Section 409A & Physician Employment Agreements

[Guest crs]

I have a physician employment agreement in which he is to be paid on severance from service (1) collections received during a specified run-out period (5 months), and (2) accrued but unpaid amounts (he receives a monthly draw and then there is a quarterly reconciliation to actual collections, and if collections exceed draws, he receives a percentage of collections).

The agreement has a "good reason" provision so the severence exemption is not available.

Are both payments on severance from service, NQDC subject to 409A?

[Everett Moreland]

I think that collection of receivables is a "condition related to the purpose of the compensation" within the meaning of 1.409A-1(d)(1).

[Guest Gompers]

EM

Are you saying that collection of the receivable represents a substantial risk of forfeiture that doen't lapse until the receivable is collected and if you pay it out in the year collected or within 2 1/2 months after the year collected you have no 409A issue?

My inclination on these agreements-- which seem to be common in many professional practices-- is simply to state a "formula" and payment date (eg. On the 15th of every month pay 60% of any receivable collected in the prior month). My question is whether this would satisfy the following in 1.409(A)-3(g)(1)

Amounts are payable at a specified time or pursuant to a fixed schedule if objectively determinable amounts are payable at a date or dates that are objectively determinable at the time the amount is deferred. An amount is objectively determinable for this purpose if the amount is specifically identified or if the amount may be determined pursuant to a nondiscretionary formula (for example, 50 percent of an account balance).

I mentioned the "receivables collection scenario" to Hogans at a conference and he thought simply specifying the payment date and the formula in writing would work.

On the other hand, I know at one conference a question was posed about college tuition. Of course "my child going to college" cannot be a triggering event. But, if you knew your child was going to college beginning in 9/08 could you design a plan that said pay me on September 1 of each year from 2008 to 2012 whatever my child's tuition is for that year. At that conference, the IRS said that this would not work as a nondiscretionary formula.

[Everett Moreland]

Gompers:

That is what I am saying. For the reasons stated in the preamble, at 70 Federal Register page 57932, I think it makes sense to specify a payment date.

[Guest Gompers]

I a little bit uneasy with that analysis because they made a specific exception for commissions. If receipt of payment imposes a substantial risk of forfeiture then I am not sure why they needed the followiing exception for commision payments:

(10) Commissions. For purposes of this paragraph (a), in the case of commission compensation, a service provider earning such compensation is treated as providing the services to which such compensation relates only in the year in which the customer remits payment to the service recipient. For purposes of this paragraph (a)(10), the term commission compensation means compensation or portions of compensation earned by a service provider if a substantial portion of the services provided by such service provider to a service recipient consist of the direct sale of a product or service to a customer, the compensation paid by the service recipient to the service provider consists of either a portion of the purchase price for the product or service or an amount calculated solely by reference to the volume of sales, and payment of the compensation is contingent upon the service recipient receiving payment from an unrelated customer for the product or services. For this purpose, a customer is treated as an unrelated customer only if the customer is not related to either the service provider or the service recipient. A person is treated as related to another person if the person would be treated as related to the other person under §1.409A-1(f)(3)(ii) or the person would be treated as providing management services to the other person under §1.409A-1(f)(3)(iv).

[Guest crs]

So the amounts are both subject to 409A, and you comply by stating a fixed payment date? We have stated that the amounts will be paid on a certain date or by the later of (i) a date within the same calendar year of such date or, if later, by (ii) the fifteenth (15th) day of the third calendar month following such date pursuant to 1.409A-3(d).

This just seems awfully complicated.

[Guest Gompers]

The more I go back and read what I just posted from the proposed regs, maybe doctors lawyers and accountatns in many compensation systems are "on commission" as defined 409A to the extent that their compensation is set to production.

