remain subject to the claims of the employer’s general creditors on insolvency.³ The executive has an unsecured contractual claim, not a secured property interest. That exposure is what defeats the economic benefit doctrine and preserves income tax deferral until distributions are actually paid.

Because a rabbi trust is a grantor trust, the employer is treated as the owner of trust assets for income tax purposes. Trust investment income, gains, and losses flow through to the employer, not the executive.⁴

What the Trust Document Must Contain Under Revenue Procedure 92-64

The IRS published model rabbi trust language in Revenue Procedure 92-64 and treats it as a safe harbor. Adopt the model language and the IRS will not argue that the trust itself creates constructive receipt or an economic benefit. If you want a private letter ruling on your arrangement, conforming to the model is required.⁵

The model trust document has to include these provisions:

Creditor access. Trust principal and earnings must be available to the employer’s general creditors under federal and state law in the event of insolvency. Participants can have no preferred claim on or beneficial ownership interest in trust assets, and their rights are limited to unsecured contractual claims against the employer.
Insolvency definition. The trust must define the employer as insolvent if it cannot pay its debts as they become due, or if it is the subject of a pending bankruptcy proceeding.
Duty to notify the trustee. The board of directors and the highest-ranking officer must inform the trustee in writing if the company becomes insolvent. If anyone claiming to be a creditor alleges insolvency in writing, the trustee must independently determine whether insolvency has occurred.
Payment suspension on insolvency. The trustee must stop all benefit payments to participants immediately on learning of insolvency and hold the assets for general creditors.
Grantor trust status. The document must state that the trust is a grantor trust under the Internal Revenue Code, with the employer as grantor.
Independent trustee. The trustee must be an independent third party with corporate trustee powers under state law, such as a bank trust department.
Payment schedule. The employer must deliver a schedule to the trustee specifying the amounts payable to each participant, the form of payment, and the payment start date. The trustee follows that schedule and handles required tax withholding.
Reversion rules. After the trust becomes irrevocable, the employer cannot direct the trustee to return trust assets until all plan obligations are satisfied. Any assets left after all benefits have been paid revert to the employer.

The trust must also be valid under state law, and every material term (especially the creditor-access provisions) must be enforceable under the applicable state’s laws. The IRS will verify enforceability if you seek a private letter ruling.⁵ The model permits some flexibility: the trust can be irrevocable from day one, or it can start as revocable and become irrevocable on a specified trigger such as a change in control. Either works as long as the creditor-access language is in place throughout.

Section 409A Funding Rules That Can Override the Trust

Even a perfectly drafted trust document will fail if the funding pattern violates Section 409A. Three funding arrangements cause the deferred compensation to be treated as an immediate transfer of property under Section 83, triggering current taxation regardless of the creditor-access clause.

Offshore Trust Assets

If trust assets are located outside the United States, the executive is treated as having received taxable property when those assets were set aside offshore. The only exception is when substantially all of the services related to the deferred compensation were performed in that foreign jurisdiction.⁶

Financial Health Triggers

A rabbi trust cannot contain any provision that restricts trust assets to participants based on a decline in the employer’s financial health. This rule targets “springing” trusts that try to convert from unsecured to secured when the employer hits trouble. If the plan includes such a trigger, or if assets are actually restricted in response to deteriorating finances, the deferred amount is taxed to the executive immediately.⁶

Restricted Periods for Underfunded Pension Sponsors

Companies that sponsor a single-employer defined benefit pension plan cannot set aside or transfer assets into a rabbi trust for nonqualified deferred compensation during a “restricted period.” That period includes bankruptcy and times when the pension plan’s funded status drops below certain thresholds.⁷

All three funding violations carry identical consequences: inclusion of the deferred amount in the executive’s gross income, an additional 20% tax, and interest at the underpayment rate plus one percentage point running back to the year the compensation was first deferred or vested.

Section 409A Plan-Operation Rules

The trust is only the funding vehicle. The underlying nonqualified deferred compensation plan has to independently satisfy Section 409A on elections, distributions, and changes. A plan-operation failure destroys the tax deferral just as effectively as a trust-structure failure.

Deferral Election Timing

An election to defer compensation generally has to be made before the calendar year in which the services creating the compensation are performed. A newly eligible participant has 30 days from becoming eligible, but the election can only cover compensation earned after the election date. Performance-based compensation tied to a service period of at least 12 months has a longer window: the election can be made up to six months before the end of the performance period, provided the outcome is still uncertain when the election is made.

