Calculating Severance Amounts Under 409A

[401 Chaos]

This is probably a dumb question but I have not seen much direct discussion of this topic and am hoping somebody can direct me to guidance in the proposed regulations.

If a terminating employee receives accelerated vesting of stock options or similar non-cash enhancements as part of a severance package, should the value of such accelerated vesting be calculated basically the same as accelerated vesting be calculated under 280G in the event of a change in control? Is there any argument that such accelerated vesting benefits should be excluded for purposes of determining whether the individual is within the 2 times comp or 2 times the 401(a)(17) limit?

Also, am I reading the "in addition to" provision in the proposed regulations correctly that the $5,000 de minimis payment provision in 1.409A-1(b)(9)(iv)© would be in addition to all the other severance benefit and reimbursement calculations? For example, could a terminating employee get 2 times 401(a)(17), continued health care coverage for 6 months, PLUS up to $5,000 in value related to accelerated stock option vesting and still come within the safe harbor? Seems to me the de minimis rule should be that notwithstanding any of the above exceptions any separation pay or benefits that are not more than $5,000 per year would be excluded from 409A regardless whether they are covered by one of the standard exceptions.

[Just Me]

This is probably a dumb answer to your question, but why would the acceleration of a stock option (presumably issued with an exercise price at least equal to the fair market value on the grant date) be a 409A issue? The stock option should fall outside of 409A entirely. In addition, accelerating the payment of 409A deferred compensation is prohibited, but not accelerated vesting of 409A compensation, even if such vesting results in an earlier payment.

I agree that the $5,000 de minimis benefit is in addition to other exceptions that may also apply.

[401 Chaos]

Thanks for the response. I agree the options themselves generally shouldn't be subject to 409A, even if vesting is accelerated. My concern is whether some value must be attributed to the accelerated vesting of stock options for purposes of determining whether the individual's total separation pay falls within the safe harbor. I raise that concern because 280G generally does place a value on such accelerated vesting for purposes of determing whether an individual's payout upon a change in control crosses the excess parachute payment threshold.

The proposed regulations do not appear to address this but the term "separation pay" would arguably seem broad enough to capture any potential value the IRS might attach to the accelerated vesting of options as part of a severance agreement. In the absence of any express guidance, I'm concerned that the IRS might draw some parallel to the 280G rules and attempt to attach some value to options as a result of accelerated vesting where a terminating employee received the max 2 times 401(a)(17) limit in cash plus accelerated vesting of options. Thanks

[Guest zora]

Are you worried about other separation pay or the options themselves? Obviously, as discussed above, the options are not subject to 409A (provided all rules for options are met), so you must be looking at other separation pay.

It seems to me that the exclusion for separation pay applies only if you have nonqualified deferred compensation in the first place. The proposed regulations say "separation pay" is not deferred compensation if the "separation pay may not exceed ...." The combination of the fact that the exception applies only if you have deferred compensation and the use of the phrase "separation pay" in both places to me suggests, maybe, that the regs mean "deferred compensation that is separation pay" is not deferred compensation if the "separation pay", i.e., the deferred compensation that is separation pay, "may not exceed ...." That is, the first time separation pay is used it can only refer to separation pay that is deferred compensation (otherwise no exception is needed) and the same phrase used again in the regulation that cannot exceed the requisite amount would have the same definition, i.e., it would only include deferred compensation subject to 409A.

Another way to look at it is if you do count non-409A compensation paid at termination, you may have to count not only the value of acceleration of the options, but also 401(k) distributions and other qualified plan distributions, disability pay, accrued but unused vacation pay, or any other payment paid upon termination, whether or not the payment is excluded from 409A.

But don't quote me on any of this, I'm not the IRS agent that will be doing the audit. But if nothing else, this may and could maybe possibly be, but I don't know of course, a good faith interpretation.

[401 Chaos]

I just wanted to bump this up to see if anybody had additional thoughts or guidance on this issue. Although I've seen others assume Zora's interpretation that amounts that would not otherwise be subject to 409A (such as accelerated vesting of nondiscounted options) should not be counted in the severance calculations, there seem to be others that assume the value of accelerated vesting may need to be counted or made to comply with 409A (see March-April 2006 NASPP Advisor suggesting that accelerated vesting of options upon termination may need to be structured to comply with the requirements of severance payments under 409A).

Although I take Zora's point that taking accelerated vesting into account creates an argument that other items paid upon termination would need to be included, seems to me the 401(k) amounts, other qualified plan amounts, unused vacation, disability amounts, etc. are likely paid out or triggered by the separation from service or other legal triggers giving the individual the right to receive those amounts rather than having them paid as "severance pay." In many cases I see accelerated vesting included as one additional piece of added compensation or severance benefits to be given to an executive in exchange for a general release against the employer and clearly included as part of a negotiated "severance package" to which the executive would not otherwise have a legal right.

Another question, if the value of accelerated vesting is to be taken into account for 409A purposes, how do you deal with the 6-month delay rule when dealing with public companies? Do you have to avoid all vesting and exercise for 6 months, do you allow for accelerated vesting but block exercise for 6 months, or something else?