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cbassociate2017

Adding payment event to short term D with CIC as trigger

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I'm working with a stock option that is currently a short term deferral because the option only vests upon a CIC.  The client now wants to add termination of employment (except for cause) as a payment event.  I am pretty sure the subsequent deferral election rules apply here, but the result seems impractical when using the possible CIC as the original payment date.  I also see a problem with the prohibition against acceleration of payment, because of course, an employee could terminate before the CIC date.  Thoughts??

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Many plans have language as to the first to occur, either CIC or voluntary term of employment not for cause (or even death or disability) Why wouldn't you have that here ?

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It looks like the preamble to the final regs addresses this (if I'm reading it correctly).

See Section IX.C, or top of page 19,270 of Fed. Reg. https://www.irs.gov/irb/2007-19_IRB

"The provisions governing subsequent deferral elections apply to all changes in the time and form of payment, whether resulting from the addition, deletion or substitution of another payment event. Commentators requested clarification of how this provision would apply where the events were not specified dates, such as the substitution of a change in control payment event for a separation from service event. In such a situation, to satisfy the rules governing subsequent deferrals, this substitution would only be permissible if the change were not effective for one year, and provided that the payment would only occur upon the later of a change in control event or at least five years following a separation from service."

The "later of" language refers back in the same paragraph to an example where the plan pays out on the later of two events.

So I guess in your situation (1) the new terms couldn't take effect for at least 12 months, and (2) the payment would be on the earlier of (a) a CIC or, (b) five years following termination of employment? That's my best guess at least. 

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9 minutes ago, EBECatty said:

So I guess in your situation (1) the new terms couldn't take effect for at least 12 months, and (2) the payment would be on the earlier of (a) a CIC or, (b) five years following termination of employment? That's my best guess at least. 

Unlike the example from the pre-amble which substituted CIC for separation, this is adding a distribution event.  Sadly, the distribution change rules would be payable at the later of separation or 5 years after CIC.  That's effectively useless.

I'm still trying to wrap my head around the design.  A stock option that vests at CIC?  What's really happening?  I don't normally think "stock option" and "409A" at the same time. 

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Thanks for the clarification. You're right--that is useless.

I've seen similar plans, but only where our clients have used the DIY method of plan design then informed us after the fact. The operation becomes more like a SAR or phantom equity plan payable only on a CIC--they have the right to exercise the option in connection with the CIC then participate in the sale. We strongly encourage them to reconsider as there are no advantages and lots of disadvantages. 

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I'm trying to wrap my head around this as well.  If it is a stock option awarded at the FMV exercise price at date of grant, it is an "exempt stock right" not subject to 409A.  It is not a short-term deferral.  The option is exercisable at will once it is vested, so there is no "payment event" governing the option.  The question does not make sense.

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22 hours ago, Linda Wilkins said:

I'm trying to wrap my head around this as well.  If it is a stock option awarded at the FMV exercise price at date of grant, it is an "exempt stock right" not subject to 409A.  It is not a short-term deferral.  The option is exercisable at will once it is vested, so there is no "payment event" governing the option.  The question does not make sense.

Straying from the OP, but say the same hypo came up with a promise to pay cash. For example, employee is entitled to $100,000 within 30 days of a CIC. Owner of company changes mind and decides not to sell company, but still wants to reward employee. If they want to add payment of $100,000 upon separation from service, it couldn't be paid until 5 years after a CIC. Still an odd outcome.

EDIT: I've had this conversation before as well: In my example, can you terminate the CIC-related agreement (which is exempt as a short-term deferral) and create a new agreement promising $100,000 upon separation from service? Is that form over substance such that the anti-abuse rule may be triggered? An impermissible substitution? A deferral of a short-term deferral subject to the subsequent deferral rules? Or is it perfectly fine?

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