409A Applicable Law - From Code to Regs to IRS Notices
(look below this table for new developments)
409A Developments (Note: separate topics headings below.
2019.07.10 Messed up Election - Employer Escapes Immediate Liability (Sixth Circuit Decision). In Wilson v. Safelite Group, Inc., the employer succeed in dismissing state law claims, because its deferred compensation plan constituted an ERISA pension plan. The case arose from an IRS audit that levied substantial penalties on a former CEO's $9.1 million account, due to deferral election failures under Section 409A. Employers should check their plans, employment agreement agreements, and any agreements involving deferred compensation - in order to assure that they close the door to tax claims based on stumbles relating to Section 409A, as well as federal tax withholding (taking into account the Henkel decision).
2016.06.22 409A Proposed Regs Released - Many Clarifications. The IRS release begins with a list of 19 clarifications being made, with a few of the notable changes being described in the following quotations from the IRS proposal:
- [Stock Awards: Forfeitures-for-Competition/Cause] Accordingly, these proposed regulations provide that a stock price will not be treated as based on a measure other than fair market value if the amount payable upon a service provider's involuntary separation from service for cause, or the occurrence of a condition that is within the control of the service provider, such as the violation of a covenant not to compete or a covenant not to disclose certain information, is based on a measure that is less than fair market value.
- [Stock Awards - Business Transactions] These proposed regulations clarify that the special payment rules for transaction-based compensation apply to a statutory stock option or a stock right that did not otherwise provide for deferred compensation before the purchase or agreement to purchase the stock right. Accordingly, the purchase (or agreement to purchase) such a statutory stock option or stock right in a manner consistent with these rules does not result in the statutory stock option or stock right being treated as having provided for the deferral of compensation from the original grant date.
- [338 Transactions] These proposed regulations affirm and make explicit that a stock purchase transaction that is treated as a deemed asset sale under section 338 is not a sale or other disposition of assets for purposes of this rule under section 409A.
- [Stock Awards - New Hires] these proposed regulations provide that, if it is reasonably anticipated that a person will begin providing services to a corporation or other entity within 12 months after the date of grant of a stock right, and the person actually begins providing services to the corporation or other entity within 12 months after the date of grant (or, if services do not begin within that period, the stock right is forfeited), the corporation or other entity will be an eligible issuer of service recipient stock.
- [Plan Terminations] The Treasury Department and the IRS have concluded that the meaning of the plan termination rule under § 1.409A-3(j)(4)(ix)(C) is not ambiguous. However, to address the questions raised by commenters, these proposed regulations further clarify that the acceleration of a payment pursuant to this rule is permitted only if the service recipient terminates and liquidates all plans of the same category that the service recipient sponsors, and not merely all plans of the same category in which a particular service provider actually participates. These proposed regulations also clarify that under this rule, for a period of three years following the termination and liquidation of a plan, the service recipient cannot adopt a new plan of the same category as the terminated and liquidated plan, regardless of which service providers participate in the plan..
2015.Sept.20 Section 409A Corrections to Employment Agreements - Time for an Ounce of Protection in The Year BEFORE Vesting (or Severance)
First the bad news: when it comes to 409A violations, the most common sources are employment agreements and releases. With surprising frequency, employers encounter 409A problems due to conditions timing severance pay to an employee's execution of a claims release. Other common sources for 409A problems arise from allowing employees to choose between receiving their severance in lump sums or installments, or receiving cash-outs of employer-paid COBRA coverage.
Now the good news: a 2015 IRS Chief Council Memo supports the correction of defective severance provisions if that occurs in the year before a termination of employment occurs. The IRS memo was actually unfavorable to the taxpayer, because it rejected a 409A correction that took place in the year severance occurred. While time remains this year, it is worth reviewing any agreements, plans, or releases that provide for severance. For a helpful diagnostic aid, see this 409A compliance checklist focused employment agreements.
2013.Nov.23 "Legally binding Rights" Tax Ruling for Bonus Deductions . . . 409A? In Field Attorney Advice dated 10/25/13, the IRS cites extensive authority for its position that legally binding rights do not exist when an employer has reserved to itself the unilateral right to reduce or eliminate bonus awards prior to making payments. While focused on when tax deductions are allowable, the memo has interesting implications under Code §409A because Treas. Reg. §1.409A-1(b)(1) provides that legally binding rights may arise -- despite an employer's reservation of rights to reduce awards -- if facts and circumstances indicate that those rights "lack substantive significance." In the absence of employer actions undermining its discretion to reduce or eliminate bonuses or other awards, the IRS Field Attorney Advice Memo is significant because it provides solid authority on which to argue that an employer's reservation of rights makes Code §409A totally inapplicable.
