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Guest mbw

Consulting Agreement

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Guest mbw

An executive (is a key employee) voluntarily terminates employment. The company enters into a consulting agreement whereby the executive gets a substantial monthly payment to provide consulting services if the company requests (which is capped each month at less than a weeks worth of time). I have already dealt with the concern whether the obligation to simply be available to consult but still get paid without consulting is a substantial risk of forfeiture. Let's assume the facts show that it is not, so the consulting compensation is deferred compensation. If the agreement is entered into after the executive terminates what are your thoughts on the specified employee delay? The delay applies to payments "on account of" separation. The executive was clearly a specified employee on the date of separation. The guidance is otherwise unclear. Seems as though the delay would apply. Thoughts?

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Looks like you need to be sure a separation from service has even ocurred. These scenarios always concern me. He'll probably do about as much work as he did when he was an employee.

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Guest mbw
Looks like you need to be sure a separation from service has even ocurred. These scenarios always concern me. He'll probably do about as much work as he did when he was an employee.

The hours are capped monthly, and the cap equals less than a weeks worth of work.

I'm not overly concerned about whether there is a separation in that sense because this is a post-termination agreement. He is not getting something to which he was previously entited becuase of a separation.

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Guest CABatty
I'm not overly concerned about whether there is a separation in that sense because this is a post-termination agreement. He is not getting something to which he was previously entited becuase of a separation.

First, generally, I agree with Steelerfan, situations like this need to be carefully considered to determine whether a separation from service has occurred. One week of work per month = 25% of the month.....did the exec's employment agreement specify a higher-than-20% level for separation from service?

Second, if it's a post-termination agreement that is not paying deferred compensation upon the Exec's separation from service, why would the 6 month delay even apply? 1.409A-3(i)(2) states that the six month delay applies to a "payment upon a separation from service." If you're saying this is a new agreement that was created after he quit (presumably the time when the legally binding right arose) then it doesn't seem like it's a payment of deferred compensation upon a separation from service.

That said, would this be considered a post-termination agreement in substitution for deferred compensation? If it's a substantial monthly payment for not a lot of services, would the IRS see this as disguised deferred compensation?

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That said, would this be considered a post-termination agreement in substitution for deferred compensation? If it's a substantial monthly payment for not a lot of services, would the IRS see this as disguised deferred compensation?

You have to wonder about that; employer's, not being used to the constraints of 409A, seem to be operating under the assumption that they can still just renegotiate prior agreements and change the payout timing or form without regard to whether 409A would consider the new agreement a substitute and thus cause a vialation.

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Guest mbw

I agree there are concerns. As for CABatty, I agree that if it is not deferred comp, there isn't a specified employee delay...hence the reason I said to assume there is no substantial risk of forfeiture. However, if it is deferred comp, even if it is entered into post-termination, isn't there an argument that the comp is "on account of" termination. He wouldn't get the consulting fee if he was still an employee.

I'm confused why we need to determine if there has been a separation from service. Why does that matter here? He is not getting a prior promised payment because of his separation. This is a new amount after his termination and it does not substitute for any other deferred comp. Are you saying that if there is no separation, he is still an employee so a simple reduction in his hours still subjects the consulting compensation to a substantial risk of forfeiture? What about the fact that he only has to be available to consult if the company requests? He gets paid for doing no work if the company doesn't request. So, that brings me back to my original post, assume that getting paid to be available is not a substantial risk of forfeiture even if he has to be available for 20% or more of the time. Wouldn't you think a post-termination agreement can be "on account of" termination and subject to the specified employee delay?

Thanks much for discussing this and your thoughts.

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Guest CABatty
As for CABatty, I agree that if it is not deferred comp, there isn't a specified employee delay...hence the reason I said to assume there is no substantial risk of forfeiture.

mbw: I think you've got to start at the beginning of the analysis, before a substantial risk of forfeiture even comes into play. The determination of whether the arrangement provides for the deferral of compensation has nothing to do with a substantial risk of forfeiture. The regs define a deferral of compensation as existing if the service provider has a legally binding right to compensation in one taxable year but the compensation is not paid until a later taxable year. A substantial risk of forfeiture comes into play when determining if the payment fits within the short-term deferral rule.

