Jump to content
Sign in to follow this  
401 Chaos

Choice of "Severance" Benefits

Recommended Posts

Would be interested in others' thoughts on this under 409A.

University leader has employment agreement that provides the individual the ability to select, at the time of termination, between the following "severance" benefits if involuntarily terminated:

1. traditional severance benefits of 12 months current salary paid out on a fixed schedule, or

2. ability to retreat to her tenured faculty position in separate department (with guaranteed research leave) at a fixed salary rate

I know the traditional severance benefits are potentially subject to 409A although they may qualify for the separation pay exception. My bigger question is how to think of the retreat to the tenured position and the research leave and, in partiuclar, the fact that the severance benefits are not set at the time the employment agreement was executed but instead gives the employee the ability to make that election at a later date.

Seems the discretion and lack of fixed benefits could be a problem. Any argument that deciding between true severance benefits and the ability for continued employment (albeit with a different department / employer) may be distinguishable? Thanks.

Share this post


Link to post
Share on other sites

You are describing a choice between severance benefits or employment. One of those is subject to 409A, the other is not. Since the choice is unknown presently, it is subject to 409A. The severance pay is clearly not currently vested (and therefore not currently taxable to the employee). However, it would become vested as of the involuntary termination date, thereby making the one year's salary continuation immediately taxable (except to the extent that the short-term deferral rules would exclude payments through the end of the year of termination).

The agreement should be reformed in such a way as to comply with 409A. Perhaps all severance payments could be paid under the short-term deferral exception. Or perhaps the choice should be modified to an automatic position within the department, with a deferred compensation piece attached to the new contract.

In any event the university's attorneys must already be reviewing all compensation for 409A compliance; they should review this situation also.

Share this post


Link to post
Share on other sites

Thanks Vebaguru.

Part of my concern even if the severance benefits were changed to encure payout within the short-term deferral exception so as to basically be exempt from 409A rather than comply is the notion of the choice between that and the employment which includes a paid research leave that appears to be very much akin to a sabbatical. I suppose it's a facts and circumstances issue as to how to think about the post-employment sabbatical and whether she has to perform substantial services in order to get those amounts but the fact that might be one alternative makes me uncomfortable. Perhaps they could pay the research leave amounts out within short-term deferral exception as well if they really want to retain her ability to chose at time of termination. Thanks.

Share this post


Link to post
Share on other sites

I think that with the payout choices you described, you won't have an SRF, so you aren't going to be able to meet the short term deferral rule. You either have to restructure this as a 409A-exempt arrangement (meet the involuntary/good reason termination and the 2X pay/24 month rules) or you can leave the choices as they are and comply with 409A.

Your OP seems to decribe a legally binding right to compensation in one year with a payment right that may extend beyond the short term deferral exeption. You might be able to create a SRF by clearly making payment conditioned on one or the other event; then you will have to make sure the money is timely paid out after the first condition lapses. So it seems that you could provide for payment on the earlier of the 2 conditions and then either meet the short term deferral rule or set forth the payment terms that apply upon each condition. We are all lucky that the transition rule is still in effect. After 1/1/08 agreements like this will blow things up.

Share this post


Link to post
Share on other sites

Steeler,

Thanks. My brian is fried so I'm not immediately understanding your SRF comment. Appears individual's current salary is above $450,000 so wouldn't be able to get full severance and fit within the separation pay exception. I think that leaves trying to comply with 409A. I read your comment to suggest that you could leave current choices as they are and comply. I'm having a hard time figuring out how to do that but still allow the employee to retain a choice as to which option to take. How would you suggest leaving choices as they are but still be guaranteed of set form, manner, timing of payment. Thanks.

Steeler, I see you have expanded on your original post while I was responding. Let me consider your additional comments. Thanks.

Share this post


Link to post
Share on other sites

You can't really leave the choices as they are and comply with 409A per se since employment is not an permitted payment event. But it could be a condition that either imposes an SRF or provides that no legally binding right exists prior to the employment or research leave. In that case you can set the payment date and terms at the time the LBR attaches or the SRF is lifted. I can't see why that wouldn't work, but it could cause some heartburn wondering if the IRS agrees.

Share this post


Link to post
Share on other sites

Let me revise what I said in the second sentence above. From a technical perspective, if the second choice in OP is made to be condition that is a valid SRF, you should have the payment terms set forth in the employment agreement, since that is presumably when the legally binding right occurs. So the agreement could provide that when the earliest vesting condition occurs (i.e. retreat to tenured employment), the right vests and fixed salary payments shall begin immediately thereafter. See Reg 1.409A-3(i) You are not locked into the short term deferral rule. The problem is that you must accept payment when the first condition lapses, so if you take tenured employment, you can't defer to termination of employment. Some flexibility is lost.