[Everett Moreland]

Gompers:

I think the rule for commissions in 1.409A-2(a)(10) is an exception to the general rule in 1.409A-2(a)(2) that an election to defer compensation for services performed during a year needs to be made before the year (even if not vested until several years later). See 1.409A-2(a)(4) and -2(b)(6) Example 6. So I don't see the rule for commissions as inconsistent with the idea that collection of accounts receivable is a "condition related to the purpose of the compensation" within the meaning of 1.409A-1(d)(1). But where the remaining uncollected accounts are assigned to the departing physician at the end of the specified run-out period, then I think that collection of the accounts is not a "condition related to the purpose of the compensation."

I would appreciate your thoughts about whether the "accrued but unpaid amounts" referred to by crs are subject to the short-term deferral rule in 1.409A-1(b)(4).

[401 Chaos]

Just curious if anybody has further thoughts on these issues in light of final 409A regulations.

I am looking at a physician agreement that provides "severance" pay in the form of a decreasing percentages of the practice's AR for three years following termination. It seems to me the first part of this is more tied to receipt of payments collected for services the doctor rendered or had a hand in but the payments beyond the first year (and I guess even some of the 1st year's payments) really seem to me to clearly be true deferred compensation arrangements. There there is a legally binding right to a certain percentage even though there is no idea how much AR the practice will actually collect. I don't think compliance there is too hard but necessitates making some changes to agreements which seems to open up can of worms.

Anybody else seeing similar arrangements or have other thoughts? Also curious if anybody may point me to an article or more detailed discussion of this issue and typical physician employment agreement issues written post-final regulations. Seems there have got to be a lot of physicians (and others) with similar arrangements.

[KJohnson]

The final regs did speak to this. Here is the langauge from the preamble which probably gives you as detailed guidance as you are going to get..

Commentators requested guidance on payment schedules contingent on

the receipt of certain payments by the service recipient. For example,

commentators requested clarification whether a plan requiring an annual

payment equal to a percentage of certain accounts receivable collected during

the prior 12-month period would qualify as a fixed time and form of payment.

The ability to schedule payments based upon the time the service recipient

receives a customer’s payment raises issues regarding the ability to, in effect,

create an impermissible event-based payment through characterizing the

payment as a schedule (for example, a payment “schedule” that pays an amount

every year if a specified transaction occurs in that year actually pays based on

whether and when the transaction occurs, which is not a permissible payment

event under section 409A). In addition, these arrangements raise issues

regarding the ability of the service recipient (or service provider) to control the

timing of the payment of deferred compensation through an ability to influence

the timing of the payment by the customer. Accordingly, the final regulations

generally provide that a schedule based upon the timing of payments to the

service recipient is not a fixed schedule of payments. However, the final

regulations also provide certain parameters under which such a plan may qualify

105

as having a fixed time and form of payment. First, if the service recipient is

comprised of more than one entity, the payments must be due from a person that

is not one of such entities (for example, not a payment due from a subsidiary

corporation to a parent corporation). Second, the payments must stem from

bona fide and routine transactions in the ordinary course of business of the

service recipient, and the service provider must not at the time such payments

are due retain effective control over the service recipient, the person from whom

the payments to the service recipient are due, or the collection of the payments.

Third, the payment schedule must provide for a nondiscretionary, objective

method of identifying the customer payments to the service recipient from which

the amount of the payment is determined, and a nondiscretionary, objective

schedule under which payments of the nonqualified deferred compensation will

be made (for example, a payment every March 1 of 10 percent of the accounts

receivable collected during the previous calendar year). Finally, the sales to

which the payment relates must be of a type that the service recipient is in the

trade or business of making and makes frequently, and either all such sales must

be taken into account or there must be a legitimate, nontax business purpose for

limiting the sales taken into account.[/color]

[Everett Moreland]

I agree with KJohnson's implicit recommendation that the agreement comply with one of the options at 1.409A-3(i)(1)(ii) and (iii). Although the final 409A regulations and preamble don't (at least in my reading) answer the question whether collection of receivables is a "condition related to a purpose of the compensation" within the meaning of 1.409A-1(d)(1), I think it's too risky to draft on the assumption that collection is a condition.