2013.Mar.06 Over $5 Million of Option Gain subject to 409A Penalties due to Below-Market Option Price. In Sutardja v U.S., the Court of Federal Claims refused a taxpayer's summary judgment motion seeking a refund of 409A penalties paid with respect to more than $5 million of income arising from the taxpayer's exercise of stock options in 2006. The court rejected arguments to the effect that 409A cannot apply to stock options, and in the process held that Notice 2005-1 provided a reasonable basis for the imposition of 409A taxes if the exercise price for the stock options is ultimately found to have been below the fair market value of the underlying shares on the grant date.
Severance from Employment
- Order of Payments if Severance Exemptions are Partially Applicable.
- Q&A-31 of the ABA JCEB's Report from its May 2010 meeting with the IRS deals with coordinating severance payments that are partially exempt under its short-term deferral rule or two year (two times pay) rule, with an acceleration of the exempt payments being allowed if the applicable plan or agreement identifies them as separate payments for 409A purposes. In that event, the exempt payment would essentially replace those that would otherwise have first been paid first, meaning that the accelerated payments do not those due later. The IRS response also addresses the overlay of 409A's six-month delay rule.
- Paid Leave in Lieu of Notice does not Delay Last Day Worked
- Report of May 2013 Meeting with IRS, which provides as follows:
- . . . The severance plan also provides that the employer may pay the employee wages for those 60 days in lieu of the employee actually performing services. The employer treats this 60-day period as paid leave. Assume an employee voluntarily terminates and receives a severance payment that is subject to Section 409A of the Code. When is the employee considered to have had a separation from service for purposes of Section 409A – on the last day the employee performs services or on the last day of the paid leave?
- Proposed Response: If the employer places the employee on paid leave, the employee does not have a separation from service until the end of the 60-day period.
- IRS Response: The Service representative disagrees with the proposed response. Under the facts presented, the employee does not appear to have the right to continued employment, and there is no reasonable expectation that the employee will return to employment. Based on the facts presented, the Service representative stated that there appears to have been a separation from service.
Release Requirements and Timing of Payments
- See Q&As-37 and 38 of the ABA JCEB's Report from its May 2010 meeting with the IRS (re forfeited installment payments and noncompliant good reason definitions).
Substantial Risk of Forfeiture
- See SROF for Code §§ 83 and 409A.
Substitutions - of New Benefits for 409A Benefits
- Replacement Plan after Ordinary Course Termination? Q&A-28 of the ABA JCEB's Report from its May 2010 meeting with the IRS deals with an ordinary course plan termination under Treas. Reg. §1.409A-3(j)(4)(ix)(C), and states that those rules do not forbid the implementation of a "replacement" plan of a kind not aggregated, under Treas. Reg. §1.409A-1(c), with the terminated plan.
Termination (of Plan)
- Consent of Participants for Plan Termination? Q&A-26 of the ABA JCEB's Report from its May 2010 meeting with the IRS states the IRS position that an employer may not provide a 409A plan participant "with a direct or indirect election with respect to whether [the employer] will exercise its discretion to accelerate a benefit" pursuant to a plan termination.
- All § 409A Plans Need Termination - per Q&A 12 from ABA JCEB Report of May 2013 meeting with the IRS, which provides:
- Termination of a plan is not a prohibited acceleration provided that “the service recipient terminates and liquidates all agreements, methods, programs, and other arrangements that would be aggregated with any terminated and liquidated agreements, methods, programs, and other arrangements under §1.409A-1(c) if the same service provider had deferrals of compensation under all the agreements, methods, programs, and other arrangements that are terminated and liquidated.”
- Would it be necessary to terminate all plans of the same type in order to fit within this exception, including plan for which the service provider was not eligible?
- Proposed Response: It is not necessary to terminate each plan of the same type for all service providers within a controlled group. It is necessary to terminate all plans of the same type in which a service provider has participated, or is eligible to participate. In other words:
- A voluntary deferral plan for an employee of a New York subsidiary could be terminated without requiring termination of the voluntary deferral plans for employees of a California subsidiary for which the New York employee would not have been eligible.
- A 10% employer contribution SERP for junior level VPs could be terminated without terminating the 25% employer contribution SERP for senior VPs.
- Of, course, the participant whose plan is terminated could not then participate in a plan of the same Section 409A type offered by the employer, including its controlled group members. This would accomplish the policy goal of prohibiting acceleration without requiring drastic retooling of a service recipient’s deferred compensation program.
- IRS Response: The Service representative disagrees with the proposed response. It would be necessary to terminate all plans of the same type for all members of all controlled groups. . . .