Monthly Archives: July 2016
Wednesday, July 27, 2016

Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.  Additionally, taxpayers can rely on the proposed regulations.

The changes are legion, so we are breaking up our coverage into a series of blog posts. This fourth in our series is about payment-related changes.  See our first three posts, “Firing Squad,” “Taking (and Giving) Stock,” and “Don’t Fear the (409A) Reaper.” Check back for one more post on these regulations.

What’s a Payment?  That’s not merely a philosophical question.  The current regulations use “payment” a great many times, but without definition.  The proposed regulations state that a payment, for 409A purposes, is generally made when a taxable benefit is actually or constructively received.  For this purpose, if something is included in income under 457(f), it is now treated as a payment for all purposes under 409A.  Additionally, a transfer of nonvested property is not a payment, unless the recipient makes an election to include the current value in income under Section 83(b).

Additional Permitted Delays for Short-Term Deferral Payments.  Amounts paid shortly after the service provider obtains the right to the payment or becomes vested are exempt from 409A as “short-term deferrals.”  The deadline is the 15th day of the third month following the year in which the right arises or the service provider becomes vested (often, March 15).  If an amount is paid after that date, it is subject to 409A and must comply with 409A’s rules to avoid adverse tax consequences.

The regulations provided a few limited exceptions where payment could be delayed and still have the payment qualify as a short-term deferral. Now there are two more!  Under the proposed rules, if payment by the short-term deferral deadline would violate Federal securities laws or other laws, then the payment can be delayed until such violation would not occur.  Unfortunately, this exception does not appear to extend to insider trading policies of the company, but in our experience, that is not often a hurdle for the settlement of equity awards that were previously granted.

Teachers, Professors, et al. Get a Break. Often times, educators and related professions have the choice of being paid over the school year or electing instead to have their 9- or 10-month salary spread out over 12 months.  Since these elections can result in a deferral of compensation, they are potentially subject to 409A (as an aside, it’s hard to see how this is in any way related to the perceived executive compensation abuses that 409A was ostensibly designed to address, but we digress).  The existing rules treated these elections as exempt and thus outside 409A, but only if a small amount of compensation was to be shifted to the next tax year based on this election.  The new proposed rules provide some additional flexibility.

Under the new proposed rules, these elections are still exempt as long as two conditions are met. First, the compensation cannot be deferred beyond the 13th month following the first day of the service period (e.g., the beginning of the school year).  Second, the service provider’s total compensation for the year cannot exceed the 401(a)(17) limit ($265,000, adjusted annually).

Wednesday, July 20, 2016

Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.  Additionally, taxpayers can rely on the proposed regulations.

The changes are legion, so we are breaking up our coverage into a series of blog posts. This third post is about the death benefit changes.  See our first two posts, “Firing Squad” and “Taking (and Giving) Stock.” Check back for future posts on these regulations.

Accelerated Payments for Beneficiaries. 409A generally allows plans to add death, disability, or unforeseeable emergency as potentially earlier alternative payment dates.  However, this special rule only applied to the service provider.  If the service provider dies, then the payment schedule applicable on the service provider’s death controlled and generally could not be changed.

The proposed rules loosen this. Now, plans can add accelerated payments on the death, disability, or unforeseeable emergency of a beneficiary.  This only applies to amounts that are being paid after the service provider’s death, but it creates some welcome flexibility.

Also, Possibly Delayed Payments for Beneficiaries. The proposed regulations say that a payment on a service provider’s death will be timely if it is made any time between the date of death and December 31 of the year after the death occurs.  Additionally, a plan is not required to have a specific payment window following death to use this rule and it can allow the beneficiary to choose to be paid any time in this window.  If a plan does have a payment period that falls in this window, payment can even be made sooner without amending the plan.

This is helpful for many reasons. Sometimes companies may not know a service provider has died until months after the death and, even once the company is made aware, it can take time to set up an estate.  This additional payment flexibility is welcome.  (However, we were surprised, with all this talk of death benefits, that the IRS did not incorporate Notice 2007-90.  It’s almost as if they didn’t write it or something.)

Thursday, July 14, 2016

Governmental Buildings and MoneyAfter more than nine years of deliberations, the IRS has finally released proposed regulations governing all types of deferred compensation plans maintained by non-profit organizations and governmental entities.

In issuing these regulations, the IRS reiterates its long-standing theme that these regulations are intended to work in harmony with, and be supplemental to, the 409A regulations. However, the IRS provides little guidance on how these regulations interact with each other.  The following discussion focuses on 3 key aspects of the new guidance: the severance exemption, the substantial risk of forfeiture requirement, and leave programs.

