Terminating Phantom Stock Plan

[TaxLawyer1978]

A client wants to terminate a phantom stock plan.  No shares have vested and value of shares minimal.  There would be no distributions on termination, therefore no acceleration on distributions.  Are we subject to the rules on terminations under 409A? in other words, can we only terminate if one of the 3 tests in 409A is met? Does it matter if there is no acceleration on distributions here because no distributions would be made. 

 

Follow up on this.  So the client is now thinking converting to an LLC and offering those same execs some type of an option plan.  I imagine that's improper substitution, but thoughts? Thanks 

[XTitan]

Yes, you would be subject to the 409A voluntary termination rules. 

[jpod]

Why?  The facts are that there would be no acceleration of distributions. 

[XTitan]

I get it, but you still have to make sure any new plan that would be aggregated with the terminating plan is not implemented prior to 3 years from the date the company took steps to terminate and liquidate the plan.  Worst case scenario - in 6 months the company has a value realizing event and those phantom shares are worth something.

[jpod]

Huh?  The facts are that there are no accelerated distributions.  I would call it a "freeze" rather than a termination, but whatever you call it the termination provisions in the regs are relevant only as exceptions to the anti-acceleration rule, so if you aren't accelerating those provisions can be ignored. 

[Luke Bailey]

If the plan is terminated and the shares are worth something in 6 months, you will have a lawsuit (probably under state law, not ERISA, depending on the plan's terms), most likely. You will, of course, want releases. Even with releases, outcome unclear, for a number of reasons.

As for the 409A issue, seems like the regs don't provide a clear answer. It would seem to me that there is an argument that without a payout the termination regs don't apply, i.e. because it is a forfeiture, not plan termination. The regs don't deal clearly with forfeiture issues. And hey, if you don't actually have a payout of any sort for 3 years, and don't start a new NQDC plan, you've complied anyway. (I'm assuming the employer does not currently have an NQDC plan of the same type that it is not terminating.) If, however, any benefit were provided within 3 years of the termination that arguably looked like compensation or a "substitute" for the lost stock plan benefit, the IRS (if it discovered the facts) should argue that 409A is violated.

[TaxLawyer1978]

Thanks all.  Follow up question.  So the client is considering converting to an LLC structure and offering some sort of an option plan to the same execs that are participants in the phantom stock plan.  Improper substitution?  I read from Luke Bailey that the answer is yes and that is also my instinct.  There are no other NQDC plans right now and would be no payout on the stock plan.

Thanks again.

[Linda Wilkins]

If it is a substitution, the new LLC could still offer an equity program so long as it "mirrored" the payout terms for the phantom shares, and there would be no prohibited acceleration or deferral of payment.  In an LLC, I'd typically use profits interests instead of options, but I don't see how those could be structured in the operating agreement to meet the payout timing requirements. I'd use restricted LLC units instead.

[Luke Bailey]

What is or is not a substitution is based on facts and circumstances, so always somewhat murky and subject to argument.