Steelerfan

Wellons v Commissioner, 31 f3d 569 (7th Cir 1994). This was not a public company, but I don't see that as necessarily relevant. The court addressed VEBAs in a footnote that suggests (to me) that if this had been a VEBA, the doctor would have gotten his deduction upon contribution to the trust at issue (obviously not a VEBA). I don't think I'd normally have much to worry about since payment would not be made unless there is an involuntary termination. But now we have a tax law that says that amounts in excess of 2X/2 years are deferred compensation even if paid upon involuntary termination, so the only real issue is whether VEBA payments for severance can exeed the 409A limit. I don't think so. Anyone disagree?

But there is no clear delineation in the tax world. Tax courts ignore the definition in ERISA and will rule that most severance is deferred comp for tax purposes because, unless the plan is mere insurance (as opposed to a guarantee of payment), severance always looks, smells and feels like a pension. Besides, if I recall properly, the definition in ERISA of severance that is welfare benefit is similar to the 409A 2X/2 year exemption. Would you agree that VEBA severance benefits should be limited by that 409A exemption? Where would you draw the line?

It's not that you can't do it, you just have to do it right. There are a few rulings where the IRS poo poos the arrangements as contingent.

I think the issue is that if the amounts are deferred compensation, you have this fundamental conflict between the "up front" deduction upon contribution to a VEBA and the later deduction for NQDC. Since a NQDC plan can't have both up front deduction and be deferred compensation, 409A could theoretically "ruin" the deduction for the VEBA (up to the exemption amounts). It's a shame that Congress didn't exempt benefits payable from VEBAs' from the definition of deferred compensation. A similar issue arises with employers who have sought to deduct pre-contributions to severance plans as welfare benefit plans, only to lose in court on the theory that the plan is really deferred comp subject to 404(a) deduciton timing rules (inclusion in GI). Except I would think that the comprehensive rules on deductibility for VEBAs should take the benefit out of the realm of 404(a) and into the deduction rules applicable to VEBAs.

Reg § 1.401(k)-1(e)(6)(i) Under this requirement, a 401(k) "plan" must provide that no “other benefit” is conditioned (directly or indirectly) on the employee's electing to make (or not to make) elective contributions under the CODA. This rule reflects the Code Sec. 401(k)(4)(A) prohibition on having benefits (other than a match) conditioned on making or not making an elective contribution.

The contingent benefit rules were a problem pre 409A, so I don't see why they would be any more of a problem now--it's only worse because of 409A. The 401(k) regulations say that participation in a nonqualified [401(k)] plan-or other benefit--may not be conditioned on the employee making or not making an election under the 401(k) plan. Oddly enough it seems that the main planning issues presented by the contingent benefit rule and 409A originate from the same issue-the need for enough flexibility to "fill up" the qualified plan first. Certainly 409A throws a huge monkey wrench by providing less flexibility to work within the confines of the contingent benefit rule.

I don't know about the contingent benefit rules, but my experience in trying to redesign wrap around plans in accordance with 409A is one of frustration. The limitations 409A places on changing deferral elections for the year prevents the kind of flexibility you want participants to have to maximize the benefits of the 401(k), while also trying to mazimize nonqualified benefits. In short, because of the "guesswork" that may be involved in maximizing qualifed plan benefits for the year, it seems better to me to separate the plans; you don't want the "lock in" requirements of 409A to force a participant to either max out too fast or undercontibute to the 401(k).

Not sure why you think this would alleviate 409A concerns. Even if the amount were in addition to the account balance, you still have to have a fixed schedule of payments. The key would seem to be whether the amount payable in a lump sum is subject to change by an action of the employer subsequent to the time when the time and form of payment is required to be fixed. In that case there would be a 409A violation because the "formula" is discretionary and the payments are not properly "fixed." I would be worried about this type of arrangement becase, as stated in OP, the employer has contol over the amount of LI and thus could "arrange" for a larger lump sum to be paid to the executive's beneficiary after the time and form of payment is required to be set by subsequently increasing the amount of coverage. Also it is not clear whether the executive has the subsequent ability to influence the employer in the amount of LI that will be received by ER when he dies. I guess my question would be--can the amount of LI be predetermined when the time and form of payment must be set in the plan? If so, then you are probably OK under 409A.

You need to read the preamble to the regs section VII B 3. Based on what you've said, the amount would be subject to manipulation and thus not deemed to be a fixed schedule of payments.

Yes and yes.

