Base Salary - Employment Agreement

[Guest shaul]

Assume an employer enters into an employment agreement with an executive that is adopted January 1 of Year One. It promises the executive an annual base salary of $200,000 for each of Year One, Two, Three and Four. It does not mention the employer's right to pay less, or to reduce the salary, in its discretion (although it retains the right to terminate him without cause).

1.) Does that promise constitute, as of January 1 of Year One, a "legally binding right" to $200,000 annually with respect to Years Two - Four? The regulations provide that a right is not legally binding if the employer can unilaterally reduce the related compensation after the employee has performed the required services - - - that does not seem to apply here (i.e., the employer could not reduce the compensation once the employee had performed the services in Years One - Four).

2.) If it constitutes a legally binding right, does that mean the employer cannot decide, for example, to pay the executive only $100,000 in Year Two, while shifting the resulting $100,000 shortfall to Year Three (i.e., paying $300,000 in Year Three)? Would that constitute an impermissible re-deferral?

Thanks.

[jpod]

Why do you think there is any "deferred compensation" here subject to 409A?

[Guest shaul]

I'm not sure that there is - - - intuitively, it seems like it should be classified as current compensation in each year - - - but the argument would be that (i) there is a legally binding (contractually enforceable) right on January 1 of Year One, to (ii) $200,000 in each of Year Two - Four. The fact that he must work each year to earn it doesn't undercut its status as a legally binding right, anymore than a substantial risk of forfeiture to a future bonus undercuts its status as deferred compensation.

[jpod]

I can't tell you why, but I don't think even the most aggressive Treasury/IRS person involved in the development of the 409A regs ever felt that you could create deferred compensation by virtue of an employment agreement providing specified compensation for services. Maybe the answer is derived as follows: there is no "legally binding right" until the employee works a day (or whatever increment you choose), at which point he has a legally binding right to compensation for that day's work which will be paid currently (and not in a subsequent year).

[Guest shaul]

I agree - - - that seems like the right answer to me as well.

[ERISA-Bubs]

I agree. Even if you could possibly classify this as a legally binding right, in all cases it is paid within 2 1/2 months of the end of the year (unless you have some strange payment cycle), so it would never constitute a deferral of compensation thanks to the short term deferral rule.