Noncompete clause

[Guest hsbander]

I have a client that wants to provide that payment under a 457(f) plan will be made within one year of termination of employment provided the employee has not violated the noncompete clause in the employee's employment agreement during that time. I don't think that is permissible under 409A. Does anyone think it can be done, and if so, how? Thank you.

[namealreadyinuse]

Are you asking whether a noncompete constitutes a risk of forfeiture for 409A? No, it does not under the proposed regulations. But . . .

you can draft a 457(f) plan with a provision for payment within one year after termination of employment and not violate 409A.

[Guest hsbander]

Are you asking whether a noncompete constitutes a risk of forfeiture for 409A? No, it does not under the proposed regulations. But . . .

you can draft a 457(f) plan with a provision for payment within one year after termination of employment and not violate 409A.

The client wants the payment to be made within 1 year of termination of employment provided that the former employee hasn't breached the noncompete clause in her employment agreement at the time of payment. If the noncompete has been breached, no payment. I know the "within 1 year of termination of employment" would be fine by itself, but I think the addition of the condition regarding the noncompete clause makes it not an acceptable time of payment provision under 409A. That's really my question -- it's whether the time of payment still works. I realize I may not have a substantial risk of forfeiture.

[Locust]

It's hard to think about because of the interaction between 409A and 457(f). I believe a legitimate noncompete can be a substantial risk of forfeiture under 457(f), though not under 409A. So it's ok under 409A (and not covered by 409A) if it is paid within 2 1/2 months following the end of the year in which termination of employment occurs. However, if the payment will be made "within 1 year of termination," that would not necessarily be by 3/15 of the year following termination (ex. termination on 12/1/2007), so it could be subject to 409A. Since it is subject to 409A, the fact that the payment date is not a fixed date but "within 1 year of termination" becomes an issue.

A way to resolve this (without having to think about it too much) would be to say that payment will be made by the 3/15 of the calendar year following the calendar year in which the employee terminated, provided the noncompete condition is met until the payment date. Of course that 3/15 might not be a full year. This approach avoids 409A. Another way might be to say that payment will be made on the first anniversary of termination of employment, provided the noncompete condition is met until the payment date. This meets 409A.

[namealreadyinuse]

It wouldn't bother me if there was a right to completely take the right to payment away. 409A is concerned with further deferral and early access to the money. It would be a forfeiture condition that does not rise to the level of a substantial risk of forfeiture for 409A. 409A would be satisfied in my mind.

[E as in ERISA]

409A is a rule regarding timing of taxation. I think that the question is whether there is any risk that the employee will be taxed at the end of that year even if he never ultimately receives the payment.

[Guest KLCarter]

A way to resolve this (without having to think about it too much) would be to say that payment will be made by the 3/15 of the calendar year following the calendar year in which the employee terminated, provided the noncompete condition is met until the payment date. Of course that 3/15 might not be a full year. This approach avoids 409A.

Do you mean that it satisfies 409A, or that it avoids 409A? How does it avoid it?

[Everett Moreland]

There are two questions here:

1. Is the noncompete a substantial risk of forfeiture under 457(f). My comments under 2. below assume it is. I think that under the § 83 regulations this is a question of fact. The IRS has a regulations project on this. See http://hr.cch.com/news/pension/091906a.asp.

2. If the noncompete is a substantial risk of forfeiture under 457(f) but not under 409A, is that a problem? It think it is not a problem. It means you can't use the 2-1/2 month rule under 409A so you have to have a payment schedule that complies with 409A. I think that if the employee forfeits before the time for payment under the payment schedule, that does not violate 409A.