I've previously expressed my own concerns and the need for it, but I think it works. That's the safest way to do it, but not always practical or possible, so the ability to bifurcate is a valuable planning tool. I would agree, but I think you would need to beef up the language to make sure the payments each constitute separate payments for purposes of 409A, otherwise, they could be considered one stream of payments entirely subject to 409A

We've got two substantially similar threads running here, maybe we can pick one. Check my other answers and see if you agree. The answer I think in this case is that the sixth month delay would not apply to a specified employee if you bifurcate the payments properly. You do not have to aggregate payments. If the amount to be paid did go over the 2X limit, you could structure the payments as completely separate from each other (bifurcated) and you could slip some of that money into the exec's pocket before 6 months under the ST deferral rule. My understanding is that the exeptions conceptually run concurrently and independent at the same time. If you bifurcate, use the ST deferral rule and structure your payments properly you can completely avoid both the 6 month rule and the 2x/limit. Payments that spill past 2 years are in compliance with 409A, so no issue there. In order to avoid the 2x limit for a really large payment you would have to pay higher amounts as a short term deferral. Here's a few examples: Example 1: Executive is entitled currently to severance upon termination without cause equal to 3 times base salary plus target bonus, payable monthly over three years. His 2007 base salary is $600,000 and his target bonus is $300,000; thus, the total amount he'd be entitled to under this formula for a termination in 2007 is $2.7 million, or $75,000 a month. In this case, we could pay him exactly what we would always have paid him, since $75,000 a month times 6 is $450,000, so his first six months of payments is within the safe harbor. Example 2: Same as example 1, only suppose the executive's base pay and bonus are such that he'd be entitled to $3.24 million, or $90,000 a month for 36 months. In that case, you could pay him $75,000 a month for the first six months, and then either adjust his remaining payments starting in month seven to account for the difference, or just pay him the aggregate difference in month seven (in this case, he'd just get an extra $90,000 payment). A more aggressive approach would allow you to ignore the $450,000 limit entirely. Here's how it works: Using the short-term deferral rule in example 2, above, you can arguably pay the entire amount that would ordinarily be paid during the first six months ($90,000 a month, or $540,000), as follows: 1. Provide that $540,000 will be paid to the executive in a lump sum within 60 days after the date of involuntary termination (which would in all events be earlier than March 15 following the year of termination). 2. Provide that starting in month seven, the executive will begin receiving $90,000 a month, to continue for 2 1/2 years. All of these exceptions are premised on severance benefits being paid only upon an involuntary termination in order to preserve the SRF. This kind of heavy planning to avoid rules should not be necessary just so an exec can an extra 100,000 or 200.000 that he probably doesn't need. But if the aggressive approach makes you a little uncomfortable, join the club!

The preamble to the regs discusses this. Commentators tried to make that argument, but Treasury is adhering to Congressional intent as set forth in the legislative history. However, with the proper language in your plan you can have until the end of the calendar year anyway, so there no need to worry too much about the magical 2.5 months.

I don't see that provision as requiring all payments to be aggregated.

That is the point i've been trying to make. Hogans confirmed you can avoid the 2Xpay/2 year exception and the 6 month rule with the ST deferral rule. There is some reason to be skeptical about avoidance of the 2X/2 year rule I think though when bifurcated payments are made. In that case it has to be clear that each payment is a separate paymebt As far as the original basis for the short term deferral rule, that is explained in the legislative history to 409A. Congress stated "It is intended that the provision does not apply to annual bonuses or other annual compensation amounts paid within 2 1/2 months after the close of the taxable year in which the relevant services required for payment have been performed." I think this has its roots in section 404--accrual basis taxpayer (corporations) deductions. The FICA regulations have the same rule. What I meant about its basis in applying to separation pay is that involuntary terminations are a substantial risk of forfeiture (as per the regulations). So up until termination, the payment is under an SRF meaning that if the employee were to leave employment voluntarily, he would have no right to payment. Thus if an employee is involuntarily terminated in 2007, the employer can pay the total amount of severance by March 15, 2008 and that amount may exceed 450,000.

Can you find a basis for aggregation of severance payments in the regs? I thought the issue was created because the regs allow for bifurcated payments and I am not aware of any aggregation requirement for severance. The basis for it is that severance paid upon involuntary termination consitutes a substantial risk of forfeiture thus allowing the short term deferral rule to apply.

I don't think the security agreement violates 409A, I think it causes taxation. Section 83 property includes a beneficial interest in assets set aside from creditors of the company. Read the legislative history to 409A. The economic benefit doctrine and constructive receipt still applies, so you are not violating 409A, but rather causing immediate taxation, so 409A becomes irrelevant since there is no deferral of income taxation.

I'm not sure why you think you are paranoid. the definition of deferred comp in the regs virtually covers the universe of payments that aren't either excluded expressly or made immediately/within the short term deferral period. It's not paranoia, it's reality!