The alternative seems unworkable, but could preserve "choice." You could "take away" the employee's right to the payment upon tenured employoment and create the LBR when the event occurs, then set the payment terms. The employee would likely have to consent to this. In that case you would have more of a plain vanilla severance plan. Then if the employee takes tenured employment he could "elect" to take payment at separation of service by virtue of not having a LBR to payment. BTW you can still utilize the severance exception for amounts up to 450,000.

Share this post


Link to post
Share on other sites

I'm confused as to why this is an issue at all. Why can't this be analyzed as a simple separation pay plan? The compensation paid if the university leader stays on is a red herring. The compensation paid to him or her for the new position is not deferred compensation at all; rather it is compensation for performing services as a tenured faculty member.

Can't it be looked at as a termination for "good reason" due to the material diminution in the leader's authority, etc?

Share this post


Link to post
Share on other sites

The problem as I saw it was that the agreement makes a promise to pay money in the future. That is classic deferred compensation. What makes it odd is that it promises to pay an amount if the employee takes a different job, but also if they involuntarily terminate. So there is a choice as to when payment will be made, except that one of the events is not 409A compliant. But even if it were, I still think you'd have an issue--you would have to decide on one of the two at the time the agreement is executed. If nothing were done, I think you could have an accelerated payment problem, as well as plan document compliance issues. If the agreement provided for salary-type payments to begin on the earlier of involuntary termination or June 1, 2010, I don't think there would be any major issues.

I thought about that good reason angle, but I think 409A requires an actual termination from service within one year of the qualifying condition, I don't think it's a constructive discharge provision. A one-year leave or sabbatical with a right to reemployment would not be a separation from service.

I thought this was a strange situation myself in that the agreement considers a tenured position as a termination. Tenure is a coveted prize these days.

Share this post


Link to post
Share on other sites

I don't think there is a "promise" to pay more in the deferred compensation sense. Why isn't this any different than the university telling the leader, "we can either fire you, or you can work, for $10/hour, as a cleaning person? The leader doesn't have a right to the $10/hour when he/she takes the position in lieu of being involuntarily terminated; he/she has a right to $10 upon working one hour.

I realize that a tenured position is more secure than a cleaning person's, but the principle is the same: The individual has to work to get paid. There is no severance or other payment upon taking the other position.

What am I missing here?

Share this post


Link to post
Share on other sites

Folks, I'm not sure I'm following everyone here but let me add a couple of additional facts.

First, this particular agreement views the tenured position as a "termination" or severance option for a couple of reasons. One, the tenured position would very likely be for a significant reduction in salary. Second, although the individual's current position is a university-affiliated position, it is with a separate legal entity from the University itself. I agree there is some confusion as to whether such a return to a different but related employer would constitute a separation from service under 409A but I can see a pretty good argument that a separation from service would have occured notwithstanding continued employment.

Second, the return to the tenured position and the compensation she would receive for ongoing services there do not worry me as much as does the guaranteed research leave aspect of the arrangement. I had seen some earlier discussions or indications under 409A that certain sabbaticals might be viewed as deferred comp. If a sabbatical or research leave were to essentially promise pay without having to provide substantial services during the period or really do anything afterwords (i.e., no work and pay), that seems to me to be a real potential deferred compensation issue. Add to that a research leave tagged on post-employment and I think the Service has some reason to be concerned that these might be used to get around 409A if they were broadly exempted. Consider here it would not only be a post-employment leave (again with a separate albeit somewhat slightly related entity) and that it is an alternative severance option and I have a hard time thinking there is no potential 409A concern. (Of course, if an individual were to plan on not following through with the tenured position, it wouldn't really make sense to take the research leave at a lower pay rate versus the 12 months severance. But if they wanted sort of partial severance / research leave plus ability to continue along on faculty for a bit, I could see chosing that option over a clear severance.)

At any rate, it seems to me that the current contract presently provides her a legally binding right to either of these two packages, albeit an unvested or contingent right. At the time of involuntary termination, she will have to make a decision and so then will have a vested right in whatever path she choses. It is not all that clear to me under 409A-3(i) that having her choice as to which package to take (even if the payment terms under each are explicitly fixed and detailed in compliance with 409A) would work. The very fact that there is a choice seems to me to be a potential problem if you view the amounts as being deferred upon execution of the agreement and creation of the LBR rather than the involuntary termination vesting date.

Share this post


Link to post
Share on other sites

The agreement may consider a return to tenured employment an involuntary termination, but 409A would not recognize it as such unless she actually separates. I'm totally confused by the second paragraph. Post-employment leave--what is that? If a person is on leave and they have a right to reemployement, I don't think they are separated from service. I not aware of paid leave being deferred compensation. If the person doesn't separate from service, I think my previous posts suggest the only other ways to get her paid while she continues to work.

