Deferral of multi-year bonus arrangements

[Guest jfsinger]

I've been unable to find guidance on the deferral of bonuses paid in multi-year arrangements. I seem to remember the topic being addressed in one of the conference calls, but can't find it in any of the printed material. Has there been guidance issued, or can we anticipate in in the mid-year regs?

Thanks, Joe

[Everett Moreland]

Notice 2005-1:

"The definition of nonqualified deferred compensation contains an exception for amounts actually or constructively received by the service provider within a short period following the lapse of a substantial risk of forfeiture. The exception is intended to address multi-year compensation arrangements, where the right to the compensation is or may be earned over multiple years but is payable at the end of the earning period. For example, a three-year bonus program requiring the performance of services over three years and entitling the service provider to a payment within a short specified period following the end of the third year generally would not constitute a deferral of compensation. The Treasury Department and the Service are, however, concerned about arrangements purported to involve a substantial risk of forfeiture and fixed payment date where the parties do not intend for the substantial risk of forfeiture or fixed payment date to be enforced. Accordingly, the Treasury Department and the Service are considering a more restrictive rule under which arrangements involving payments in later taxable years structured to coincide with a lapse in a substantial risk of forfeiture would constitute deferrals of compensation subject to § 409A. However, even under a more restrictive rule, the Treasury Department and the Service anticipate that a payment within a short period following a scheduled vesting date and, in specified circumstances, within a short period following an accelerated vesting date, would be permitted under the statutory authority provided to permit accelerated payments that are not inconsistent with the purposes of the statute. Comments are requested with respect to these issues and the extent to which additional guidance is required to prevent arrangements designed to evade application of § 409A."

[Guest jfsinger]

Thanks, Everett. The quoted section of 2005-1 addresses the issue of whether or not a multi-year arrangement is defined as deferred compensation (probably not), but does not address when an election to defer a payment to be made as a result of a multi-year arrangement must be made.

For example, if I am due to receive a payment in March of '06 as the result of a multi-year bonus arrangement ending on 12/31/05, can I make an election to defer that payment as late as 6/30/05? Or, should that election have been made in the year before the start of the mutli-year period?

[Everett Moreland]

I misread your question. If I understand your question, I think the following from A-4© answers it:

"Notwithstanding the foregoing, if an election is provided to the service provider with respect to the taxable year in which payment of the compensation will occur, and the service provider elects a taxable year later than the taxable year in which he or she obtained a legally binding right to the payment, the arrangement constitutes a deferral of compensation subject to § 409A, including the deferral election timing rules of § 409A(a)(4)."

My reading of this (without having gone through the legislative history to confirm it) is that the election needs to be made in the year before the start of the multi-year period. This is something I've not thought through, so I'd check this against the legislative history.

[Guest changdynasty]

Will the plan meet the definition of a performance based plan?

I can only infer by your question as to whether the election can be made by 6/30/05 that the multi-year bonus plan might be performance based but was not certain.

[Guest AEA]

Possibly as a follow-up to changdynasty's post, if the multi-year bonus was performance based, wouldn't the election to defer need to be made only 6 months before the end of the performance period?

If jfsinger's example, it would need to be made by June 30, 2005 and not in the year before the start of the multi-year period, correct?

I'm working with a 3-year bonus program, based on performance goals for each year and requiring employment through the full period (except death, disability or retirement) for a payout. The first payout would also be March of 2006, but there are subsequent 3-year period (2004-2006, 2005-2007). I had read the regs and notice to impose the 6-month before rule. Does that seem right?

[Guest DMK]

Don't forget that the deferral election also has to be made when it is substantially uncertain that the performance goals would be met. If the bonus cycle is over 3 years, would there really be substantial uncertainty with only 6 months left to go?

[Guest AEA]

The only uncertainties I can come up with is 1) you do not know the full amount of the bonus until the committee decides if the final year's goal is met (the total amount is undetermined, so how do you elect how much to defer?) and 2) if you are not employed at the end of the third year (other than by reason of death, disability, or retirement), you get nothing. I am still debating on whether any of this is substantial.

Also, what if a year's goals are not met? For example, what if there will be no bonus for 2004 because the goals weren't met, but the goals were met in 2003 and everyone hopes they will be met in 2005. Is there an election that needs to be made by 3/15/2005 because an amount will be paid in 2006? or is there an election for the 2003 amount due on 3/15/2005 and the election for 2005 can wait until 6/30/2005?

ALSO if there it is a 3-year program, are elections made 6 months before the end of each year (i.e. - if the years are 2005, 2006, and 2007, a separate election is made on 6/30/2005 for 2005's amount, on 6/30/2006 for 2006's amount and on 6/30/2006 for 2007's amount) OR does the participant make one election on 6/30/2005 or 12/31/2004 (extended to 3/15) for the whole 3 years??