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  • BC Network
    Tuesday, February 21, 2017

    On January 20, 2017, President Trump signed an executive order entitled “Regulatory Freeze Pending Review” (the “Freeze Memo“).  The Freeze Memo was anticipated, and mirrors similar memos issued by Presidents Barack Obama and George W. Bush during their first few days in office.  In light of the Freeze Memo, we have reviewed some of our recent posts discussing new regulations to determine the extent to which the Freeze Memo might affect such regulations.

    TimeoutThe Regulatory Freeze

    The two-page Freeze Memo requires that:

    1. Agencies not send for publication in the Federal Regulation any regulations that had not yet been so sent as of January 20, 2017, pending review by a department or agency head appointed by the President.
    2. Regulations that have been sent for publication in the Federal Register but not yet published be withdrawn, pending review by a department or agency head appointed by the President.
    3. Regulations that have been published but have not reached their effective date are to be delayed for 60 days from the date of the Freeze Memo (until March 21, 2017), pending review by a department or agency head appointed by the President. Agencies are further encouraged to consider postponing the effective date beyond the minimum 60 days.

    Putting a Pin in It: Impacted Regulations

    We have previously discussed a number of proposed IRS regulations which have not yet been finalized.  These include the proposed regulations to allow the use of forfeitures to fund QNECs, regulations regarding deferred compensation plans under Code Section 457, and regulations regarding deferred compensation arrangements under Code Section 409A (covered in five separate posts, one, two, three, four and five).

    Since these regulations were only proposed as of January 20, 2017, the Freeze Memo requires that no further action be taken on them until they are reviewed by a department or agency head appointed by the President.  This review could conceivably result in a determination that one or more of the proposed regulations are inconsistent with the new administration’s objectives, which might lead Treasury to either withdraw, reissue, or simply take no further action with respect to such proposed regulations.

    A Freeze on Reliance?

    The proposed regulations cited above generally provide that taxpayers may rely on them for periods prior to any proposed applicability date.  Continued reliance should be permissible until and unless Treasury takes action to withdraw or modify the proposed regulations.

    The DOL Fiduciary Rule

    The Freeze Memo does not impact the DOL’s fiduciary rule, which was the subject of its own presidential memorandum, discussed in detail elsewhere on our blog.

    Tuesday, August 2, 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 last in our series is about the changes to the proposed income inclusion regulations and the other minor changes and clarifications made by the regulations.  See our prior posts, “Firing Squad,” “Taking (and Giving) Stock,” “Don’t Fear the (409A) Reaper,” and “Getting Paid.”

    Preventing Waste, Fraud, and Abuse (Okay, well, mostly just abuse). The only change to the proposed income inclusion regulations was to “fix” the anti-abuse rule that applied to correcting unvested amounts that violated 409A.  “Why?” you might ask.  Apparently, because people were abusing it.

    Under the proposed income inclusion regulations, a broken (that’s a technical legal term) 409A arrangement could be fixed in any year before the year it would vest (what we will call “nonvested” amounts). The prior proposed regulations did not put many parameters on how the fix had to happen (other than it needed to, you know, comply with 409A).

    Some hucksters (again, technical term) were apparently amending arrangements that complied with 409A to make them noncompliant. Then they would amend them again to “fix” them in the way they wanted.  This would allow them to get around the change in election rules, as long as the amount would not vest that year.  Clever, perhaps, but pretty clearly not within the spirit of the rules.

    To prevent this kind of abuse, the IRS has revised this permitted correction rule. First, if there is no good faith basis for saying that the arrangement violates 409A, it cannot be fixed.

    Second, the regulations provide a list of facts and circumstances for determining if a company has a pattern or practice of permitting impermissible changes. If they do, then they would not be able to fix a nonvested amount.  The facts and circumstances include:

    • Whether the service recipient has taken commercially reasonable measures to identify and correct substantially similar failures upon discovery;
    • Whether substantially similar failures have occurred with respect to nonvested deferred amounts to a greater extent than with vested amounts;
    • Whether substantially similar failures occur more frequently with respect to newly adopted plans; and
    • Whether substantially similar failures appear intentional, are numerous, or repeat common past failures that have since been corrected.

