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kgr12

Post Employment Consulting and Separation from Service

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An executive retires with a nonqualified plan benefit, but has an ongoing part-time consulting agreement that will continue for at least one year, under which services will be provided at approximately 25% to 35% of the time put in during the several years leading to retirement. He is considered an independent contractor during the consulting period.

My understanding is that this is in the gray area between more than 20% and less than 50% where there is no presumption as to whether the executive separated or not.

My question is about language in the regulations (1.409A-1(h)(2)(ii)), which states that, in the case of an independent contractor, "No amount will be paid to the service provider before a date at least 12 months after the day on which the contract expires under which the service provider performs services for the service recipient (or, in the case of more than one contract, all such contracts expire);"

Assuming that the employer has treated executive as not separating from service, would that "12 months after expiration until you make payment" rule also apply in the situation where an employee transitions to an independent contractor?

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I think that under 1.409A-1(h)(1)(ii) the 20% to 50% gray area applies to what actually happens after you initially determine this is a sep'n from service based on the 20% or less anticipated level, but it turns out that in fact the level is above 20%, but below 50%. Here, since the services are anticipated to be more than 20%, you don't have a separation from service as employee.

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Thank you for your reply.

So I think you are coming down on the side of you look at the status when the separation from service actually occurs (i.e. the individual was an independent contractor when there was separation from service)  and ignore the status as an employee when the benefit accrued. Am I reading you correctly?

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If I understand your question correctly, kgr12, it doesn't seem like you have a separation from service at the first break. The employer's expectation is above 20%, so the individual has not separated, even though now working as an ic, not employee. So then, to determine when a separation does occur, since the individual is an ic, it would appear that you have to shift to the 1.409A-1(h)(2) rules, so you can't pay the amount that is accumulated as an employee until you satisfy either (h)(2)(I) (complete end to contract with no expectation of renewal), or you go under the (h)(2)(ii) safe harbor, which you described in your question.

If the good faith expected drop in service level at the time of transition from employee to ic was 20% or less (instead of 25% to 35% as in your question), then the outcome would be different because the initial break (transition from employee to ic) would likely be a separation from service.

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Although this will not help in your situation, I recommend that a Plan provide a definition of separation from service that utilizes a "less than 50%" of the average level of services in the prior 36 months, as is permitted.  This would allow your situation to constitute a separation.

I have a question about how you determined a 25% to 35% level of hours worked for an executive, obviously not an hourly-paid employee.  Did you ask the executive how much time he spends on company business (which could be, for example, 80 hours per week)?  I have suggested being conservative and limiting the hours worked to 40. 

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Thank you to both of you for your replies.

Linda, in answer to your question, it is based a statement in the independent contractor agreement that the amount worked would be in that range (the work actually done is documented in support of this), and also on the rate of pay in the agreement relative to annualized pay in the 36 months prior to the end of the  employment relationship. 

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