Stock Repurchase at Retirement

[Guest 409A newbie]

This question involves a private medical practice with a small number of practitioners, all of which are stockholders. As is common, the docs have stock repurchase agreemetns so that when they retire, the corporation buys their stock back. The stock price is based on book value minus debts, which I think is ok. But there's a "floor" on that formula so that the doc gets at least $100,000. I know of no reasonable valuation method that would put the stock price at anywhere close to that (it's currently in the range of $20,000-$30,000).

This situation seems to clearly implicate the basic 409A provisions. My question is whether there is an exception that might apply or, if not, how to make this sort of arrangement 409A compliant.

I'm not sure if this matters, but the docs all bought their stock for $100,000. The purchase price was paid for by salary deductions over 3 years.

I'm new to this, so....speak....slowly.....

Thanks in advance for any help or insight anyone can offer.

[jpod]

I am not so sure it is disquised deferred compensation. It sounds like a perfectly sensible business deal that the redemption price will be book value, but not less than the capital which the shareholder has contributed to the enterprise.

Assuming for the sake of argument it is deferred compensation, why is it not compliant with 409A?

[Guest AOM]

Were the salary deductions taxed before they were used to pay the purchase price?

If yes, there was no deferral of tax (and no earnings) and therefore no 409A issue.

If no, then the tax was deferred and it would be deferred compensation. If that's the case, then it seems to me to be 409A compliant already (the $100,000 and any earnings -- which in this case is $0 -- are payable upon separation from service). In this case their lawyer should also look over their stock repurchase agreement to make sure it has the necessary 409A language.

[Guest 409A newbie]

I am not so sure it is disquised deferred compensation. It sounds like a perfectly sensible business deal that the redemption price will be book value, but not less than the capital which the shareholder has contributed to the enterprise.

Assuming for the sake of argument it is deferred compensation, why is it not compliant with 409A?

I agree it's sensible. I only wish that 409A excluded sensible arrangements. I see two possible 409A issues:

The first regards a retiring doc. A retiring doc has a right to receive at least $100,000 at retirement. This right vests when he becomes a shareholder, which usually happens several years before retiring. The way I read 409A, that's deferred comp because he's receiving compensation in a year after the year in which the right to receive it vests. Am I being too literal in my reading?

The second regards shareholder docs when a new doc buys in. When a doc buys in, he takes on an obligation to pay the corporation $100,000 over 3 years. This obligation is essentially paid to the other shareholder docs because they split the profits (which are increased as a result of the reduction in the new doc's salary). This looks like deferred comp to me because they're receiving additional compensation in a year following the year in which their right to receive the compensation vests. Again, am I being too literal?

[Guest 409A newbie]

Were the salary deductions taxed before they were used to pay the purchase price?

If yes, there was no deferral of tax (and no earnings) and therefore no 409A issue.

If no, then the tax was deferred and it would be deferred compensation. If that's the case, then it seems to me to be 409A compliant already (the $100,000 and any earnings -- which in this case is $0 -- are payable upon separation from service). In this case their lawyer should also look over their stock repurchase agreement to make sure it has the necessary 409A language.

I think the deductions were taken out pre-tax, but I'll have to check to make sure.

Assuming that's the case, what's the basis for the conclusion that the arrangement is 409A compliant? Is it because the doc is just getting out what they put in? That makes sense to me, but what exception does that fall under? I'm not seeing anything in the statute or regulations that would make me conclude that an arrangement like this, which seems to meet the broad definition of deferred compensation, would not trigger 409A.

[jpod]

It doesn't sound right that they effected the $100k buy-in by paying him $100k less in salary over three years, because the receipt of the stock would then be taxable; i.e., from a tax viewpoint he purchased the stock for $0, and if it had a floor repurchase price of $100k then he would have $100k of taxable income upon receipt of the shares (see IRC Section 83).

If he paid $100k of after-tax money for the stock, he has a tax basis of $100k for the shares. Upon redemption he gets $100k or book value if higher. Under these facts where is the "deferred compensation"? Note: it needs to be "compensation" before it can be "deferred compensation."