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  • BC Network
    Tuesday, February 6, 2018

    On December 22, 2017, President Trump signed the bill popularly referred to as the “Tax Cuts and Jobs Act” (the “Act”) into law.  The Act contains significant changes to Section 162(m) of the Internal Revenue Code that are effective for taxable years beginning after December 31, 2017. In this article, we provide a summary of the changes to Section 162(m) and suggest planning considerations for publicly held corporations.

    Summary of Changes to Section 162(m)

    Among other changes to Section 162(m), the Act eliminated the performance-based compensation exception to the $1 million deduction limitation under Section 162(m).  The Act amended the scope of the covered employees, corporations, and compensation for purposes of the $1 million limitation on the deduction for compensation paid to certain employees under Section 162(m). The changes to Section 162(m) include the following:

    • Eliminating the performance-based compensation and commission exceptions from compensation subject to Section 162(m). Under the prior rules of Section 162(m), performance-based compensation and commission were excluded from the $1 million deduction limitation. This change means that a corporation’s compensation committee no longer will be required to establish objective performance goals within 90 days of the start of an applicable performance period and that shareholder approval of the compensation terms and maximum amounts payable no longer is required for Section 162(m) purposes.
    • Expanding the definition of publicly held corporations to include corporations that file reports under Section 15(d) of the Securities Exchange Act of 1934, as amended, which will subject certain corporations with publicly traded debt and certain foreign private issuers to the deduction limitation of Section 162(m). Under the prior rules, only corporations with publicly traded equity were subject to Section 162(m).
    • Expanding the definition of covered employee to include any individual who served as the CFO during the taxable year. In addition to the CEO and CFO, the definition continues to include the three other highest compensated officers required to be reported to shareholders under the Securities and Exchange Commission rules. The prior rules excluded the CFO.
    • Expanding the definition of covered employee to include any individual who was a covered employee in any taxable year beginning after December 31, 2016, so that once an employee is covered under Section 162(m) for any year, that individual will continue to be covered for all future years. Under the prior definition, covered employees were determined each year without regard to whether an individual was a covered employee in a prior year. With this change, payments to former employees (such as severance payments and stock option exercises) will be subject to the $1 million deduction limitation.
    • Expanding the scope of compensation subject to Section 162(m) to include amounts paid to an individual other than the covered employee, including a covered employee’s beneficiary following the employee’s death.

    Transition Rule for Contracts in effect on November 2, 2017

    The Act includes a transition rule under which the changes to Section 162(m) will not apply to compensation paid pursuant to a written binding contract that was in effect on November 2, 2017, provided that no material modification is made after that date. The Act’s conference agreement between the House and Senate makes clear that a contract that was in place prior to November 2, 2017, and that is renewed after that date, will be treated as a new contract that will no longer qualify for the transition rule. The requirement of a written binding contract under the transition rule raises issues such as whether a contract or plan subject to the compensation committee’s discretion to adjust a performance award downward will result in the contract being ineligible for the transition rule. We expect that future guidance from the Internal Revenue Service will address these issues and will provide additional guidance as to what constitutes a written binding contract and a material modification.

    Considerations in Planning for the New Section 162(m)

    Corporations covered by Section 162(m) should review their current compensation arrangements now to identify the contracts and plans that may take advantage of the transition rule.  We recommend the following:

    • In order to determine what constitutes a written binding contract, it may be helpful to look to applicable state law or analogous federal laws, until we have further guidance from the IRS.
    • Once identified, any change to a contract should be carefully reviewed to determine whether it will cause the arrangement to lose the benefit of the transition rule. In the absence of guidance from the Internal Revenue Service, guidance and interpretations under other tax laws that included transition relief for agreements that had not been subject to a material modification, such as Section 409A of the Internal Revenue Code, may be helpful in determining whether such a modification has been made.
    • In addition, because contracts eligible to take advantage of the transition rule are subject to the prior Section 162(m) rules, they must be administered in compliance with the prior requirements related to performance-based compensation, including the requirement to certify the attainment of the performance goals.

    For new performance-based compensation arrangements, the repeal of the performance-based pay exception allows corporations increased flexibility in the establishment and operation of performance-based pay programs.