As with the 409A regulations, the 457 regulations exempt severance pay plans from the rules and taxes applicable to deferred compensation. The 457 regulations apply similar criteria with one notable exception: they do not apply the 401(a)(17) compensation limit in determining the “two times” dollar cap on amounts that can be paid pursuant to an exempt severance pay plan.  Practitioners in the for-profit arena currently believe they enjoy wide latitude in restructuring severance arrangements that are exempt from 409A.  It would not appear that practitioners will have that same latitude for severance arrangements that are exempt from 457, unless the arrangements also satisfy the severance pay exemption under 409A, particularly with regard to the dollar cap limit.

Historically, the proposed 457 rules afforded greater flexibility with respect to what is considered a substantial risk of forfeiture, particularly in the context of non-competes and rolling risks of forfeiture. The regulations restrict, but do not eliminate this flexibility by establishing requirements that must be satisfied for non-competes and rolling risks of forfeitures to create a substantial risk of forfeiture.  Despite the fact that there is wide latitude in restructuring short-term deferral arrangements in the for-profit arena, these restrictions will limit the ability to  restructure short-term deferral arrangements when using non-competes or rolling risks of forfeiture without taking into consideration whether any restructuring would constitute a separate transgression of the 409A rules.

Finally, the proposed 457 regulations raise the possibility that many leave programs, especially those maintained by governmental entities, could be suspect as deferred compensation arrangements. A paid leave program may be considered suspect if it allows large amounts of leave to be accumulated over the course of many years.  In our experience, this is not an uncommon design for many governmental and educational leave programs.  If the IRS does not retreat from this position, many such employers may need to reassess the structure of their leave programs.  The position taken in the proposed 457 rules might also give for-profit employers some pause as to whether the IRS might take a view that overly liberal leave programs may be subject to 409A requirements as deferred compensation.

Notwithstanding the long-awaited guidance afforded by these regulations, practitioners and plan sponsors would have welcomed greater guidance with respect to the interaction of the 409A and 457 rules. For instance, the rules could have better addressed where and how the 409A rules claw back some of the greater flexibility historically provided by the proposed 457 rules.  In the absence of guidance, some of that greater flexibility may turn out to be illusory – and the IRS will have failed to adequately highlight the pitfalls that await those that rely upon the greater flexibility afforded 457 arrangements.  Such failure to adequately address the interaction of the regulations raises some troubling questions and possible traps for the unwary.

Wednesday, July 13, 2016

Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.  Additionally, taxpayers can rely on the proposed regulations.

The changes are legion, so we are breaking up our coverage into a series of blog posts. This second post relates to changes in stock awards and stock sales.  See our first post, “Firing Squad.”  Check back for future posts on these regulations.

Discounted Stock Buybacks Are Now Okay, Sort of. The existing regulations had a trap for the unwary.  If the stock subject to an option or stock appreciation right (SAR) was subject to a buyback at other than fair market value, then the option or SAR may not be exempt from 409A.  This makes sense when the price is more than fair market value since that could be disguised deferred compensation.  However, often times, companies will have shareholder agreements with discounted buybacks on termination for cause or if an employee violates a non-compete or similar covenant.  Unless an exception applied, this would mean that the option or SAR would have to comply with 409A’s timing rules, which are often contrary to what both the company and the recipient desire.

Under the new proposed rules, mandatory buybacks at less than fair market value are okay as long as they only apply if either (A) the recipient is terminated for cause or (B) the occurrence of a condition within the recipient’s control (such as the violation of a non-compete).  Though these buybacks are also permitted under existing rules as long as they are so-called “lapse restrictions” (which means they have a limited duration), the additional flexibility provided by the proposed regulations is welcome in this area.

Awards Prior to Date of Hire can Still Be Exempt. Under the existing rules, an option or SAR had to be for stock of the company for which the individual was working (or certain affiliated entities) for it to be exempt from 409A.  But what if you wanted to grant an option to someone prior to date of hire?  That option would technically need to comply with 409A and its onerous timing requirements.

The proposed rules add additional flexibility in this regard. You can grant an option or SAR and have it be exempt as long as the service provider is expected to start work within 12 months (and actually does so).  If the service provider doesn’t start work within that 12 month period, then the award has to be forfeited (but honestly, you probably wanted it that way anyway).

