Indemnification under 409A?

[ERISAatty]

In negotiating a executive's employment agreement on behalf of an employer recently, the executive's attorney requested that the employer agree to INDEMNIFY the executive, in the event that the employment and nonqualified deferred comp. agreement turned out NOT to comply with 409A, and therefore resulted, in the future, in tax liability as a result of income inclusion.

We said no, and it was left at that.

But I'm wondering if anyone else has thought about this.

Since 409A puts the whole burden of a failed 409A-subject plan on the employee, it seems that the employer has no interest in agreeing to indemnify any employees. The employer's interest is just to draft the plan properly. But I suppose, in theory, indemnification is permissible, if both parties are willing.

Any thoughts?

[mbozek]

Why not since the indemnificaton payment will be taxable income to the employee which will further the main reason for enacting 885- to raise revenue. Congress expected that employers will gross up ees to eliminate the impact of taxes and penalties imposed under 885 rather than design plans that will conform to the law. An employee in 35% bracket who has 60k in taxes will need 90k extra plus additional amount if 20% penalty tax applies. I am assuming that the 20% penalty tax applies to the gross amount of payment before income tax is taken out which will require that the amount needed to pay taxes be divided by the sum of the marginal tax rate plus 20% so if 60 k is tax due for ee in 35% bracket, gross payment would be 133,333 ($26,666 for 20% penalty + 46,666 income tax@ 35% =73,333 to IRS)

[TCWalker]

I have thought about it and deem it standard nego. for all relevant agreements on the plaintiff's E-L side.

Afterall, the employer is almost always in a better position, better resourced to determine the relevant application of 409A to the employee and influence the terms of the agreement accordingly.

Another way of looking at it; if the agreement is later found to have violated 409A the employer is likely to get sued and I suspect the blanket release won't work. Moreover, I guess it calls the integrity of the entire release into dispute. That's where the employer derives a benefit from indemnifying and saving the release.

[Kirk Maldonado]

ERISAatty:

You said:

Since 409A puts the whole burden of a failed 409A-subject plan on the employee, it seems that the employer has no interest in agreeing to indemnify any employees. The employer's interest is just to draft the plan properly. But I suppose, in theory, indemnification is permissible, if both parties are willing.

How is this indemnification any different than the gross-up for the golden parachute taxes (which is pretty common)?

[E as in ERISA]

I think that you'd distinguish between violations that the employer solely controls (e.g., the plan provides for distribution options not allowed and causes violations for the participants) versus violations that the employee can help fix (an impermissible distribution that the employee can restore). I would think that the employer would only indemnify in the first, if at all. And that would be more similar to the 280G issue. But I certainly wouldn't expect the employer to indemnify a situation that the employee might be able to fix.