    Finally, the regulations require that a broken amount be fixed using a method provided in IRS correction guidance. This doesn’t mean that you have to use the correction guidance for unvested amounts.  What it means is that, if a method is available and would apply if the amount was vested, then you have to use the mechanics of that correction (minus the tax reporting or paying any of the penalties).  For example, under IRS Notice 2010-6, if a plan has two impermissible alternative times of payment for a payment event, it has to be corrected by providing for payment at the later of the two times.  You would have to fix a nonvested amount in the same manner under these rules.

    While these changes are intended to ferret out abusers of the rules, this does make it harder for well-intentioned companies who merely have failures to make changes.

    Other Minor Changes and Clarifications.  The proposed regulations also confirmed and clarified the following points of the current final regulations:

    – 409A does apply to non-qualified arrangements of foreign entities that are also subject to 457A.

    – Entities can be subject to 409A as service providers in the same way that individuals are.

    – Payments can be accelerated for compliance with bona fide foreign ethics laws or conflicts of interest laws.

    – On plan termination and liquidation outside a change in control, all plans of the same type (e.g., all account balance plans) have to be terminated. And no additional plans of that type can be adopted for three years.  This is what the IRS always understood the rule to be, but they just made it clearer in these proposed regulations.

    – Payments can also be accelerated, without limit, to comply with Federal debt collection laws.

    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 2, 2014

    Employment Termination and ReleaseSeparation agreements almost always contain release provisions whereby one or both parties agree to waive claims that they may have against the other party; when the employee releases claims, he or she typically gains compensation or a benefit that he or she is not already entitled to receive.  In a world in which every terminated employee is a potential plaintiff, employers should have a good grasp on how to draft a valid and enforceable release in a separation agreement.  Here are five tips every employer should consider when drafting this type of a release.

    Tip No. 1:  Offer Valid Consideration

    In order to have a valid and enforceable release agreement, the employer must provide the employee with payments or benefits the employee is otherwise not entitled to receive.  Therefore, payments or benefits the terminated employee is otherwise entitled to receive either by law or pursuant to an employment agreement generally do not satisfy the consideration requirement.  For example, conditioning the employee’s release on the receipt of his final paycheck, earned commissions or vacation pay specified by an employee handbook or other policy will not constitute valid consideration.  While severance pay is the most common type of consideration, it is not the employer’s only option.  Valid consideration can also include notice pay (i.e., pay in lieu of notice), continuation of health benefits at the employer’s expense (note, there are tax issues associated with this approach), bonuses, unearned vacation pay, outplacement services or use of office services (e.g., secretarial, computer access, etc.), or relocation expenses reimbursement, among others..

    Again, the most common type of consideration offered in exchange for an employee release is severance pay.  However, as mentioned above, this severance pay has to be something other than what the employee is already entitled to receive.  For example, if the employer has a severance plan written into an employee handbook in which the employee is entitled to receive one week of severance for each year of service and the payment is not conditioned on a release of claims, the severance payment offered in exchange for a release must exceed what the employee is already entitled to receive.  However, there is a simple way around this issue – the written severance plan can expressly condition the receipt of severance upon the employee executing a release.  This is discussed in more detail in Tip 2.

    In sum, when drafting a release, the employer should always ask:  Is this benefit or payment something the employee is already entitled to receive?  If it is, then it is not valid consideration and the release will be unenforceable.

