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Can You Change Payment Terms of Otherwise Exempt Severance Benefits?


401 Chaos

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Situtation is this: Employer and employee entered into an employment agreement in 2008 which provides for 12 months of salary continuation paid in substantially equal payroll installments if employee is involuntarily terminated. Severance amounts are based on base pay immediately prior to termination. So, under the terms of the employment agreement, the severance benefits most likely will qualify for an exemption from 409A under the 2 times pay / involuntary termination provision; however, an exemption is not guaranteed because the final salary / severance amounts are not known until termination. (Also, while it is possible that all severance benefits will be paid prior to 2 1/2 months after end of year in which termination occurs, that is not required so the agreement does not ensure short-term deferral exemption.)

Employer is now terminating employee. Employer wants to change / enhance severance terms slightly by basically permitting employee to choose as part of the separation agreement whether to receive the 12 months of severance in regular installments or receive an immediate lump sum amount. As it turns out, the employee's current salary is $250,000 so well below maximum amount to qualify for two times involuntary pay exception.

Is there a concern that amending the severance provisions under the existing employment agreement could be construed as an impermissible acceleration or substitution of an existing deferred compensation arrangement where all the beenfits will qualify for the 2 times pay exception under 409A anyway? (If the original agreement somehow ensured that the payouts would have in all cases been exempt from 409A--say if it had required payment in all cases within the short-term deferral period--I would not worry as that would have presumably escaped regulation under 409A but here the severance provision seem to provide for deferred compensation arrangement subject to 409A (although possible that it may qualify for an exception depending on actual numbers). Any thoughts would be appreciated.

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Guest George Chimento

-- Is there a concern that amending the severance provisions under the existing employment agreement could be construed as an impermissible acceleration or substitution of an existing deferred compensation arrangement where all the beenfits will qualify for the 2 times pay exception under 409A anyway? --

There is a constructive receipt issue, but I assume you know that. The 409A question is a good one.

You do not have a “non-qualified deferred compensation plan” because your plan is not considered to provide for a deferral of compensation, due to the 2 / 2 severance plan exception. Accordingly, the acceleration and postponement elections you are granting do not violate 409A, which only applies to non-qualified deferred compensation plans.

I was concerned about the special deferral rule in 1.409A-2(a)(11) for separation pay. That rule cross-references the broad definition of separation pay in 1.409A-1(m), which is without regard to the 2 / 2 and other exceptions. That special deferral rule says that it is not necessary to make a deferral choice before starting services (in the case of separation pay), but the choice cannot be changed after the legally binding right -- the written agreement in your case -- is established. See Example 11.

However, example 11 (and 12) are each based on plans that do not fall within the 2 /2 exception, so I don’t think they intended to prevent renegotiation of 2/2 severance arrangements after the date of the legally binding right. I wish they had included a specific example for a 2 /2 separation pay plan, because this is the situation we are more likely to see.

So, I think you do have constructive receipt concerns, but not a 409A problem if the structured arrangement stays in the 2 / 2 exception. Don’t take it to the bank. This is just friendly and non-binding advice. Another interpretation would be to say that a renegotiation after the legally binding right is an impermissible deferral of compensation. I hope others contribute to the discussion.

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  • 3 months later...

Just wondering if anybody has any additional thoughts or guidance on this issue.

I actually have another similar question that seems to raise some of the same concerns. In this case, employment agreement provides that individual will be entitled to reimbursement of continuation coverage premiums under group health plan upon involuntary termination for severance period of 6 months. As a result, I think the original arrangement / reimbursement plan approach would be exempt from 409A under special rule permitting reimbursement of group health expenses for up to maximum COBRA period. Both parties would now prefer to change the COBRA reimbursement to a straight lump-sum cash payment that would approximate the amount to be paid for COBRA reimbursements but the employee would not be obligated to use it for COBRA or any other medical expenses--can use it for whatever they want and will be taxed on it just like additional cash severance amount (which it is). Because the new payment will be paid in a lump sum at termination / separation from service, that arrangement itself would not provide for a deferral--i.e., it would be paid out within short-term deferral exemption period. Does completely ignoring old employment agreement provision for reimbursement of continuation coverage raise 409A issues here. The switch seems to me to be one of swapping one previously 409A exempt benefit / right for a new 409A exempt benefit. Thanks.

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