    • Performance goals no longer need to be pre-established or objectively determinable. This change will permit compensation committees greater flexibility in taking into account events that occur during the performance period when determining whether the performance goals have been satisfied.
    • Performance goals no longer need to be approved by the compensation committee within 90 days of the beginning of the performance period.
    • The compensation committee may reserve the discretion to adjust performance-based awards up or down based on actual performance.
    • To limit the impact of the repeal of the performance-based pay and commission exceptions, a corporation may consider permitting or requiring covered employees to defer receipt of all or a portion of the individual’s compensation or extending the payment schedule over a period of years in a manner such that the payments would fit within the $1 million deduction limit for the year. These strategies may implicate additional legal requirements applicable to deferred compensation which should be taken into account, including under Section 409A.

    In addition, the changes to Section 162(m) may present state tax deduction issues in states which conform sections of their tax code to the federal tax code. In states that permit deductions for performance-based pay under state tax laws mirroring the prior version of Section 162(m), the performance-based pay deduction may continue to be available for performance-based plans that comply with the prior rules of Section 162(m) until the state brings its tax law into conformity with the new federal Section 162(m). Amended or newly established performance-based plans designed under the new federal Section 162(m) may lose a state tax deduction for performance-based pay in states that have not conformed to the new federal Section 162(m) because these plans will not comply with the prior Section 162(m) performance-based pay exception rules.

    Finally, in addition to planning for compliance with the transition rule and the repeal of the performance- and commission-based compensation exceptions, corporations should consult with their outside advisers to determine whether and how to describe the changes relating to Section 162(m) in their proxy statements.

    The changes to Section 162(m) and the repeal of the performance- and commission-based pay exceptions pose a significant change in the tax rules governing executive compensation and, likely, a major shift in how corporations will compensate their executives as a result. We expect future guidance from the Internal Revenue Service will be issued to assist with compliance. With this in mind, corporations subject to Section 162(m) should consult with their legal counsel, compensation consultants, and other outside advisers to implement any changes to their compensation programs and comply with the new rules.

    Tuesday, January 23, 2018

    On December 22, President Trump signed “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (“Bill”) into law. The Bill was previously named the much-shorter “Tax Cuts and Jobs Act,” but was changed after a senator pointed out that the name violated an obscure Senate rule.

    The new employee benefit and executive compensation provisions in the Bill affect both individuals and employers. The good news for colleges and universities is that the harshest employee benefit provisions directed at colleges and universities were not included in the final Bill. The bad news is that the executive compensation and fringe benefit changes directed at tax-exempt organizations are unfavorable to institutions of higher education.


    The House passed a version of the Bill that would have repealed the exclusion from income for qualified tuition reductions provided by educational institutions to (i) employees and their spouses or dependents and (ii) graduate teaching assistants.  The House’s version of the Bill also eliminated the exclusion for education assistance (up to $5,250 per year per employee) that was available to all employers.

    Fortunately, both of these changes were eliminated in the final Bill.


    The Bill places a 21% excise tax on the amount of annual compensation in excess of $1,000,000 paid to covered employees of most tax-exempt organizations, including tax-exempt institutions of higher education.

    Covered Employees

    A “covered employee” is any employee—including a former employee—who is either one of the five highest compensated employees of the organization for the taxable year, or an employee who was a covered employee of the organization (or any predecessor to the organization) for any preceding taxable year beginning in 2017.


    Compensation generally includes all taxable remuneration payable to a covered employee (“Compensation”).  For purposes of this rule, remuneration is considered payable in the first year that it is no longer subject to a substantial risk of forfeiture, regardless of when actually paid. A substantial risk of forfeiture exists when a person’s rights to remuneration are conditioned upon the future performance of substantial services or the occurrence of a condition related to the purpose of the remuneration. So, to determine the total Compensation of a covered employee in any year, an employer must add together current salary and other current taxable remuneration as well as any future rights to payments (but only for the first year in which such future payments are no longer subject to a substantial risk of forfeiture).

    Compensation does not include designated Roth contributions or amounts paid to licensed medical professionals for medical or veterinary services. Licensed medical professionals include doctors, nurses, and veterinarians. The Bill does not provide any guidance on what qualifies as medical or veterinary services, but the IRS may promulgate regulations to clarify the provisions of this Code section.

    Compensation of a covered employee by an applicable tax-exempt organization includes amounts paid by all related tax-exempt organizations and governmental entities. So, if two related organizations each pay a covered employee $900,000, even though neither organization pays the covered employee more than $1,000,000 individually, both will be liable for a 21% tax on a portion of the amount over $1,000,000 that the covered employee receives (here, $800,000). Each related organization is liable for the amount of taxes proportional to Compensation it pays the covered employee during the year. In the example above, each organization would be liable for half of the taxes assessed because each organization paid the covered employee an equal amount. However, if one organization paid $450,000, and the other paid $1,350,000, the first organization would owe one-quarter of the total tax assessed and the other organization would owe three-quarters of the total tax assessed.