    Tip No. 2:  Condition Severance on the Execution of a General Release and Compliance With Other Contractual Provisions

    If the employer negotiates the payment of severance in an employment agreement, it should always require the employee to execute a release as a condition of receiving severance (note the timing rules for this requirement discussed in Tip 3).  By failing to include this provision, the employee could collect severance and still sue the employer for breach of the agreement, discrimination, or other claims under the employment relationship.  Besides conditioning the payment of severance on signing a release, the employer should also condition payment of severance on compliance with other contractual provisions of the agreement such as provisions relating to the return of the employer’s documents and property, non-disparagement, noncompetition, nondisclosure of confidential information, and nonsolicitation of customers and employees.  Not only does this approach incentivize employees to honor their post-employment contractual obligations, but it also potentially avoids litigation by giving the employer the option to simply discontinue severance payments if the employee breaches the agreement.

    Tip No. 3:  Comply with Section 409A of the Internal Revenue Code

    So far it seems simple—condition receipt of severance payments upon the execution of a release waiving employment claims such as disability discrimination, age discrimination, etc.  It seems fair to say that severance payments don’t begin until the employee returns the release agreement.  However, this type of arrangement creates potential issues under 409A of the Internal Revenue Code (“Section 409A”).  Under Section 409A, the concern is that the employee could wait to execute the release until the year following his or her termination in order to control the year in which he or she receives (and is taxed on) the severance payments.  Because the severance is taxable when actually paid, the employee could hold on to a release and defer taxation in a manner the IRS deems abusive.  The penalties for failure to comply with 409A are harsh (including a 20% excise tax).  Although it is the employee who is ultimately penalized, these issues are typically brought up by employee’s counsel during negotiations.

    There are two common solutions for addressing the problem raised above.  First, payment could begin upon a fixed cut-off date following termination of employment so long as the release becomes effective before that date.  While this solution is relatively easy to implement, employees may not get their payments as quickly as they would like.  Alternatively, the separation agreement could call for severance to begin upon return of the signed release within a fixed window (90 days maximum) following termination of the employment.  To avoid the problem of the employee holding on to the release to affect the year the severance is taxable, the agreement would need to provide that if the release consideration period spans two calendar years, then the severance payments will be made (or commence, as applicable) no earlier than the first day of the second calendar year.  While this approach is potentially more desirable for the employee, it can be harder for the employer to administer.

    Legal counsel experienced with drafting 409A separation agreements can avoid potential liability by including “safe harbor” provisions or restructuring the agreement.  Accordingly, employers should always consult counsel with Section 409A expertise when an employment agreement or separation agreement provides for any form of severance.

    Tip No. 4:  Use Clear Language in the Release

    To the extent possible, draft an agreement that is simple and comprehensible.  The agreement does not need to be a formal, lengthy agreement.  Generally for claims to be effectively waived by agreement, the release must be “knowing and voluntary.”  To avoid a potential challenge from an employee that their release was not “knowing and voluntary,” an employer should use clear language in the release.  Furthermore, an employer should give an employee a reasonable amount of time to consider the release and afford the employee the opportunity to consult separate counsel.  Note that the time period for considering and revoking a release might be governed by statute, and many states have specific statutory requirements that must be met in order to obtain an enforceable release.

    Tip No. 5:  Be as Specific as Possible, but Consider the Requirements of Each Waived Claim

    Depending on the jurisdiction, a court may construe employee releases narrowly, limiting them to claims explicitly released.  To avoid the potential challenge of the agreement being overbroad, employers should, if possible, include a release of specific claims (e.g., ADEA, ERISA, Title VII, etc.).

    As a result, employers should consider the requirements implicated by each released claim.  For instance, a waiver of Age Discrimination in Employment Act (ADEA) claims must comply with the requirements of the Older Workers Benefit Protection Act, 29 U.S.C. §§621 et sq. (“OWBPA”).  Under OWBPA, the waiver must be “knowing and voluntary”, as described in the statute.    While courts have not traditionally applied the OWBPA requirements to non-ADEA claims, given the particular requirements of the OWBPA, it may be beneficial for an employer who is asking for a release of ADEA and non-ADEA claims to draft a release that complies with the OWBPA requirements.