There might be a simple solution to this that I can't see, but I would venture a good guess that 409A was as much a thought when this agreement was drafted as you were when you were concieved by your parents. You say "At the time of involuntary termination, she will have to make a decision and so then will have a vested right in whatever path she choses." It is not even clear that she will be terminated, let alone involuntarily. But only that she will have a choice to take a different job. That choice makes the termination voluntary and thus not subject to SRF. therefore she has a vested right already. That's why short term deferral won't work (see my first post). It seems to me this is the issue that has to be cleared up. The employer should make the decision--she's either fired or or she can take the tenured job. If you give the employee the choice, its voluntary and 409A will kill you because you have not complied.

If I'm right, then you cannot provide the package the way it was initially contemplated by the parties. 409A has taken away a lot of arrangement flexibility and this could be a casualty.

Share this post


Link to post
Share on other sites

Steelerfan,

Thanks for your thoughts. I don't disagree that this type arrangement may be a casulty of 409A and appreciate your thougths. I was under the impression these particular provisions were pretty common in university settings and so was hopeful others may have figured an easy alternative but I am not hearing one.

As to post-employment leave, I simply meant paid leave without having to perform significant services. My reading of the definition of separation from service under 409A suggests that you could definitely have a separation from service even though your employment / pay continued for a sabbatical or leave period if the facts and circumstances never contemplated having the individual render any meaningful services to the service provider. I agree though that may not really be the case here since the various employers are all related but was trying to find some additional comfort that a separation from employment would not be considered to have occurred. Although the current employer offers up the retreat as an option in lieu of severance, it is contingent on the individual having retained her tenured position with the other employer so, I guess you might argue that the main employer cannot absolutely guarantee the availability of the tenured position. Thanks again.

Share this post


Link to post
Share on other sites

I agree that if, in the new position, the former leader would not be performing substantial services, the amounts would be deferred compensation. I just assumed that his/her new position would require such services.

Share this post


Link to post
Share on other sites
I agree that if, in the new position, the former leader would not be performing substantial services, the amounts would be deferred compensation. I just assumed that his/her new position would require such services.

How does this fact turn "regular " compensation into deferred compensation? The regulations don't hinge on how substantial services are--the IRS doesn't visit us at work to see if we sit around all day or actually work. Wouldn't this fact only be relevant if you were trying to establish a SRF?

Share this post


Link to post
Share on other sites

I guess the phrase I should have used is "bona fide services" used in the definition of "Termination of employment" at 1.409A-1(h)(1)(ii). Putting aside what the definition of the "level" of performing services is, if he or she is working over 50% of the level worked at before switching jobs, there is no termination of employment. I guess I agree that you can look at it as if there is a SRF because he or she is required to perform substantial services in order to receive the compensation, but I go back to my cleaning person example and don't think it is necessary to look at it that way. Do you think that every time an employer gives an employee the option of terminating employment or changing positions, if the employee chooses the latter, there is deferred compensation and a 409A issue?

Share this post


Link to post
Share on other sites

Do you think that every time an employer gives an employee the option of terminating employment or changing positions, if the employee chooses the latter, there is deferred compensation and a 409A issue?

Not in the average circumstance. But in the OP there is an employment agreement with reference to payment on termination. You can bet that where a promise is made in an employment agreement, 409A will rear its ugly head, even if it's just to make sure it doesn't apply. In this case I thought it did.

Share this post


Link to post
Share on other sites

I also agree it wouldn't apply in all (or even most) cases.

Maybe I'm overly paranoid, but I do think that it could be a concern though if an agreement provides an employee a choice among the following severance benefits upon an involuntary termination: (1) severance pay equal to twice an employee's monthly base pay at time of termination for each year employed by employer; or (2) X amount of dollars without having to perform any services plus the right to earn additional salary for future employment with another, marginally related employer.

I think the above is very similar to the benefits being offered in my OP. It will inherently be a facts and circumstances test but I think sabbaticals or research leaves following resignation of one post are often structured so that the individual gets to take an immediate leave and receive pay without any expectation of having to perform any services while on leave. That seems very much like severance pay to me--just labeled something else. Different arrangements no doubt will work differently but I believe under many such policies in the past an employee could select the sabbatical / research leave option, collect payment for a year, never provide any services to their most recent employer (or anybody else), and then resign "employment" at the end of the leave without having to pay any amounts back or work in the tenured position for any length of time. Again, maybe I'm overly paranoid but that seems potentially abusive in a way that may raise eyebrows at the Service if one were to try and argue that the leave payments were for bona fide services or otherwise escaped 409A.

Share this post


Link to post
Share on other sites

I'm not sure why you think you are paranoid. the definition of deferred comp in the regs virtually covers the universe of payments that aren't either excluded expressly or made immediately/within the short term deferral period. It's not paranoia, it's reality!

Share this post


Link to post
Share on other sites

Well, "reality" unfortunately is one word for it. I could think of a few others as well. :angry:

Thanks again to everybody for their thoughts.

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

×
×
  • Create New...