    The Bill also places a 21% excise tax on the amount of “excess parachute payments” paid to covered employees of most tax-exempt organizations, including tax-exempt institutions of higher education.

    Parachute payments are taxable payments available to a covered employee contingent on the employee’s termination of employment (“Parachute Payments”). An excess parachute payment is any such taxable payment in excess of three times the base amount allocated to such payment. The base amount is the annualized includable Compensation of the covered employee for the five taxable years ending before the date of the employee’s separation from employment. So, if an employee’s annualized Compensation (including amounts not subject to a substantial risk of forfeiture) is $200,000, any amount over $600,000 paid to the employee contingent upon his separation from service would be taxed at a rate of 21%.

    Many of the concepts described in the preceding section apply in the Parachute Payment context.  The definitions of “covered employee” and “Compensation” are the same, and Parachute Payments do not include amounts paid to licensed medical professionals for medical or veterinary services.  In addition, amounts payable to non-highly compensated employees and distributions from qualified plans, 403(b) plans, and 457(b) plans do not count as Parachute Payments.

    One element of uncertainty associated with the Parachute Payment excise tax relates to amounts which become fully vested upon an involuntary termination of employment under a Section 457(f) plan.  Assume, for example, that a covered employee would be entitled to a $300,000 payment under a Section 457(f) plan on the earlier of an involuntary separation from service without cause or March 1, 2025.  Assume further that the covered employee is involuntarily terminated without cause on January 1, 2025 and receives a lump sum payment of $300,000.  By analogy to the golden parachute payment regulations issued under Internal Revenue Code Section 280G, the value of such payment for purposes of the 21% excise tax should equal at most the value of the two-month vesting acceleration rather than the full $300,000, but this is not clear pending further guidance from the Internal Revenue Service.

    If an amount is subject to the Parachute Payment excise tax, it will not also be subject to the Excess Compensation excise tax described in the preceding section.


    The first step for employers potentially affected by either of these excise taxes will be to identify their covered employees and the covered employees’ annual Compensation and potential Parachute Payments due upon severance from employment. After identifying the Compensation and potential Parachute Payments associated with each covered employee, employers may want to restructure certain covered employees’ compensation. Affected employers will need to weigh competing interests: (i) the need to retain skilled executives and other key employees against (ii) the added tax costs and the perception of donors and the public in the event either excise tax might apply to payments to a covered employee.


    The Bill also increases the amount of unrelated business taxable income of a tax-exempt organization by any amount that is paid or incurred by the organization (i) as a qualified transportation fringe, (ii) made to a parking facility used in connection with qualified parking, or (iii) towards any on-premises athletic facility. For example, if an organization pays $100 a month for an on-premises gym on behalf of an employee, $1,200 ($100/month x 12 months) will be added to that organization’s unrelated business taxable income.

    When considering this new provision, employers will want to weigh their own financial interests with the interests of their employees. While no longer providing the fringe benefits discussed above may save unrelated business income taxes, doing so would undoubtedly be viewed unfavorably by employees.

    Thursday, November 9, 2017

    Last week the House unveiled its tax overhaul plan, the Tax Cuts and Jobs Act (“Act”).  The Act’s proposals related to employee benefits and compensation are as follows:

    Nonqualified Deferred Compensation

    Perhaps one of the most talked about aspects of the Act (at least among benefits practitioners) is the demise of Code section 409A and the creation of its replacement, Code section 409B.

    Under the proposed Code section 409B regime, nonqualified deferred compensation would be defined broadly to include any compensation that could be paid later than the March 15 following the taxable year in which the compensation is no longer subject to a substantial risk of forfeiture, but with specific carve-outs for qualified retirement plans and bona fide vacation, leave, disability, or death benefit plans.  Stock options, stock appreciation rights, restricted stock units, and other phantom equity are included expressly in the definition of nonqualified deferred compensation.

    All nonqualified deferred compensation earned for services performed after 2017 would become taxable once the substantial risk of forfeiture no longer exists, even if payment of the compensation occurs in a later tax year.  As a result:

    • Stock options and stock appreciation rights would become includible in income in the year in which the award vests, without regard to whether they have been exercised.
    • An employee’s deferral of any salary under a nonqualified deferred compensation arrangement until separation from service or otherwise would result in the inclusion of such amount in the employee’s income in the year earned.
    • All salary continuation payments under a severance arrangement would be taxable in the year in which the termination of employment occurs.