    Concluding Thoughts:

    While this list is not by any means exhaustive, it highlights some of the most important considerations in drafting a valid and enforceable release in a separation agreement.  As a concluding thought, while obtaining a release can be very desirable, an employer should be tactful in asking for a waiver of claims.  Asking for a waiver in a separation agreement could inadvertently suggest that the employer believes that employee has a claim against it.  To avoid any unnecessary litigation, an employer should be thoughtful in its approach to negotiating a release and always consult counsel with expertise in employment law.

    Thursday, November 8, 2012

    It’s that time of year again!  Time to ensure year-end executive compensation deadlines are satisfied and time to plan ahead for 2013.  Below is a checklist of selected executive compensation topics designed to help employers with this process.

    I.       2012 Year-End Compliance and Deadlines

    □      Section 409A – Amendment Deadline for Payments Triggered by Date Employee Signs a Release

    It is fairly common for an employer to condition eligibility for severance pay on the release of all employment claims by the employee.  Many of these arrangements include impermissible employee discretion in violation of Section 409A of the Internal Revenue Code because the employee can accelerate or delay the receipt of severance pay by deciding when to sign and submit the release.  IRS Notice 2010-6 (as modified by IRS Notice 2010-80), includes transition relief until December 31, 2012 to make corrective amendments to plans and agreements.

    Generally, the arrangement may be amended to either (1) include a fixed payment date following termination, subject to an enforceable release (without regard to when the release is signed), or (2) provide for payment during a specified period and if the period spans two years, payment will always occur in the second year.  We recommend employers review existing employment, severance, change in control and similar arrangements to ensure compliance with this payment timing requirement.  The December 31, 2012 deadline for corrective amendments is fast approaching.

    □      Compensation Deferral Elections

    Compensation deferral elections for amounts otherwise payable in 2013 must generally be documented and irrevocable no later than December 31, 2012.  The remainder of 2012 is sure to pass quickly, especially with the added distractions of the elections and tax law uncertainty.  Employers should consider additional communications to ensure the deadline is not overlooked. (It’s also a good time to confirm 409A compliance generally, as we have discussed previously.)

    □      Payroll Deduction True-Up for Fringe Benefits and Other Compensation

    Some employers utilize a rule for administrative convenience that permits income and employment tax withholding on certain items of compensation to be made at the end of the year (i.e., imputed income on after-tax long-term disability premiums).  Employers should ensure that all payroll deductions for taxable compensation for the year are taken into consideration.

    □      Annual Compensation Risk Assessment for SEC Reporting Companies

    Beginning with the 2010 proxy season, companies have been required to perform a risk assessment of their compensation policies and practices.  The purpose of the assessment is to evaluate compensation-related risk-taking incentives.  Where a company determines that its employee compensation program includes  “risky” pay policies and practices, it must include disclosures (including mitigating practices).  In recent addresses, representatives of the SEC have included a “reminder” to public companies that the compensation risk assessment must be performed annually.

    □      Compensation Consultant Conflict of Interest Assessment for SEC Reporting Companies

    Beginning with the 2013 proxy season, the Dodd-Frank Act requires a company to disclose whether the work of its compensation consultant has raised any conflict of interest.  The assessment should consider six specified factors outlined in the rules.  The purpose of the assessment is to determine whether the work of the consultant raised a conflict of interest.  If the company determines a conflict of interest was raised, the company must disclose the nature of the conflict and how the conflict is being addressed.

