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"Top Hat" Exemption/Former Employees


Guest M. Salsbury

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Guest M. Salsbury

Does anyone have a reaction to whether allowing former employees to participate in a nonqualified deferred compensation plan under the circumstances described below would cause the plan to fail to qualify for the "top hat" exemption under ERISA. The plan in question is a plan that allows executives with nonqualified stock options to defer receipt of employer stock upon the exercise of the NSO until the occurence of a particular event, such as retirement, or until a specified date selected by the participant. The employer has several former employees (all of which qualified as part of the employer's "select group of management or highly compensated employees" when they were employees) that have NSOs that it would like to allow participate in the plan. The employer does not aniticipate that many of its employees will participate in the plan (you do not actually become a "participant" in the plan until you make an election to defer receipt of employer stock upon the exercise of an NSO). Thus, if the former employees participate in the plan, they could constitute a fairly high percentage of the participants in the plan (e.g., 33% to 40%).

Any comments would be appreciated.

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Guest EAKarno

Non-employees aren't subject to ERISA. Therefore, I don't even think a "top-hat" exception is needed in this case.

Now, one could argue that the compensation ties back to a time when they were employees. However, back then the plan was a non ERISA stock option plan and the participants "top-hat" employees.

I just don't see any problem here.

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Guest M. Salsbury

Would the plan really be treated as a stock option plan for purposes of ERISA? The plan is a separate plan from the stock option plan. It operates basically as follows: Participants elect to defer receipt of employer stock upon the exercise of employer NSOs. Participants then exercise their NSOs (at least 6 months after making the deferral election), and the shares that they would have received but for the deferral election are credited to a "deferral account" maintained under the plan. The deferral account is credited with "dividend equivalents" in shares of employer stock at the same time and in the same amount as dividends paid on the employer's stock (but at the discretion of the Committee administering the plan, "dividend equivalents" could be credited in the form of cash). The participants receive the amounts credited to their deferral accounts when they terminate employment for any reason. Wouldn't this feature of the plan bring the plan within the scope of ERISA (i.e., because it "results in a deferral of income by employees for periods extending to the termination of covered employment ...)?

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The only way for this idea to work is for the IRS to accept the position that the (former) employee has received nothing more than an unfunded promise to pay. It seems to me that the IRS could take the position that the former employee exercised the options, had constructive receipt of the cash and then made an election to defer income. You need to condsider very carefully how the transactions are structured. I doubt that there is any authority on the matter, but I seem to recall that the IRS issued a PLR in 1999 on a similar (or perhaps identical) idea.

In addition, to the state tax issue that Kirk raised, you need to be concerned about:

1. FICA taxes (how do you withhold from a former employee)?

2. finanical statement impact

3. SEC rules ?

4. 162(m)

If the idea works, the amount deferred will be taxable as NQDC to the taxpayer.

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  • 2 weeks later...
Guest bswift

Back to your original question - can nonemployees participate in a deferred compensation plan established by an employer? sure, nonemployee directors do it all the time. however, the employer's deferred compensation plan needs to allow nonemployees to participate because the concept does require that a valid election be made at some point in time before the options are exercised. typically the employer and the participant are going to want the terms of the deferral governed by some type of plan. requirements of the stock for stock exercise equal to the exercise price(which prevents taxation under section 1031). although the irs has yet to rule on the issue, informally they believe that the election should be made before the options are vested, a position that most practitioners believe is too conservative. a deferred comp plan established for nonemployees is not subject to erisa, but as kirk pointed out above, you need to watch out for the state law issues. hope that helps.

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