    Further, a substantial risk of forfeiture exists only so long as the compensation remains subject to the service provider’s continued substantial future services.  The satisfaction of performance conditions would no longer qualify as a substantial risk of forfeiture.

    All nonqualified deferred compensation earned for services performed before 2018, to the extent not previously includible in income, will be included in income in the last tax year beginning before 2026 or, if later, the date the substantial risk of forfeiture with respect to such compensation no longer exists.  A limited period of time would be provided during which such nonqualified deferred compensation may be amended to conform the date of distribution to the date such amount would be required to be included in the participant’s income without violating Code section 409A.

    Performance-Based Compensation

    The Act also would eliminate the exception to the Code section 162(m) limit on deductible compensation for performance-based compensation, effective January 1, 2018.  The definition of a “covered employee” for purposes of application of Code section 162(m) would change to include an employee who is the principal executive officer or principal financial officer at any time during the taxable year or one of the top three highest-paid employees (or who has ever been a covered employee after 2016).

    Since satisfaction of the specified performance targets would no longer constitute a substantial risk of forfeiture, an employee who participates in a long-term incentive plan that does not require continued employment through the end of the performance period as a condition to receiving the bonus (or the Company subsequently waives such requirement) would be required to include the bonus amount in income in the year in which no additional services are required (even if the final performance results are unknown).

    Beginning in 2018, tax-exempt organizations would become subject to a 20% excise tax on all compensation (cash and the cash value of all remuneration, including benefits paid in a medium other than cash, except for payments to a qualified retirement plan and amounts that are excludable from the employee’s gross income) in excess of $1 million paid to the five highest-paid employees.

    Retirement Plans

    Many of the proposed changes for qualified plans would be favorable for participants.

    Hardship distributions would no longer require participants to cease making contributions during the six-month period after the distribution.  In addition, a defined contribution plan could permit participants to receive a distribution from qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), profit sharing contributions and earnings on any such contributions.  In addition, participants would no longer be required to seek any available plan loan first to alleviate their financial need.

    The minimum age at which a defined benefit pension plan could permit commencement of in-service benefits or a state and local government defined contribution plan could permit an in-service distribution is reduced from age 62 to age 59 ½.

    A participant would have until the due date for filing his or her tax return to roll over a loan balance from a qualified plan to an individual retirement account (IRA), instead of the current 60 day period, before such amount is treated as a distribution.

    Miscellaneous and Fringe Benefits

    Effective January 1, 2018, the following benefits would become taxable to the employee:

    • Reimbursed dependent care expenses under a dependent care assistance program (DCAP) and employer-provided onsite daycare
    • Qualified tuition reimbursement plan benefits
    • Adoption assistance plan benefits
    • Qualified moving-expense reimbursements
    • Employee achievement awards given in recognition of length of service or safety achievement
    • Employer contributions to an Archer Medical Savings Account (accounts could not be established after 2005). Such contributions also would be non-deductible by the employer.

    Transportation fringe benefits would continue to be excludible from employees’ income, but an employer would no longer be entitled to a deduction.

    As expected, the House is engaged in intense negotiations on various parts of the Act so the extent to which any of these provisions will remain in their current iteration in the final version is yet to been determined.

    For more information on the Act’s proposals related to estate transfer taxes, read the Trust Bryan Cave blog’s summary of the Act.

    Tuesday, September 19, 2017

    Securities and executive benefits attorneys and public companies that maintain equity incentive plans should be aware of a new theory of recovery under the “short-swing profit rule.” Plaintiffs’ attorneys have recently asserted a new form of claim alleging liability under the short-swing profit rule when shares are withheld to satisfy applicable taxes upon the vesting of awards.

    Overview of the Short-Swing Profit Rule

    The short-swing profit rule generally provides for strict liability of Section 16 insiders (i.e. an executive officer, director or 10% or more shareholder) if they engage in purchases and sales, or sales and purchases, of issuer equity securities within a six-month period that are not exempt under Section 16. Pursuant to Section 16 of the Exchange Act, a suit to recover short-swing profits may be instituted by the issuer or a shareholder in the name and on behalf of the issuer if the issuer fails or refuses to bring suit within 60 days after request. In practice, a plaintiff’s attorney will frequently make a demand on an issuer to seek recovery of short-swing profits after the attorney identifies non-exempt insider purchases and sales of issuer equity securities within a six-month period and, if the issuer does not resolve the issue to the attorney’s satisfaction, the attorney may then bring suit against the insider.  The potential liability to a Section 16 insider is the disgorgement of any profits earned between the purchase and the sale of the subject securities.  While there is no direct liability on the issuer under the short-swing profit rule, plaintiffs’ attorneys frequently seek a fee from the issuer for identifying the transaction creating Section 16 liability.