    II.     2013 Planning

    □      Section 162(m) Employer Compensation Deduction Limit

    Section 162(m) of the Internal Revenue Code limits the deduction for a publicly-held corporation to $1 million for each covered employee (typically the chief executive officer and four most highly compensated officers, other than the CEO and CFO).  This deduction limit does not apply to “qualified performance-based compensation.”  To qualify for the exception, the compensation must be payable solely on account of the attainment of one or more pre-established performance goals and other technical requirements must be satisfied.  Employers should review their plan design and administrative practices to ensure compliance with the technical requirements.  For example:  (1) review the timing of prior shareholder approval to determine whether new shareholder approval must be obtained in 2013, (2) confirm that the compensation committee is comprised solely of two or more “outside directors,” and (3) ensure that the committee timely establishes the performance goals for the new performance period, and pre-certifies the level of achievement of the performance goals at the end of each performance period.  A few other technical requirements to note include:

    • If the company issues restricted stock and restricted stock units (RSUs) that are designed to qualify as performance-based compensation, any related dividends and dividend equivalents must separately satisfy the performance-based compensation requirements (i.e., must be contingent on achievement of the performance goals).
    • It is common for a shareholder-approved equity plan to include a per-employee share limit for a stated period for awards granted under the plan.  It is important for the company to keep track of this limit to ensure actual awards do not exceed this cap.

    New for 2013 – Deduction Limit for Health Insurance Providers and Related Entities

    A new provision enacted under the Health Care Reform law takes effect on January 1, 2013.  New Section 162(m)(6) of the Internal Revenue Code limits the deduction covered health insurance providers (and their related entities) may take for compensation paid to certain employees in excess of $500,000.   There is no performance-based compensation exception to this limit.

    □      Monitor Tax Law Changes

    There are a number of tax law changes scheduled to occur beginning in 2013 that will impact required income and employment tax withholding for many forms of executive and equity compensation.  Congress could act to extend some tax rate cuts beyond 2012.  We recommend employers monitor tax law developments and be prepared to make changes to current payroll reporting processes.  Below are some of these changes:

    Employment Taxes.  On October 16, 2012, the Social Security Administration announced employment tax rates for 2013.  The taxable wage base for earnings subject to the Social Security tax for 2013 is $113,700, up from $110,100 in 2012.  In addition to an increase in the Social Security taxable wage base, the tax withholding rate is scheduled to return to 6.2% (the temporary 4.2% reduced rate is scheduled to expire at the end of 2012).  The Medicare tax also applies and the required withholding rate is an additional 1.45% with no wage limit.  Starting in 2013, an additional Medicare tax of 0.9% applies to earnings from wages and other taxable compensation over a threshold amount (i.e., $200,000-$250,000 based on filing status).

    Supplemental Wage Withholding.  The supplemental wage withholding rate is used by  employers for income tax withholding on bonus, commissions, severance payments, equity awards and other special payments.  The supplemental wage withholding rate for 2012 is 25% or a mandatory 35% once aggregate supplemental wages exceed $1 million for the year.  Due to the scheduled expiration of the Bush-era tax cuts, the 2013 rates are scheduled to increase to 28% and 39.6% for aggregate amounts in excess of $1 million.

    □     Proxy Statement Preparation for SEC Reporting Companies

    With the implementation of Say on Pay, proxy statement disclosures serve as a key investor communication tool to help explain the company’s compensation program and how it ties to company performance.  Now is the time to improve disclosures and implement best practices for the upcoming proxy season.  Below are some areas for consideration:

    • Add an executive summary at the beginning of the proxy statement
    • Reorganize the proxy and improve the table of contents
    • Begin the CD&A with highlights including company financial performance and the absence of problematic pay practices
    • Add a comparison of realizable pay to Summary Compensation Table pay (consider using charts and graphs)
    • Explain how the performance pay measures and targets were selected and the outcome of actual results
    • Improve disclosure of peer group selection, benchmarking and company rank
    • Explain recent compensation design changes and rationale for the changes
    • Remove excess words and repetitive disclosures

     

     Disclaimer/IRS Circular 230 Notice

    Tuesday, October 30, 2012

    On October 16, 2012, Institutional Shareholder Services (ISS) issued for comment several proposed proxy voting policy changes.  The following would affect U.S. public companies:

    Board Matters

    Current Policy: Recommend vote against or withhold votes from the entire board (except new nominees, who are considered case-by-case) if the board failed to act on a shareholder proposal that received the support of either (i) a majority of shares outstanding in the previous year; or (ii) a majority of shares cast in the last year and one of the two previous years.

