Two Times Pay for Separation Pay Plans

[401 Chaos]

Hoping somebody can help me out. I must be missing a wrinkle or something obvious but do not recall hearing this issue specifically addressed and do not see in the final regulations a way to cover an employee under the 2 times pay separation pay plan exception if the employee was hired in the same year as the year of termination and thus had no compensation from the service recipient in the the year prior to the termination year.

Is it supposed to be the case that the separation pay plan exception only applies to employees that were employed with the employer for at least part of the preceding year or is this interpreted as simply allowing 2 times the employee's annual rate of pay at time of termination in such situations? Unfortunately, the terms in the final regulations do not appear to be defined or cross-referenced in a way that helps clarify this issue.

[Guest Harry O]

Why are you trying to fit into this exception? There are others available. Why not just pay the severance in a lump sum within 2.5 months of the end of the year in which the employee terminates employment? This is a short-term deferral and you can pay a trillion dollars without any 409A worries.

[401 Chaos]

Thanks for thought on the short-term deferral exception. I agree that would make things easier; however, the company has some specific reasons for desiring a long-term installment payment plan in this situation due to some particular cash-flow concerns as well as a desire to police noncompete provisions and possible offsets in the case of future employment.

As a result, I'm still considering the applicability of the 2 times pay calculation for recent hires. I can see where the IRS would want to use prior year amounts in order to avoid potential abuses if allowed to use current salary as a benchmark for the severance amounts but it seems a bit harsh to think that should prohibit application to anybody not working in the preceding year, particularly since the amount is subject to the two times 401(a)(17) limit as well. Thanks

[namealreadyinuse]

I have never heard any exception mentioned. Policy-wise, wouldn't the Treasury want this person to be outside the exception because of the low compensation? I don't think they will be sympathetic.

[Just Me]

I noticed this issue when the final regulations were published. "Annual rate of pay" does not have any provision for looking at the current year pay or other alternatives when the person has no prior year compensation with the employer. My conclusion was that you couldn't use the exception for newly-hired individuals (and perhaps the frequency of involuntarily terminating someone in the same year you hired them would not be very great). Since cash flow is a problem for your situation, so a short-term deferral lump sum wouldn't work, then it seems like you'll need to be sure the payments satisfy Section 409A form and timing requirements. Not fitting within the exceptions doesn't mean you can't do what you want, it just reduces your flexibility.

[401 Chaos]

Thanks Just Me. That's where I am too.

I agree it shouldn't come up all that often but we see a fair bit of last hired, first fired sort of thinking, particularly in group layoff situations which I think are subject to the same 2 times limit as well.

I also agree that it should not be that big of a deal to comply with 409A here, particularly in a private company context. Unfortunately, the employment lawyers really like to have their cake and eat it too by insisting on paying the severance in installments but then pushing to qualify for a 409A exception rather than having to think through possible 409A compliance. Having to distinguish between recent hires and those employed in the prior year just adds another wrinkle or trap for the unwary.

A separate but related issue on the compliance front that I have not heard directly addressed since release of the final regulations. Employment lawyers will typically provide for severance payments made in installment to be paid in accordance with the company's regular payroll schedule or something similar. I have heard some practioners say that such a provision is not definite enough to comply with 409A while others have suggested that is too extreme a concern (i.e., that anybody who thinks you would change normal payroll practice simply to alter severance payments has never had to change payroll timing). Anybody see anything in the final regulations or heard any informal IRS guidance that addresses this issue or suggests that ability to pay within a given calendar year when specific payment date is not specified covers this issue.

[Steelerfan]

The Preamble pages 19255-19256 talk about how the time and form of payment requirements may be met where the plan does not designate a specific payment date or taxable year of the service provider. The rule will be satisfied only if the period during which such payment may be made is restricted either to a specified taxable year of the service provider or a period of not more than 90 days and the service provider is not provided an election as to the taxable year of the payment.

Therefore as long as the plan provides that payments must begin within 90 days of separation from service, it seems you would be ok to pay based on the company's regular payroll schedule, as long as you otherwise meet the rules discussed in the section entitled "Payment Schedules With Fixed or Formula Payment Limitations" starting on page 19256.