Do you think that every time an employer gives an employee the option of terminating employment or changing positions, if the employee chooses the latter, there is deferred compensation and a 409A issue? Not in the average circumstance. But in the OP there is an employment agreement with reference to payment on termination. You can bet that where a promise is made in an employment agreement, 409A will rear its ugly head, even if it's just to make sure it doesn't apply. In this case I thought it did.

How does this fact turn "regular " compensation into deferred compensation? The regulations don't hinge on how substantial services are--the IRS doesn't visit us at work to see if we sit around all day or actually work. Wouldn't this fact only be relevant if you were trying to establish a SRF?

The agreement may consider a return to tenured employment an involuntary termination, but 409A would not recognize it as such unless she actually separates. I'm totally confused by the second paragraph. Post-employment leave--what is that? If a person is on leave and they have a right to reemployement, I don't think they are separated from service. I not aware of paid leave being deferred compensation. If the person doesn't separate from service, I think my previous posts suggest the only other ways to get her paid while she continues to work. There might be a simple solution to this that I can't see, but I would venture a good guess that 409A was as much a thought when this agreement was drafted as you were when you were concieved by your parents. You say "At the time of involuntary termination, she will have to make a decision and so then will have a vested right in whatever path she choses." It is not even clear that she will be terminated, let alone involuntarily. But only that she will have a choice to take a different job. That choice makes the termination voluntary and thus not subject to SRF. therefore she has a vested right already. That's why short term deferral won't work (see my first post). It seems to me this is the issue that has to be cleared up. The employer should make the decision--she's either fired or or she can take the tenured job. If you give the employee the choice, its voluntary and 409A will kill you because you have not complied. If I'm right, then you cannot provide the package the way it was initially contemplated by the parties. 409A has taken away a lot of arrangement flexibility and this could be a casualty.

The problem as I saw it was that the agreement makes a promise to pay money in the future. That is classic deferred compensation. What makes it odd is that it promises to pay an amount if the employee takes a different job, but also if they involuntarily terminate. So there is a choice as to when payment will be made, except that one of the events is not 409A compliant. But even if it were, I still think you'd have an issue--you would have to decide on one of the two at the time the agreement is executed. If nothing were done, I think you could have an accelerated payment problem, as well as plan document compliance issues. If the agreement provided for salary-type payments to begin on the earlier of involuntary termination or June 1, 2010, I don't think there would be any major issues. I thought about that good reason angle, but I think 409A requires an actual termination from service within one year of the qualifying condition, I don't think it's a constructive discharge provision. A one-year leave or sabbatical with a right to reemployment would not be a separation from service. I thought this was a strange situation myself in that the agreement considers a tenured position as a termination. Tenure is a coveted prize these days.

Let me revise what I said in the second sentence above. From a technical perspective, if the second choice in OP is made to be condition that is a valid SRF, you should have the payment terms set forth in the employment agreement, since that is presumably when the legally binding right occurs. So the agreement could provide that when the earliest vesting condition occurs (i.e. retreat to tenured employment), the right vests and fixed salary payments shall begin immediately thereafter. See Reg 1.409A-3(i) You are not locked into the short term deferral rule. The problem is that you must accept payment when the first condition lapses, so if you take tenured employment, you can't defer to termination of employment. Some flexibility is lost. The alternative seems unworkable, but could preserve "choice." You could "take away" the employee's right to the payment upon tenured employoment and create the LBR when the event occurs, then set the payment terms. The employee would likely have to consent to this. In that case you would have more of a plain vanilla severance plan. Then if the employee takes tenured employment he could "elect" to take payment at separation of service by virtue of not having a LBR to payment. BTW you can still utilize the severance exception for amounts up to 450,000.

You can't really leave the choices as they are and comply with 409A per se since employment is not an permitted payment event. But it could be a condition that either imposes an SRF or provides that no legally binding right exists prior to the employment or research leave. In that case you can set the payment date and terms at the time the LBR attaches or the SRF is lifted. I can't see why that wouldn't work, but it could cause some heartburn wondering if the IRS agrees.

I think that with the payout choices you described, you won't have an SRF, so you aren't going to be able to meet the short term deferral rule. You either have to restructure this as a 409A-exempt arrangement (meet the involuntary/good reason termination and the 2X pay/24 month rules) or you can leave the choices as they are and comply with 409A. Your OP seems to decribe a legally binding right to compensation in one year with a payment right that may extend beyond the short term deferral exeption. You might be able to create a SRF by clearly making payment conditioned on one or the other event; then you will have to make sure the money is timely paid out after the first condition lapses. So it seems that you could provide for payment on the earlier of the 2 conditions and then either meet the short term deferral rule or set forth the payment terms that apply upon each condition. We are all lucky that the transition rule is still in effect. After 1/1/08 agreements like this will blow things up.