    Proposed Policy: Recommend votes against or withhold votes from the entire board (with new nominees considered case-by-case) if it fails to act on any proposal that received the support of a majority of shares cast in the previous year.

    The proposed change is intended to increase board accountability. ISS is specifically seeking feedback as to whether there are specific circumstances where a board should not implement a majority-supported proposal that receives support from a majority of votes cast for one year.

    Say-on-Pay Peer Group

    Current Policy: ISS’s pay-for-performance analysis includes an initial quantitative screening of a company’s pay and performance relative to a group of companies reasonably similar in industry profile, size and market capitalization selected by ISS based on the company’s Standard & Poor’s Global Industry Classification (GICS).

    Proposed Policy: For purposes of the quantitative portion of the pay-for-performance analysis the peer group will continue to be selected from the company’s GICS industry group but will also incorporate information from the company’s self-selected benchmarking peers.  When identifying peers, ISS will afford a higher priority to peers that maintain the company near the median of the peer group, are in the company’s own selected peer group and that have selected the company as a peer.

    The change is likely a direct response to criticism from companies that the ISS-selected peer groups are not comparable and in many cases do not take into account multiple business lines.  ISS is specifically requesting comments on whether there are additional or alternative ways that ISS should use the company’s self-selected peer group, what size range (revenue/assets) should be used for peer group determination and what other factors should be considered in constructing the peer group for pay-for-performance evaluation.

    Say-on-Pay Realizable Pay Analysis

    Current Policy:  If the quantitative pay-for-performance screening demonstrates unsatisfactory long-term pay for performance alignment or misaligned pay, ISS will consider grant-date pay levels or compensation amounts required to be disclosed in the SEC summary compensation table to determine how various pay elements may work to encourage or to undermine long-term value creation and alignment with shareholder interests.

    Proposed Policy: Rather than focusing solely on grant-date pay levels, the qualitative analysis for large-cap companies may include a comparison of realizable pay to grant-date pay. Realizable pay will consist of relevant cash and equity-based grants and awards made during the specific performance period being measured, based on equity award values for actual earned awards or target values for ongoing awards based on the stock price at the end of the performance measurement period.

    In its recent annual survey, 50% of investors indicated that they consider both granted and realized/realizable pay as an appropriate way to measure pay-for-performance alignment.  ISS has requested comments as to how to define realizable pay, whether stock options should be considered based on intrinsic value or Black-Scholes value and under what rationale and what should be an appropriate measurement period for realizable pay. (more…)

    Tuesday, July 24, 2012

    Every 409A attorney knows the look. It’s a look that is dripping with the 409A attorney’s constant companion – incredulity. “Surely,” the client says, “IRS doesn’t care about [insert one of the myriad 409A issues that the IRS actually, for some esoteric reason, cares about].” In many ways, the job of the 409A attorney is that of knowing confidant – “I know! Isn’t it crazy! I can’t fathom why the IRS cares. But they do.”

    There are a lot of misconceptions out there about how this section of the tax code works and to whom it applies. While we cannot possibly address every misconception, below is a list of the more common ones we encounter.

    I thought 409A only applied to public companies. While wrong, this one is probably the most difficult because it has a kernel of truth. All of the 409A rules apply to all companies, except one. 409A does require a 6-month delay for severance paid to public company executives. However, aside from this one rule, all of 409A’s other rules apply to every company.

    But it doesn’t apply to partnerships or LLCs. Wrong, although again a kernel of truth. Every company, regardless of form, is subject to 409A. However, the IRS hasn’t yet released promised guidance regarding partnerships or LLCs, most of the 409A rules (like the option rules) apply by analogy.