Change in Control Rule Applies to Exempt Stock Rights. Sometimes in a transaction, employees with stock awards are given rights to get paid on the same terms as shareholders.  For awards subject to 409A, the rules generally permit this as long as the payments do not go beyond five years from the date of the change in control.  However, since options and SARs with fair market value strike prices are exempt from 409A, there was some question as to whether this rule could be used with those awards.  These proposed regulations confirm that it can.

A Stock Sale Means a Stock Sale. Generally, if a company’s stock is sold, the employees are not treated as having terminated employment/separated from service for 409A purposes.  On the other hand, in an asset sale, the buyer and seller can agree whether the sale constitutes a separation from service/termination of employment for 409A purposes.

But under Section 338 of the Code, parties can elect to treat a stock sale as a deemed asset sale for tax purposes. Does this include 409A, which would then allow them to choose whether a separation from service has occurred?  The proposed regulations say it does not.  Therefore, employees will not have a separation from service, even if a 338 election is made.

Monday, July 11, 2016

PenaltyThe Department of Labor (DOL), along with several other federal agencies, recently released adjusted penalty amounts for various violations. The amounts had not been adjusted since 2003, so there was some catching up to do, as required by legislation passed late last year.

These new penalty amounts apply to penalties assessed after August 1, 2016 for violations that occurred after November 2, 2015 (which was when the legislation was passed). Therefore, while the penalty amounts aren’t effective yet, they will be very soon and they will apply to violations that may have already occurred.  Additionally, per the legislation, these amounts will be subject to annual adjustment going forward, so they will keep going up.

The DOL released a Fact Sheet with all the updated penalty amounts under ERISA.  A few of the highlights are:

General Penalties

  • For a failure to file a 5500, the penalty will be $2,063 per day (up from $1,100).
  • If you don’t provide documents and information requested by the DOL, the penalty will be $147 per day (up from $110), up to a maximum penalty of $1,472 per request (up from $1,100).
  • A failure to provide reports to certain former participants or failure to maintain records to determine their benefits is now $28 per employee (up from $10).

Pension and Retirement

  • A failure to provide a blackout notice will be subject to a $131 per day penalty (up from $100).
  • A failure to provide participants a notice of benefit restrictions under an underfunded pension plan under 436 of the tax code will cost $1,632 per day (up from $1,000).
  • A payment in violation of those restrictions will be $15,909 per distribution (up from $10,000).
  • A failure of a multiemployer plan to provide plan documents and other information or to provide an estimate of withdrawal liability will be $1,632 per day (up from $1,000).
  • A failure to provide notice of an automatic contribution arrangement required under Section 514(e)(3) of ERISA will also be $1,632 per day (also up from $1,000).

Health and Welfare

  • Employers who fail to give employees their required CHIP notices will be subject to a $110 per day penalty ($100, currently).
  • Failing to give State Medicaid & CHIP agencies information on an employee’s health coverage will also cost $110 per day (again, up from $100).
  • Health plan violations of the Genetic Information Nondiscrimination Act will also go up to $110 per day from $100. Additionally, the following minimums and maximums for GINA violations also go up:
    • minimum penalty for de minimis failures not corrected prior to receiving a notice from DOL: $2,745 (formerly $2,500)
    • minimum penalty for GINA failures that are not de minimis and are not corrected prior to receiving a notice from the DOL: $16,473 (up from $15,000)
    • cap on unintentional GINA failures: $549,095 (up from $500,000)
  • Failure to provide the Affordable Care Act’s Summary of Benefits and Coverage is now $1,087 per failure (up from $1000).

The above penalty amounts are usually maximums (the penalties are “up to” those amounts), which means the DOL has the discretion to assess a smaller penalty. Employers and plans should be mindful of these and the other penalty increases described in the fact sheet.  These increased penalties give the DOL additional incentive to pursue violations and assess penalties.  They also give the DOL greater negotiating leverage in any investigation.  For these reasons, it pays to be aware of the various compliance obligations (and any associated timing requirements) and make sure your plans’ operations are consistent with those obligations.

Thursday, July 7, 2016

Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.

The changes are legion, so we are breaking up our coverage into a series of blog posts. This first post is all about the changes related to the end of the service relationship.  Check back for future posts discussing other aspects of these proposed regulations.

Severance Safe Harbor Available for Bad Hires. Severance is, surprisingly to some, generally considered deferred compensation subject to 409A.  However, severance can be exempt from 409A if the severance is due to a truly involuntary separation under 409A and does not exceed two times the lesser of (1) the employee’s prior annual compensation or (2) the limit on compensation for qualified plans under Code Section 401(a)(17) (currently $265,000, for a limit of $530,000).  To qualify for the exemption, the severance must also be paid by the end of the second tax year following the year of separation.  This is sometimes referred to as the “two years, two times” rule.

