Severance/6-month delay/involuntary termination

[smm]

The preamble and the regulatios are clear that separation payments made upon an involuntary termination of employment (or a voluntarytermination that is deemed to be involuntary) and qualify for the 2 year/200% of compensation exception are not subject to the 6-month delay for specified employees. What about separation payments that exceed the 200% cap on compensation but are made in a lump sum on the date of an executive's involuntary termination (or qualifying voluntary termination). If I am reading the regulations correctly, that payment is subject to a substantial risk of forfeiture and vesting occurs on the date of the involuntary termination. Thus, this payment qualifies for the short-term deferral exception and can be made without the 6-month delay. Am I reading this right? I have read several commentaries. Very few mention this (Deloitte's does) and several say that the 6-month delay is not available if a severance payment exceeds the 200% cap even if it imade within the 2 and 1/2 month extension. Thoughts are appreciated.

Along the same lines, please confirm that the 6-month extension applies to distributions to specified employees who terminate employment voluntarily when the voluntary termination is not deemed to be an involuntary termination. Plan says that employee can elect to terminate his employment anytime within one year beginning on the happening of an event. Payments are made in a lump sum on the date of termination.

thanks.

[Guest Harry O]

Agree with both of your conclusions.

[Steelerfan]

The interplay between the short-term deferral (STD) exception and the severance pay limit is not entirely clear. Based on Dan Hogans comments, I believe the following to be viable interpretations.

If the entire amount of severance will be paid within the STD period, then the the severance pay limitations may be exceeded. EG you can pay 1 Million upon involuntary termination within the STD period.

Bifurcated payment problem: Where some of the payment will be made within the STD period and some after, it is not so clear. Conservative approach would be to limit the amount paid as a STD to the lesser of 2x prior pay or 450,000, then pay the balance in accordance with 409A restrictions (ie 6 month delay). However, Hogans informally stated that you can exceed the 2x pay limitation using the STD rule with bifurcated payments. Meaning that you could pay 650,000 within STD period and pay the rest in accordance with 409A restrictions. I don't know anyone who is totally comfortable with this conclusion, considering that Hogans will most likely leave the service soon and there is no formal guidance on this point. The problem is that this interpretation could make the severance pay limits virtually irrelevant since the large majority of cases will involve vesting on termination.

[smm]

The interplay between the short-term deferral (STD) exception and the severance pay limit is not entirely clear. Based on Dan Hogans comments, I believe the following to be viable interpretations.

If the entire amount of severance will be paid within the STD period, then the the severance pay limitations may be exceeded. EG you can pay 1 Million upon involuntary termination within the STD period.

Where some of the payment will be made within the STD period and some after, it is not so clear. Conservative approach would be to limit the amount paid as a STD to the lesser of 2x prior pay or 450,000, then pay the balance in accordance with 409A restrictions (ie 6 month delay). However, Hogans informally stated that you can exceed the 2x/2 year limitations using the STD rule. Meaning that you could pay 650,000 within STD period and pay the rest in accordance with 409A restrictions. I don't know anyone who is totally comfortable with this conclusion, considering that Hogans will most likely leave the service soon and there is no formal guidance on this point.

[smm]

Sorry about the above, I presses the send button too soon. I'm curious, when is Hogans leaving, where is he going and when.

[Steelerfan]

Sorry about the above, I presses the send button too soon. I'm curious, when is Hogans leaving, where is he going and when.

It's only speculation that he will leave.

[Guest Harry O]

Not sure why you are uncomfortable with applying the STD exception to the first six months of 24 months of severance payments. The regs are quite clear that you can treat each installment as a separate payment or the entire series as a single payment. And you can still "stack" the 2x exception on top of this.

[Steelerfan]

Not sure why you are uncomfortable with applying the STD exception to the first six months of 24 months of severance payments. The regs are quite clear that you can treat each installment as a separate payment or the entire series as a single payment. And you can still "stack" the 2x exception on top of this.

I guess because it make the 2x exception seem largely irrelevant and an interpretation that makes one part of the regulations irrelevant seems suspect to me. Similar to a court's reluctance to interpret a statute in such a manner. I wonder if this result was contemplated when the regs were finalized. Doesn't it seem plausible that the IRS could come out in formal guidance and say that the 2x exception overrides the short term deferral exception, meaning that any installment that is paid with the 2.5 months cannot be greater than the 2x limit? I mean how can anyone determine with certainty that the STD exception trumps and then if it does what is the purpose of the 2x limit? Any comment appreciated.

[Locust]

Issue on the stacking issue.

I've read that in order to meet the 2X/2 year exception all payments made on separation are aggregated, so that if you had a lump sum of 2 X pay immediately following separation and also installment payments over a year, that the entire amount (both the lump sum and the installments) would be subject to 409A.

If that is the case, and if you had a specified employee, the entire amount would be in violation because payments in the first 6 months violate the 6 month rule. Do you think that is a correct reading of the separation pay/short term deferral exceptions?

[Guest mbw]

How would/would the conclusion change if the payment was only installments over three years and not a lump sum? Assume the installment payments during the first six months do not exceed the 2x limit. Is there no six month delay in this case?

[Steelerfan]

How would/would the conclusion change if the payment was only installments over three years and not a lump sum? Assume the installment payments during the first six months do not exceed the 2x limit. Is there no six month delay in this case?