Thus, for this situation where you've stated that the exec had no right to this compensation prior to entering into this agreement, the legally binding right arises when the exec and the company enter into the consulting agreement. The consulting agreement, from what you've described, is compensation for services performed (the one-week availability) during the duration of the agreement - essentially, a "base salary" for the exec for his consulting services. That, in and of itself, is not deferred compensation. The 409A regs are broad, but not that broad. Does the agreement also provide for a severance payment if the agreement is terminated early, or provide that the compensation is accrued and paid at the end of the agreement? That could raise issues....

As you've described the agreement, seems to me like it's not deferred compensation.

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Guest mbw
As you've described the agreement, seems to me like it's not deferred compensation.

Interesting. I appreciate your view. It is partly convincing...I'm just not sure if I'm completely there yet. Maybe 409A is making me overanalyze this.

It is clear that the promise to pay someone compensation for the next two years is a legally binding right to compensation that is or may be payable in the future...i.e. deferred compensation. Thus, it implicates 409A and must comply with 409A unless there is an exception. I skipped over this part because I thought it was the obvious part but you seem to disagree. I would appreciate your thoughts on why this is not deferred compensation.

One exception is the STD exception...which applies to regular you-work-I-pay-you arrangements. If this was an arrangement where the consultant got a substantial sum of money after consulting for the month, I might see your point. But this is an arrangement where the consultant gets the substantial sum of money simply to be available. He gets paid even if he does not consult. Hence the reason I raise the substantial risk of forfeiture...it does not seem to be a substantial risk of forfeiture within the STD rule and this exception does not apply. As I am not aware of any other exception...it must comply with 409A.

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The consulting agreement, from what you've described, is compensation for services performed (the one-week availability) during the duration of the agreement - essentially, a "base salary" for the exec for his consulting services. That, in and of itself, is not deferred compensation. The 409A regs are broad, but not that broad.

As you've described the agreement, seems to me like it's not deferred compensation.

Not sure I agree. I look at these consulting agreements as agreements for a term. In the normal situation of salary, there is an at will relationship to pay ongoing as the money is earned. But in a contract for a term with payments that go beyond the STD period there is a legally binding right to comp beyond the 2.5 months. Albeit complying with 409A is easy, all you have to do state how payment will be made, such as in accordance with the compnayies normal payroll practice, monthly, etc.

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Guest CABatty

mbw and Steelerfan - you raise interesting points...

For the original question - whether the payment would be subject to the 6 month delay rule....I think we all agree that the legally binding right arises when the consulting agreement is entered into, after the executive's separation from service.

My opinion is that, since the legally binding right to the compensation arose after the separation from service, the 6 month delay rule doesn't apply. Separation from service is a payment event of compensation that has already been deferred. Since the consulting agreement didn't exist at the time of separation from service, then there wasn't any deferred compensation to be paid under the consulting agreement upon his separation from service. I think the only issue here, assuming any deferred comp the exec is otherwise entitled to is in compliance with 409A, is whether the agreement is an extension or modification of an existing agreement, which I believe mbw has said is not an issue.

Now, if I'm reading the last two posts correctly, Steelerfan and mbw - you guys seem to be saying that, if an executive has an employment agreement with a set term, then the promise to pay the executive his base salary for that term is deferral of compensation, even if the agreement could be terminated by either party at any time and the base salary for the remaining term is not required to be paid. An employment agreement that provided that the exec received $xxxx amount annually, without specifying when it is paid, would be in violation of 409A. Fair assessment??

....I think I may have to agree with you. I'll have to think about it some more but right now I got nothing...

But this is an arrangement where the consultant gets the substantial sum of money simply to be available. He gets paid even if he does not consult.