But what if you make a bad hire or otherwise decide you want to fire someone in the same year you hired them? Is the severance safe harbor still available?  Treasury confirmed that, indeed, it is.  In that case, the limit is two times the lesser of (1) the employee’s annualized compensation for the year of termination or (2) the 401(a)(17) limit.

Reimbursement of Legal Fees for Bona Fide Employment Claims is Exempt. Trial lawyers (or more likely their clients), rejoice!  Some employment agreements contain provisions where the employee can be reimbursed for legal fees if they succeed in a claim they bring against the company following termination.  These legal fee reimbursement provisions always had an uncertain status under 409A, until now.  The IRS has said that if they are a result of a bona fide dispute, they are exempt from 409A.

Employees Becoming Contractors Can Have a Separation from Service. An employee who transitions to an independent contractor status can have a separation from service as an employee in connection with that transition if his/her level of services as an independent contractor are low enough to constitute a separation. Usually, this means that the former employee could provide no more than 20% of the level of services s/he was providing as an employee over the prior 36-months.  We always believed this was the rule, but there was some language in the regulations that caused others to question it. The IRS has clarified the rule, stating that such a reduction in services rendered constitutes a separation from service.

Tuesday, July 5, 2016

Part-time and full-time job working businessman business man conceptTypically, when a participant receives annuity payments from a defined benefit pension plan where he or she has a basis in the benefit (what Code Section 72 calls an “investment in the contract”), a portion of the payment is treated as a recovery of that basis. Therefore, it is not taxable to the participant.  That portion is determined under the rules of Code Section 72.  The most common way in which an employee has basis in his or her benefit is by making after-tax contributions.  Currently, this is more common in governmental defined benefit plans than other plans.

However, it was not clear how these basis recovery rules worked in the context of phased retirement distributions. The IRS recently issued Notice 2016-39 to address the treatment of payments made by a qualified defined benefit pension plan to an employee during phased retirement.  Phased retirement is the period during which an employee begins to take distributions of a portion of his or her retirement benefits from a plan while continuing to work on a part-time basis.  During these periods, it may be difficult for the plan to do the typical calculation under Code Section 72.  Additionally, the employee may be continuing to accrue additional benefits, which would further complicate the calculation.

The Notice provides that if certain conditions are met, the payments will not be considered amounts received as an annuity for purposes of Code Section. This means that, if the employee made after-tax contributions to the plan or otherwise has a basis in his or her benefit, then a portion of the payment will be treated as basis recovery and will be excluded from income using the calculation rules under Code Section 72(e)(8) described in the Notice.

The Fix

According to the Notice, any payments received by an employee from an applicable plan will not be treated as received from an annuity if all the following conditions are met:

    1. The employee begins to receive a portion of his or her retirement benefits when he or she enters phased retirement and begins part-time employment;
    2. The employee will not begin receiving his or her full retirement benefits until ceasing employment and commencing full retirement at an indeterminate future date. For this purpose, a date is “indeterminate” as long as it can be changed. Since the employee and employer can always agree to a later date, nearly every date will be indeterminate for this purpose;
    3. The plan’s obligations to the employee are based in part on the employee’s continued part-time employment, which impacts both the duration of the phased retirement benefits and the amount of additional retirement benefits the employee accrues during the phased retirement period. In other words, the plan only pays phased retirement benefits as long as the employee is part-time and the employee’s part-time status affects the employee’s ability to accrue benefits under the plan (although the Notice does not appear to say how it affects the accrued benefit); and
    4. Under the terms of the plan, the employee cannot make an election as to the form of the phased retirement benefit to be paid during phased retirement. Instead, the employee must elect a distribution option at full retirement that applies to the employee’s entire retirement benefit, including the portion that commenced as phased retirement benefits. In other words, the employee’s benefit at full retirement must be reduced by the actuarial equivalent of the amount received during phased retirement.

Any amounts that are not received as an annuity will be subject to the special basis recovery rules in the Notice. Specifically, the amount excludible from the employee’s gross income will be a portion of each payment, calculated by multiplying the amount of the payment by the ratio of the employee’s investment in the contract (i.e., the employee’s basis) to the present value of the employee’s accrued benefit. The Notice provides that the basis recovery fraction may be fixed at the time payments begin under a phased retirement program. This avoids the need to redo the calculation as the employee makes additional contributions to the plan.

The IRS also issued Revenue Procedure 2016-36, which provides that this Notice will not apply to amounts received from a non-qualified contract.