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severance and specified employee compensation


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The 409A default rule for determining specified employee compensation uses 1.415(c)-(2)(a) compensation, items in 1.415(c)-(2)(b) and excluding those in 1.415(c)-(2)(c).

The default definition says the special timing rules of 1.415(c)-(2)(e) are not to be used. The special timing rules of 1.415(c)-(2)(e) are of two types: one type is elective, i.e. post termination regular compensation can be included if paid within 2 &1/2 months. That's clearly excluded for the default. The other type is mandatory (exclusion of severance and post-term NQ payouts triggered by termination). 

Issue: do severance and NQ payouts triggered by termination count as compensation under the default rule of 1.415(c)-(2)(a) for measuring specified employee compensation.

Example: Administrative officer terminates in January of a calendar testing year with small compensation that would not put him in the top 50. If large severance is included , he would be in the top 50 (and the result is that an administrative officer ranked #51 by compensation does not get on the list).

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8 hours ago, gc@chimentowebb.com said:

and excludes those in 1.415(c)-(2)(b)

you meant -(2)(c), I think.

 

8 hours ago, gc@chimentowebb.com said:

Does this mean that severance and NQ payouts based on termination are included as specified compnsation, even though these two items are NEVER allowed as compensation for purposes of Section 415?

gc@chimentowebb.com, my copy of the reg (1.409A-1(i)(2)) says you apply without any of the elective special timing rules.That's all. Not counting severance is not elective for 415.

8 hours ago, gc@chimentowebb.com said:

Example: Administrative officer terminates in January of a calendar testing year with small compensation that would not put him in the top 50. If large severance is included , he would be in the top 50 (and the result is that an administrative officer ranked #51 by compensation does not get on the list).

 

8 hours ago, gc@chimentowebb.com said:

Example: Administrative officer terminates in January of a calendar testing year with small compensation that would not put him in the top 50. If large severance is included , he would be in the top 50 (and the result is that an administrative officer ranked #51 by compensation does not get on the list).

Please note the 409A rules regarding specified employee determination and effective dates in 1.409A-1(i). It does not seem to me that you are.

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Hi Luke. 

 I have the correct reg. cite for this 409A default definition of compensation. It's 1.415(c)-2(a).

More importantly, the point I am making is that severance needs to be excluded when determining specified employees, and not just for the default definition of compensation.

Excluding severance is not an elective timing rule. Excluding severance is a requirement for any definition of compensation in IRC 415.

This is not just an issue for those using the default definition. It also applies to those using the W-2 safe harbor in the 415 regulations, or any permitted definition.

Think about this. Virtually every 409A treatise says that using W-2 income with addbacks for pre-tax deferrals is the easy way to determine compensation for specified employees. Not one of them points out that a W-2 includes severance (and post-termination non-qualified payments that are triggered by separation, another item that can never be used for 415 purposes).

I'm thinking that many people are preparing lists of specified employees and not realizing that severance should not be part of the compensation. I'm puzzled this never appears in any of the 409A Treatises or articles.  

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The use of a January date in your example does give one pause.... 

I agree that if your plan provides that comp is based on the default rule in 415, severance should not be included whether it was paid pre- or post-termination of employment as that comp definition includes only amounts received for services actually rendered.  (I didn't use quote marks as I have not busted out the books but I think that is right).  This rule would not apply to NQDC, so timing seems relevant.  

However,  I am not certain about your blanket statement that severance is never included when using the W-2  6041 definitions.  I believe severance and NQDC are includible in W-2 compensation and are reportable, including for purposes of the 415 safe-harbor definitions.  Can you provide authority for your blanket statement?

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RTM, no question about severance. It is in a W-2, but not in the W-2 safe harbor for 415 (or 409A). 

Here is how I read this. The authors of the final 409A Specified Employee regs provided that in addition to the default 1.415(c)-(2)(a) definition (with adjustments) that any other 415 definition would work, including 415 safe harbors.

One of those 415 safe harbor rules is W-2, with pre-tax add backs and exclusion of post-employment severance. IRS Exam Guidelines for 415(c) are clear about severance exclusion, even in its W-2 safe harbor. https://www.irs.gov/irm/part4/irm_04-072-007#idm140256657577984 This exclusion of severance for 415 happened in April, 2007, when 415 regulations were restated. Prior to that, severance was allowable for 415.

I doubt very much that the authors of the 409A regs in that same 2007 timeframe were aware of the change in 415, or would have cared much had they known that severance was no longer 415 compensation.

My conclusion is that anyone using a W-2 definition for a Specified Employee List, who accordingly includes severance, is incorrect. Severance is not acceptable compensation  under 415. However, because of the historical coincidence that severance could be used for 415 until April, 2007, when IRS was also writing the 409A regulations,  I believe IRS would probably give a pass to those who are using W-2s with severance to develop their Specified Employee lists. 