    New Plaintiffs’ Claims when Shares are withheld to pay Taxes

    The withholding of shares to satisfy the applicable taxes upon vesting of an award under an equity incentive plan is considered a disposition of shares to an issuer and has traditionally been considered exempt from the short-swing profit rule under Exchange Act Rule 16b-3(e) if the plan or award agreement permits such withholding and such plan or agreement has been approved in advance of the transaction by the issuer’s board of directors, a committee of two or more “non-employee directors” (as defined in Rule 16b-3), or an issuer’s shareholders. However, in several recent cases, plaintiffs’ attorneys have claimed that insider or issuer discretion to elect to have shares withheld at the time of vesting of awards (as opposed to the automatic withholding of shares upon vesting of the award) is not exempt under Rule 16b-3(e), and as a result, the executive is subject to liability under the short-swing profit rule.  In one such case, the court summarily rejected the plaintiff’s claims.  Other cases remain pending.  Commentators have suggested that plaintiffs’ new theories are very weak.

    Considerations in response to Plaintiffs’ Claims

    Notwithstanding the lack of success of these new theories to date, issuers should consider taking steps to minimize the risk of these types of claims either by providing for automatic withholding of shares to satisfy applicable taxes in equity plans and award agreements (which issuers may find undesirable or impracticable), or alternatively, having their board of directors or a committee of non-employee directors approve each withholding transaction in advance (which many issuers will also find impractical).  Also, issuers may want to confirm that their forms of award agreements clearly provide for withholding of shares, and that the board or committee clearly approve the use of such forms when making equity grant awards, to ensure that Section 16 prior approval requirements are met.  In any event, issuers may wish to warn their insiders of potential claims resulting from engaging in a withholding transaction and a non-exempt purchase of securities within any six-month period.

    If you or your organization would like more information, please contact your trusted Bryan Cave LLP lawyer or one of Bryan Cave LLP’s corporate finance or executive compensation lawyers.

    The employee benefits and executive compensation team would like to thank Andrew Rodman and Rocio A. Chavez for preparing this blog post.

    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.

    Friday, December 9, 2016

    vote-do-not-useLast month, Institutional Shareholder Services (ISS) published updates to its proxy voting guidelines effective for meetings on or after February 1, 2017.  Key compensation-related changes include the following:

    Non-Employee Director Compensation Programs

    In the case of management proposals seeking shareholder ratification of non-employee director compensation, ISS will review such proposals on a case-by-case basis utilizing the following factors:

    • Amount of director compensation relative to similar companies
    • Existence of problematic pay practices relating to director compensation
    • Director stock ownership guidelines and holding requirements
    • Vesting schedules for equity awards
    • Mix of cash and equity-based compensation
    • Meaningful limits on director compensation
    • Availability of retirement benefits or perquisites
    • Quality of director compensation disclosure

    To the extent the equity plan under which non-employee director grants are awarded is on the ballot, ISS will consider whether it warrants support.  When a plan is determined to be relatively costly, ISS vote recommendations will be case-by-case, looking holistically at all of the factors, rather than requiring that all enumerated factors meet certain minimum criteria.

    Equity Plan Scorecard

    Proposals to approve or amend stock option plans, restricted stock plans and omnibus stock incentive plans for employees and/or employees and directors are evaluated using an equity plan scorecard (EPSC) approach.  For 2017, ISS has made the following changes to the EPSC:

    • Addition of New Dividends Payment Factor. Full points will be earned only if the equity plan explicitly prohibits, with respect to all award types, the payment of dividends prior to the vesting of the underlying award.  However, accrual of dividends for payment upon vesting is acceptable.  If such prohibition is not set forth in the equity plan or is incomplete, no points will be awarded.
    • Modification of Minimum Vesting Factor. The equity plan must specify a minimum vesting period of at least one year for all types of awards in order to earn the full points.  Plan provision permitting the reduction or elimination of the one-year vesting requirement under an individual award agreement will result in no earned points.

    Additional information regarding the updates to the EPSC policy is expected in the ISS Equity Compensation Plans FAQ scheduled to be published later this month.

    Amendments to Cash and Equity Incentive Plans

    The ISS clarified that it will vote for proposals to amend executive cash, stock or cash and stock incentive plans if the proposal (i) is only to address administrative features or (ii) seeks approval for Code section 162(m) purposes only and the committee administering the plan consists entirely of independent outsiders.

    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.