Permissible Distribution Events

The plan must limit distributions to one of six triggering events:⁸

Separation from service.
Disability, as defined in the regulations.
Death, with payment to the executive’s beneficiaries.
A specified time or fixed schedule set out in the plan.
Change in control (ownership, effective control, or a substantial portion of assets).
Unforeseeable emergency causing severe financial hardship beyond the executive’s control.

Any distribution outside these categories violates Section 409A.

Six-Month Delay for Specified Employees of Public Companies

If the executive is a “specified employee” of a publicly traded company, distributions triggered by separation from service must be delayed for at least six months after the departure date. Death during the waiting period ends the delay early. Accumulated payments can be released as a lump sum on the first day of the seventh month, or each individual payment can simply be pushed back six months.⁸

What Happens When the Rules Are Broken

Section 409A places the penalty on the executive, not the employer. On a design or operation failure, all vested compensation deferred under the plan for the current year and all preceding years becomes immediately includible in the executive’s gross income, to the extent not already taxed.⁶

On top of the income inclusion sits an additional tax equal to 20% of that amount, plus interest calculated at the underpayment rate plus one percentage point, running as if the compensation had been taxable in the year it was first deferred or, if later, the year it vested. For someone who has been deferring for a decade, the combined bill can wipe out much of the deferral’s value.

Plan-operation violations trigger these penalties under Section 409A(a). Funding violations trigger the identical penalty structure under Section 409A(b). Either path, same result.

The ERISA Top Hat Filing

A rabbi trust arrangement almost always sits inside a “top hat plan” under ERISA. A plan is exempt from ERISA’s normal participation, vesting, funding, and fiduciary rules if it is unfunded and maintained primarily to provide deferred compensation for a select group of management or highly compensated employees.⁹

A plan counts as unfunded for this purpose so long as participants have no greater rights to plan assets than the employer’s general creditors. That is precisely what a properly structured rabbi trust delivers, which is why the assets can sit in a trust account without breaking the ERISA exemption.

The employer files a top hat plan statement electronically with the Department of Labor within 120 days after the plan first becomes subject to ERISA. The statement lists the employer’s name and address, its EIN, a declaration that the plan is maintained primarily for a select group of management or highly compensated employees, and the number of plans and employees covered.¹⁰ Each new top hat plan needs its own filing; an existing filing does not cover a plan adopted later. Amending an existing plan to add a new class of participants does not, however, require a new filing.¹¹

When Employment Taxes Are Actually Due

Income tax deferral is the point of the arrangement, but FICA taxes follow a different clock. The employer withholds the employee share and pays its own matching share as of the later of two dates: the date the executive performs the services creating the right to the deferred amount, or the date the deferred amount is no longer subject to a substantial risk of forfeiture.¹² Immediately vested deferrals owe FICA in the year of service. Vesting-scheduled deferrals owe FICA when they vest.

Because Social Security tax applies only up to the annual wage base ($184,500 in 2026), most executives receiving nonqualified deferred compensation already exceed the threshold on regular salary alone.¹³ The deferred amount often owes only the 1.45% Medicare tax, plus the 0.9% additional Medicare tax on earnings above $200,000. Paying that smaller tax early while deferring the much larger income tax is usually a favorable trade.

A nonduplication rule finishes the picture. Once FICA has been paid under the special timing rule, neither that amount nor any future investment earnings on it are subject to FICA again at distribution. Skip the special timing rule, and the full distribution (principal plus decades of earnings) becomes FICA wages at payout.¹²

1
eCFR. 26 CFR 1.451-2 – Constructive Receipt of Income
2
Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection With Performance of Services
3
U.S. Department of Labor. Advisory Opinion 1992-13A
4
Office of the Law Revision Counsel. 26 U.S. Code 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners
5
BenefitsLink. Revenue Procedure 92-64
6
Office of the Law Revision Counsel. 26 U.S. Code 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans
7
Internal Revenue Service. Nonqualified Deferred Compensation Audit Technique Guide
8
eCFR. 26 CFR 1.409A-3 – Permissible Payments
9
Office of the Law Revision Counsel. 29 U.S. Code 1051 – Coverage
10
eCFR. 29 CFR 2520.104-23 – Alternative Method of Compliance for Pension Plans for Certain Select Employees
11
U.S. Department of Labor. Top Hat Plan Statement
12
eCFR. 26 CFR 31.3121(v)(2)-1 – Treatment of Amounts Deferred Under Certain Nonqualified Deferred Compensation Plans
13
Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings for Social Security