IRS Issues Additional Guidance Under Section 409A for Nonqualified Deferred Compensation Plans
The IRS has recently issued additional guidance under Internal Revenue Code (“IRC”) section 409A in the form of proposed reliance regulations. The regulations provide largely minor changes and clarifications many of which are helpful under very specific circumstances. The guidance stems from the input of practitioners and the IRS’s own experience in the 9 years since the final regulations were issued in 2007.
Summarized below are the most significant changes that we believe are relevant to our readers. For a complete list of all the changes, please see Proposed Regulations sections 1.409A-1 through 1.409A-6 published by the Treasury Department on June 21, 2016.
Short-Term Deferral Rule
The regulations provide that payments that would otherwise qualify under the short-term deferral rule will continue to qualify even if made after the applicable 2½ month period if made to comply with federal securities laws, provided that the payment is made as soon as practicable after the payment would not cause a violation of the securities laws.
The definition of ‘eligible service recipient stock’ is modified to include a corporation or other entity for whom the individual receiving the stock right is reasonably expected to begin providing services within 12 months of the grant of the right. If the individual does not begin providing services within 12 months of the grant, the stock right must be forfeited.
The new regulations provide that a stock right is still exempt from section 409A if it can be repurchased for other than fair market value (the 2007 regulations require a repurchase at fair market value) in connection with a termination for cause or a breach of a non-compete or non-solicitation covenant by the service provider.
Under the 2007 regulations, payments of deferred compensation to a service provider may be delayed where the value of the payout is tied to the service recipient’s stock value. In this case, the payments may be made on the same terms and in the same manner as the seller receives as long at the payout period does not exceed 5 years. The new regulations provide for the same delayed payment schedule for holders of stock rights and incentive stock options in connection with a sale of the company.
Severance Pay Safe Harbor
The regulations clarify that separation pay plans that meet the safe harbor exemption (involuntary separation pay) from section 409A includes service providers that did not have compensation from the service recipient in the prior year (i.e., began and ceased providing services in the same tax year).
Payments at Death
Under the 2007 regulations, a continuing problem has been the timely payment to a beneficiary upon the service provider’s death or the death of a beneficiary who had become entitled to payment. The new regulations provide that payment on account of the service provider’s (or a beneficiary’s) death will be considered timely made if paid to a beneficiary or estate any time beginning with the date of death and ending on December 31 of the year following the year of death.
Acceleration of Benefit Payments
The proposed regulations provide that the addition of the accelerated payments on account of death, disability, or an unforeseeable emergency of a beneficiary who has become entitled to payments on the death of a service provider, will not violate the rules against the acceleration of payments, even though payments that would not have otherwise been payable may be paid to the new beneficiary or estate immediately.
The new regulations expand the current exception, which was generally limited to $5,000, that allows acceleration of payments to comply with federal debt collection laws. The new regulations allow acceleration of payments reasonably necessary to comply with federal debt collection laws without regard to the amount.
Transfers Not Qualifying as Payment Under Section 409A
The new regulations provide that transfers of restricted stock, stock options, or interests in a section 402(b) trust are not considered payments for purposes of section 409A unless the transfer results in immediate taxation to the recipient. It appears that some taxpayers were deferring taxation after the payment from plans subject to section 409A using ‘grey’ areas under the 2007 regulations. IRS has now closed these transactions down, so that they cannot be used to further defer taxation of the payments.
These regulations provide clarifications and some new flexibility in specific situations to companies with deferred compensation plans and severance plans subject to section 409A. As always, additional clarification and flexibility provided by IRS are helpful and welcome in this area of the tax law and clients are encouraged to review their plans in light of these changes to ensure compliance and to take advantage of any areas of additional flexibility.
The proposed regulations are effective when finalized, but may be relied upon until the final regulations are actually published. Accordingly, the IRS will not assert new positions that are contrary to these proposed regulations.
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