 

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On ‎9‎/‎21‎/‎2020 at 10:38 PM, gc@chimentowebb.com said:

Think about this. Virtually every 409A treatise says that using W-2 income with addbacks for pre-tax deferrals is the easy way to determine compensation for specified employees. Not one of them points out that a W-2 includes severance (and post-termination non-qualified payments that are triggered by separation, another item that can never be used for 415 purposes).

The point I was trying to make in the last comment of my first post, gc@chimentowebb.com, is that while severance is excluded from 415(c) comp, and therefore from the specified employee (SE) determination, you determine your SE's as of 12/31 of Year 1, effective 4/1 of the next year, so an SE's separation from service (and presumably his or her severance payment) are going to be in a year after the year in which the SE's status as such, based in part on his/her compensation, was determined. Presumably this is why the issue is seldom or never mentioned as a potential trap for the unwary, as you indicate. Because it isn't, at least in most conceivable fact patterns.

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Thanks for the link but I guess I am just dense.  I don't see the authority for your statement.  s 31.3401(a)-1(b)(4) states severance is in wages.  (this reg also updated in 2007).  Looking for the statement that says don't ever include severance in the 415 W-2 safe harbor definition.  

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Dear RTM and Luke.

First the easy answer for RTM. Click the link for IRS examinations in my earlier post. https://www.irs.gov/irm/part4/irm_04-072-007#idm140256657577984   scroll to the bottom and you will see that Agents examining plans for 415 violations are supposed to exclude severance, even with plans which use the W-2 safe harbor for 415. For 409A lists of Specified Employees the regulations do not say you can use W-2 with only an add-back for qualified pre-tax items. They say you can use the W-2 safe harbor in 415 (or other permitted 415 methods). None of these 415 methods allow severance to be included. This was a new wrinkle added to 415 regulations in April, 2007. 

Next for Luke. I fully agree the problem is not with the terminated employee on the List who is mistakenly considered a Specified Employee because of a big severance payment. Chances are that the 6 month rule will not apply to him unless his 6 month post-termination period extends into the next 12 month Administrative Period. The problem is with the active employee who is 51st in rank, and never gets on the List because of the mistake in counting the terminated employee's severance as part of his compensation. That 51st employee should have been on the List and the 6 month rule should apply to him in the following Administrative Period. 

Good to discuss. I really don't think the IRS will punish anyone who has been using W-2s with severance included. They probably aren't even aware of this technical point.

 

 

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Hate to beat a dead horse but I don't see it as easily as you guys do.

Treas. Reg. s 1.415(c)-2(e)(3)(iv):  "if they are paid after severance from employment with the employer maintaining the plan,"

The IRM conveniently omits that phrase.  That highlighted language means (to me at least) that severance paid any time after severance from employment is not included in 415 comp even if it’s paid within the time period in (e)(3)(i) [2½ months/end of LY].  Otherwise, why is the underlined language in the Regulations?   

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51 minutes ago, RTM said:

Hate to beat a dead horse but I don't see it as easily as you guys do.

Treas. Reg. s 1.415(c)-2(e)(3)(iv):  "if they are paid after severance from employment with the employer maintaining the plan,"

The IRM conveniently omits that phrase.  That highlighted language means (to me at least) that severance paid any time after severance from employment is not included in 415 comp even if it’s paid within the time period in (e)(3)(i) [2½ months/end of LY].  Otherwise, why is the underlined language in the Regulations?   

Fully agree with you that that is what the reg says. But what I've always scratched my head over is whether they really intended that you could pay severance before the termination date and hey, you can include it for 415 then. Do you think it really works that way? I think most plans just say you don't include severance, like the IRM.

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This is a good point. Severance paid prior to termination is includible for 415. I've never seen this for top executives, who we are concerned about for this 409A topic, but it is a practice when people in lower ranks are terminated.

So let's qualify this. For in-service severance, an employer using the W-2 safe harbor or the witholding safe harbor for the Specified Employee List would include it.

For Employers using the default method for populating a 409A list, I think it would be disregarded because this would probably be considered a special timing option which gets disregarded for the default method. In additon, excluding the in-service severance still complies with 415, and for the specified employee list anything that complies with 415 is OK. 

The advantage of disregarding it, even though permitted, is the terminated employee, as Luke points out,  is not really a concern. For the terminated employee with disregarded in-service severance, the 6 month period will probably have lapsed by the start of the next administrative period. All that happens by disregarding the in-service severance is to bring #51 into the top 50. 

 

 

 

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