457(f) Substantial Risk of Forfeiture

[EBECatty]

I'm hoping to get others' input on the correct standard for the future performance of substantial services under 457(f) for non-elective employer payments. Under section 1.457-12(e)(1)(ii) of the proposed regulations, "the determination of whether an amount of compensation is conditioned on the future performance of substantial services is based on the relevant facts and circumstances, such as whether the hours required to be performed during the relevant period are substantial in relation to the amount of compensation." There is no minimum vesting period in the proposed regulations or preamble.

When adding to current compensation or extending a substantial risk of forfeiture, proposed regulation 1.457-12(e)(2)(iii) requires performance of at least two years of future substantial services.

Under example 1 in proposed regulation 1.457-12(e)(3), a one-year (January to January) vesting period is implemented, which goes unmentioned as the example is aimed at an insubstantial amount of post-termination consulting services. One would think that if a two-year minimum deferral were required to begin with, the example would not need to resort to measuring the amount of work performed during the one-year period (or would use a longer duration). But the general substantial risk of forfeiture rule only looks at the amount of work performed, not the duration of the future services.

I know there has been a general rule of thumb stemming from section 83 that a minimum two-year deferral period is required to validly delay a substantial risk of forfeiture.

While it may be a matter of degree, I'm interested to hear others' takes on the following, all non-elective employer payments, all outside the short-term deferral date if the substantial risk of forfeiture is deemed not to take hold because it's less than two years:

• On July 1, 2021, employer awards employee a bonus payable on June 30, 2022, provided they remain employed full-time until the date of payment. 
• On December 1, 2021, employer awards employee a bonus payable on June 30, 2022, provided they remain employed full-time until the date of payment.
• On December 1, 2021, employer awards employee a bonus payable on June 30, 2023, provided they remain employed full-time until the date of payment.
• On December 1, 2021, employer awards employee two separate bonuses, one payable on June 30, 2022, and one payable on June 30, 2023, provided they remain employed until each separate payment date.
• On December 1, 2021, employer awards employee five separate bonuses, one payable on each succeeding June 30, provided they remain employed until each separate payment date.

Would anyone argue that some or all of these would immediately vest and be taxed on July 1, 2021, or December 1, 2021, as the case may be?

[Luke Bailey]

EBECatty, because under the proposed 457(f) regs arrangements that are short-term deferrals under 409A, but substituing 457(f)' SRF standard, are not deferred comp subject to 457(f), I don't think any of the examples you list would even be subject to 457(f), assuming they pay off within the short-term deferral period.

[EBECatty]

Luke, thanks and I agree all would be exempt as short-term deferrals assuming that a SROF exists until the date of payment.

My question/concern is whether a SROF exists at all because in some contexts a two-year period has historically been considered "insubstantial." 

For example, along the lines of the discussion in section IV.A here:

https://www.ipbtax.com/media/publication/33_KPO RBB 409A Vesting.pdf

Page 18 here:

https://www.irs.gov/pub/irs-tege/eotopicm97.pdf

Page 7 here:

https://static1.squarespace.com/static/51d2e43de4b0ae74dc6c43a5/t/58078a7c6a49634ccacf1e8b/1476889212983/Transcript+of+457(f)+IRS+hearing+(10+18+16).pdf

Discussion here under the heading "Two-year minimum deferral for non-elective supplemental employer dollars":

https://splawfirm.net/updates/2016/11/supplemental-memo-to-the-irs-on-the-proposed-457f-regulations

And some others, including the Section 409A Handbook.

If a two-year minimum deferral period is required even for non-elective payments, I don't think any of my examples above work except the last few years of the five-year hypothetical. If no SROF ever exists, the payments in each example would be outside the short-term deferral period, which would end March 15, 2022 (again, setting aside the five-year example). In that case, all would be taxed under 457(f) in 2021. 

I generally have not seen this rule cause a problem in good-faith situations - except maybe with elective deferrals - but am curious how much other people plan around it. Applying it literally would cause problems that I simply have never encountered in practice; for example, a new hire as of July 1, with an employer on a July 1 - June 30 fiscal year, has an employment agreement with a guaranteed bonus of $100,000 on June 30 of the end of her first year, provided she remains employed. If a two-year minimum deferral period is required, that would immediately tax the bonus, which again I have never encountered as a problem.

[Luke Bailey]

OK, I see what you're saying now, EBECatty. I think the two-year minimum for SRF applies only where the employee is electing to defer current comp or is agreeing to an extension of the SRF, so think there would be (a) 457(f) SRF and (b) a 409A STD, and not 457(f) deferral, in all of the situations you posit, at least under the proposed regs.

[EBECatty]

Thanks. That's where I'm coming down too, unless the final regs say otherwise. 

[Luke Bailey]

OK, EBECatty. I think we've got 'em outnumbered.

[Peter Gulia]

EBECatty, consider giving the Treasury department the benefit of your observations.  When a rulemaking’s comment period has closed, the agency is not mandated to consider a late-filed comment but nothing precludes considering it, at least for the agency’s internal thinking.  In my experience, Treasury lawyers consider even a late-filed comment when it has intelligent and useful observations, as your letter would have.