Does he get paid if he's not available for consulting? In other words, if he takes another job, does he still get paid? I don't have my regs with me - does refraining from taking a job constitute a substantial risk of forfeiture? If not, then probably yes the STD exception doesn't apply, and 409A must be complied with. But, as explained above, I don't think the 6 month delay is one of the 409A rules that has to be complied with at this time.

ka-peesh??? thoughts??? opinions???

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Now, if I'm reading the last two posts correctly, Steelerfan and mbw - you guys seem to be saying that, if an executive has an employment agreement with a set term, then the promise to pay the executive his base salary for that term is deferral of compensation, even if the agreement could be terminated by either party at any time and the base salary for the remaining term is not required to be paid. An employment agreement that provided that the exec received $xxxx amount annually, without specifying when it is paid, would be in violation of 409A. Fair assessment??

Not exactly, but stating how the salary will be paid in such instances is smart.

Many of the "consulting" agreements I've seen (including the one described here) seem to be little more than excuses to pay an exec some money or in other cases an attempt to keep an executive who doesn't really want to be around full time. But in these cases, there is often a "guaranteed" payment involved. No matter what happens, he's gettin paid. It looks like salary, but it's guaranteed like a bonus, only payable in installments that look like salary. This is common after a CIC. The consulting agreement adds an air of authenticity as though the executive is earning the money. In these types of agreements, I think 409A should apply. For example, the executive should not be able to go back to the employer and say, lets call this off and just pay me the rest of what you owe me now and we'll part ways.

In your example above, that looks more like a statement of the base salary payable as long as the executive performs--that doesm't look like deferred comp to me.

I agree with mbw that simply being available to work doesn't create an SRF. 409A does not recognize forbearance of working as an SRF (as does section 83) Good question tho, what happens if he takes another job, will the employer stop paying?

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Guest mbw
Good question tho, what happens if he takes another job, will the employer stop paying?

The agreement provides that it will be terminated if the exec wants to terminate it or if the exec breaches the agreement. So it seems to me that if he does not show up to consult when asked he could potentially get nothing more. While this may make it more like a SRF I don't think the risk is substantial. You can probably make an argument it is but I am not comfortable with the position. Especially since this will be scrutinized after the fact. And we all know how it will end...exec will get 24 months of essentially continued salary and maybe will put in some hours but probably not a lot and probably not any some (or several) months. Now even if this is deferred comp, it complies (setting aside the spec ee delay for a minute) because it is paid under a fixed schedule.

However, back to the spec ee delay, does the agreement comply if there is no delay? I agree that this is paid only after termination but the spec ee rules could arguably be not that narrow as I read them...delay applies to any payment "upon" a termination. This seems broad. I acknowledge that the purpose of the delay is essentially to prevent an exec from taking his money and running when the company is sinking and the particular facts don't seem to fit within that purpose. So perhaps interpreting a payment "upon" a separation means that the payment rights exists prior to the separation. In my opinion, the solution is to draft the agreement to break the payments into two amounts. The first "set" of payments fit within the STD period so that they spread through the six-month delay (and hence no real delay) and the second "set" pays the rest. But this takes us back to prior postings debating the issue of breaking up payments.

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I wouldn't try to argue SRF since this agreement doens't require the substantial performance of services to obtain the amount, which is the 409A standard.

Part of the reason why determining if a separation from service has ocurred would be helpful is that if he has truly separated as an employee then he cannot currently be a specified employee and therefore whether these payments could be considered to be made upon separation would only matter if the IRS has reason to believe you are trying to get around the 6 mo. delay rule. That said I think it's a stretch to argue that these payments could be subject to the six month delay rule on the theory that he was a specified employee when he separated and these payments could be considered payments due to that separation. If you are looking for some more assurance, I agree with CAbatty that if the legally binding right is created while the executive is an independent contractor, these payments would not be subject to the 6 mo delay rule. The way I understand the 409A scheme, is that a payment upon separation means the payment event is the separation and that a previously earned amount is being paid. In your example, the payment event is not separation, they are merely payments made under a set time and form. But I like the idea of using the STD rule when in doubt.

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