We've got two substantially similar threads running here, maybe we can pick one. Check my other answers and see if you agree.

The answer I think in this case is that the sixth month delay would not apply to a specified employee if you bifurcate the payments properly. You do not have to aggregate payments. If the amount to be paid did go over the 2X limit, you could structure the payments as completely separate from each other (bifurcated) and you could slip some of that money into the exec's pocket before 6 months under the ST deferral rule. My understanding is that the exeptions conceptually run concurrently and independent at the same time. If you bifurcate, use the ST deferral rule and structure your payments properly you can completely avoid both the 6 month rule and the 2x/limit. Payments that spill past 2 years are in compliance with 409A, so no issue there.

In order to avoid the 2x limit for a really large payment you would have to pay higher amounts as a short term deferral. Here's a few examples:

Example 1: Executive is entitled currently to severance upon termination

without cause equal to 3 times base salary plus target bonus, payable

monthly over three years. His 2007 base salary is $600,000 and his target

bonus is $300,000; thus, the total amount he'd be entitled to under this

formula for a termination in 2007 is $2.7 million, or $75,000 a month. In

this case, we could pay him exactly what we would always have paid him,

since $75,000 a month times 6 is $450,000, so his first six months of

payments is within the safe harbor.

Example 2: Same as example 1, only suppose the executive's base pay and

bonus are such that he'd be entitled to $3.24 million, or $90,000 a month

for 36 months. In that case, you could pay him $75,000 a month for the

first six months, and then either adjust his remaining payments starting in

month seven to account for the difference, or just pay him the aggregate

difference in month seven (in this case, he'd just get an extra $90,000

payment).

A more aggressive approach would allow you to ignore the $450,000 limit entirely. Here's how it works:

Using the short-term deferral rule in example 2, above, you can arguably pay the entire amount that would ordinarily be paid during the first six months ($90,000 a month, or $540,000), as follows:

1. Provide that $540,000 will be paid to the executive in a lump sum

within 60 days after the date of involuntary termination (which would in

all events be earlier than March 15 following the year of termination).

2. Provide that starting in month seven, the executive will begin

receiving $90,000 a month, to continue for 2 1/2 years.

All of these exceptions are premised on severance benefits being paid only upon an involuntary termination in order to preserve the SRF. This kind of heavy planning to avoid rules should not be necessary just so an exec can an extra 100,000 or 200.000 that he probably doesn't need.

But if the aggressive approach makes you a little uncomfortable, join the club!

[Guest mbw]

I agree with your analysis. Do you think your doc has to specifically say that each installment is a "separate payment"? If it doesn't now, can you amend it before the end of the year?

[Locust]

I'm not really convinced - I think it is ambiguous. Here is my message from the other thread.

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I think the basis for the aggregation is the definition at 1.409A-1©(2)(D) "All deferrals of comepnsation with respect to that service provider under all separation pay plans [with certain exceptions]. . are treated as deferred under a single plan."

I think you have to have this rule, otherwise the 6 month restriction on payments on account of separation to a specified employee (publicly traded cos.) would be too easy to avoid in the context of separation pay plans - the plan would pay the first 6 months of payments by the end of the short term deferral period, then pay the rest after the end of the 6 month period.

Also, the 2Xpay/2 year exception would be fairly meaningless - just stick all of the separation pay in excess of 2x pay in the short term deferral period.

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What it comes down to is that application of the short term deferral rule separately from the 2Xpay/2 year rule would mean that the 6 month rule is meaningless in the context of separation pay, provided that the payments are completed before the end of the ST deferral period - maybe that's the point.

Also, to some extent the 2 X pay rule wouldn't be much. All you would have to do would be to add a clause that said: "notwithstanding the above, if the total amounts promised exceed 2 x pay, the excess amount shall be paid no later than 2 1/2 months following the end of the calendar year in which the executive is involutarily terminated." The result would be that none of the compensation would be deferred and none of it would be subject to the 6 month rule or any other 409A restrictions.

[Steelerfan]

I'm not really convinced - I think it is ambiguous.

I've previously expressed my own concerns and the need for it, but I think it works.

What it comes down to is that application of the short term deferral rule separately from the 2Xpay/2 year rule would mean that the 6 month rule is meaningless in the context of separation pay, provided that the payments are completed before the end of the ST deferral period - maybe that's the point.

That's the safest way to do it, but not always practical or possible, so the ability to bifurcate is a valuable planning tool.

Also, to some extent the 2 X pay rule wouldn't be much. All you would have to do would be to add a clause that said: "notwithstanding the above, if the total amounts promised exceed 2 x pay, the excess amount shall be paid no later than 2 1/2 months following the end of the calendar year in which the executive is involutarily terminated." The result would be that none of the compensation would be deferred and none of it would be subject to the 6 month rule or any other 409A restrictions.

I would agree, but I think you would need to beef up the language to make sure the payments each constitute separate payments for purposes of 409A, otherwise, they could be considered one stream of payments entirely subject to 409A

[Steelerfan]

I agree with your analysis. Do you think your doc has to specifically say that each installment is a "separate payment"? If it doesn't now, can you amend it before the end of the year?

Yes and yes.

[Just Me]

Sorry about the above, I presses the send button too soon. I'm curious, when is Hogans leaving, where is he going and when.

It's only speculation that he will leave.

Well, speculate no more. Looks like Hogans has been a partner at Morgan Lewis for about three weeks now.