    But I can still change how something is paid on a change of control. Maybe, but maybe not. If a payment is subject to 409A, there are severe restrictions on how it can be modified, even on a change of control. Even payments not subject to 409A by themselves can, inadvertently, be made subject to 409A if the payment terms are modified. There is some latitude to terminate and liquidate plans in connection with a change in control, but – word to the wise – these termination payments are very tricky to implement and require a pretty comprehensive review of all plans in place following the change in control.

    409A only affects executives. Nope. Any time “deferred compensation” is implicated, 409A applies, even to rank and file. In fact, 409A can have adverse effects for a mind boggling array of employees, including innocuous arrangements like school-year teacher reimbursement programs!

    And the definition of deferred compensation is broad, including such items as severance agreements or plans or even bonuses, if paid beyond the short-term deferral period. As a practical matter, many rank and file severance and bonus plans qualify for exemptions that make them not subject to 409A’s restrictions on time and form of payment, but it’s still worth reviewing them to make sure.

    Okay then, it only applies to employees, right? Wrong again. Directors and other independent contractors are subject to 409A’s grip. There are some exemptions, but, again, they are difficult to implement.

    What’s the company’s tax burden if we screw up? This question itself is not a misconception, but the unstated assumption – that it’s the company’s liability – is.  The penalties fall entirely on the employee, director, or contractor.

    But put yourself in the shoes of an executive who, unexpectedly, gets hit with a 409A penalty. The executive may argue that the employer designed the plan and the employer administered the plan. The executive’s role was to work, possibly even contribute his or her own money to the plan, and reap the benefit down the road.  The IRS rules say that something got messed up and the executive owes substantial additional taxes – perhaps even before payment is made from the plan – through no fault of the executive.

    What’s the first thing the executive does? Turn to the employer and loudly proclaim, “Make me whole.”

    In addition, employers can also have additional direct withholding and reporting penalties. Depending upon culpability, those penalties can be very large.

    The bottom line is that 409A potentially applies to anyone who hires anyone else to do anything for them – and does not pay them immediately.

    Other BenefitsBryanCave.com 409A Posts

    Disclaimer/IRS Circular 230 Notice

     

    Wednesday, April 4, 2012

    This post is the fifth and final post in our BenefitsBryanCave.com series on five common Code Section 409A design errors and corrections. Go here, here, here, and here to see the first four posts in that series.

    Code Section 409A abhors discretion. One concern with discretion is that it could lead to the type of opportunistic employee action or employer/employee collusion that hurt creditors and employees during the Enron and WorldCom scandals.

    Another concern is that discretion could be used opportunistically to affect the taxation of deferred compensation. Consider an employment agreement with a lump-sum payment due at any time within thirteen months following a change in control, as determined in the employer’s discretion. This provision would permit the employer to pick the calendar year of the payment. Because non-qualified payments are generally taxable to the recipient when paid, this type of provision would allow a company to essentially pick the year in which the employee is taxed on the payment. In this situation, the IRS would be concerned that the plan participant (who often has great influence with the company) would collude with the company so that the resulting payment was of most tax benefit to the participant.

    Code Section 409A addresses this problem by restricting the timing of a deferred compensation payments following a triggering event to a single taxable year, a period that begins and ends in the same taxable year, or a period of up to 90 days that could potentially span two taxable years. If the “up to 90 day period” approach is taken, Code Section 409A also requires that the service provider not have the right to designate the taxable year of the payment. Most plans provide for payments within a 90 day period following the appropriate Code Section 409A triggering event.

    Plans are occasionally drafted using a payment period longer than 90 days. Fortunately, the IRS allows correction of these over-long payment periods. The correction is to amend the plan to either remove the over-long payment period from the plan or to provide for an appropriate period of time for the payment. This amendment can even occur within a reasonable amount of time following the Code Section 409A triggering event, but penalties would apply. As always, certain correction documents must be filed with the IRS.

    Click here for other 409A-related posts.