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Is a PTO Bank Nonqualified Deferred Compensation?


Guest djw

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Employer maintains a Paid Time Off Bank. Employees are credited with X PTO days annually to be used for vacation, illness, etc. Any days credited but not used during the year are carried forward to future year(s) and may be used at the choosing of the employee. When an employee terminates employement, the accumulated PTO value is paid (I'm not sure if it's paid at 50% or 100%, but a significant percentage of accumualted PTO will be paid and not forfeited). I realize that there are 409A exceptions for bona fide illness pay and vacation pay arrangements, but the cash out at termination of employment does not appear to fit into those categories. To me, it appears to be a nonqualified deferred compensation arrangement. Do you agree? If it is nonqualified deferred compensation, does receiving the income as vacation or sick pay (if taken as such) while employed result in impermissible acceleration? Thank you for your comments.

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I think it is 409A deferred comp--rights earned in one year but payable at least possibly in later years. I think the program should be documented in a way to comply with 409A by 12/31/2009.

I think if the only way to get use of the PTO bank hours before employment termination is to be sick and otherwise not entitled to pay, then it would seem to be a bona fide illness plan.

If part or all of the PTO bank hours can be cashed out sooner, such as merely on application to the extent that the hours exceed a certain number or for hardships defined more broadly than 'unforeseeable emergencies' as defined in the 409A regs, then I think you've got a 409A tax problem.

If the program is too broad now, but you plan to tighten it up incident to 409A document requirements, you might have a problem to the extent you attempt to restrict amounts currently accessible.

You should consult an attorney knowledgeable with 409A and the regs.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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IRC Section 409A does not apply if "the plan provides bona fide vacation leave, sick leave, [or] compensatory time". 1.409A-1(a)(5). IRC Section 457(e)(11)(A)(i) similarly treats "Any bona fide vacation leave, sick leave, [or] compensatory time . . . plan" as not deferring compensation. The examples at 1.457-4(d)(1) indicate that at least some sick leave and vacation leave plans allowing accumulated leave to be cashed out provide bona fide leave. The IRS CPE publication here http://www.irs.gov/pub/irs-tege/chap601.pdf discusses (without much help) whether a leave plan is bona fide.

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In response to the 409A regs in proposed form, many practitioners asked the IRS to include a definition of bona fide sick leave and vacation leave, and asked about 'borrowing' from the 457 regs. Early indication was the IRS would provide a definition in the final 409A regs. Nevertheless, the IRS did not do so when it finalized the regulations.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Below is some relevant IRS guidance:

72 Federal Register at 19234:

"Several commentators requested clarification of when a leave program will be treated as a bona fide sick leave or vacation leave plan for purposes of section 409A. Another commentator requested a clarification of the definition of a compensatory time plan. Because the definitions of these terms may raise issues and require coordination with the provisions of section 451, section 125, and, with respect to certain taxpayers, section 457, the final regulations do not address these issues.

"Notice 2005–1, Q&A–6 provides that, until further guidance, taxpayers whose participation in a nonqualified deferred compensation plan would be subject to section 457(f) may rely on the definitions of bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan applicable for purposes of section 457(f) as also being applicable for purposes of section 409A. Until further guidance, such taxpayers may continue to rely on such definitions for purposes of section 409A."

72 Federal Register at 19275:

"Notice 2005–1, 2005–1 CB 274, is obsoleted for taxable years beginning on or after January 1, 2008, except for the following sections of the guidance which remain effective as modified by any other applicable guidance: Q&A–6 (application to arrangements covered by section 457) . . . ."

Notice 2007–86, Section 4:

"Notice 2005–1 is obsoleted only for taxable years beginning on or after January 1, 2009, except for the following sections of Notice 2005–1, which remain effective after that date as modified by any other applicable guidance: Q&A–6 (application to arrangements covered by section 457) . . . ."

Notice 2005-1, Q&A-6:

"Further, pending additional guidance, State and local government and tax exempt entities may rely on the definitions of bona fide vacation leave, sick leave, compensatory time, disability pay, and death benefit plans for purposes of § 457(f) as applicable for purposes of applying § 409A to nonqualified deferred compensation plans under § 457(f)."

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Everett,

Is there an implication that because there was specific mention of the 457 definition applying to 457f plans subject to 409A that the 457 definition does not apply to the more common plans subject to 409A, i.e., those that are not also subject to 457f?

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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J Simmons:

The IRS guidance could be read to make that implication. Perhaps with too much optimism, you could also read the IRS statement at 72 Federal Register 19234 about coordinating guidance under 409A with guidance under 451, 125, and 457 as indicating that IRS guidance under 409A will follow the 457 regulations as to whether a bona fide leave plan can include a provision allowing leave to be cashed out.

My perspective might be skewed from familiarity with governmental leave plans that allow leave to be cashed out, but I think the IRS would have given some warning if a leave plan by a taxable employer could not include a reasonable cash-out provision without complying with 409A. I've worked on the assumption that a reasonable leave cash-out provision need not comply with 409A. If I'm wrong I want to know.

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Hey, Everett,

I don't know that you are wrong--or right. As is so often voiced on this board, it would be nice to have definitive IRS guidance. In the absence of guidance, then, it is a matter of how comfortable you can be that your plan is 'bona fide', whatever that might eventually be defined to be.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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  • 2 months later...

I believe a question I asked recently on the board mirrors this thread. I agree with Everett Moreland's take. To add another question to this scenerio, what if the employee's are able to decide (request) when to take the accumulated value? The employee can take the accumulated value in lump-sum immediately or request to receive the payment in the next calendar year. How does this, if at all, affect the situation regarding 409A? Typically what I have seen is the employer mandates when the employee takes the payment instead of the employee getting a choice. Does this matter?

Benjamin Smith

Senior Manager - Indirect Tax

Ernst & Young

317.681.7495

Benjamin.Smith@ey.com

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If the payment is made after the end of the year in which the services earning the right to that pay were performed, you need to analyze for 409A implications and likely have a document that conforms to 409A. If there is any discretion by the employee or even the employer as to the timing, such may only be exercised in ways comporting with the 409A regs, or you face the 20% extra tax.

There is an exception for bona fide vacation pay plans, but no definition is provided even though such was requested by practitioners while the regulations were pending in their proposed state.

Caution suggests having a 409A-compliant plan document even if neither the employer or the employee has discretion over the timing, e.g. unused vacation pay will be cashed out for everyone upon termination of employment.

Discretion by the employee to take the previously earned vacation pay in a year after earned but before termination would require compliance with the 409A election rules, unless you are confident that the arrangement is a bona fide vacation pay plan (keep in mind, the IRS has not yet defined that). In speaking with HR directors, that type of flexibility is relatively new in vacation pay plans--so that feature might of itself blow the arrangement out of the ambit of 'bona fide vacation pay plan'.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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  • 1 month later...
I think it is 409A deferred comp--rights earned in one year but payable at least possibly in later years. I think the program should be documented in a way to comply with 409A by 12/31/2009.

Why 12/31/09?

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I suppose a typo. Four months plus after posting, can't say whether my intent on April 6 was "1/1/2009" or "12/31/2008".

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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