Earned and vested before 2005?

[J Simmons]

Situation: Before 2004, ER issued 30 shares of discounted, restricted stock to EE subject to a repurchase per formulaic price. No additional shares were granted after that. Repurchase is triggered by the EE's death or the ER giving notice to the EE after the termination of employment, which the ER could delay doing. Payout is withing 90 days of either repurchase event. Once the ER gives notice to repurchase, the EE can per original grant provisions postpone the repurchase of the 30 shares by 6 months for every 12 months worked after grant of restricted stock. Employment ended in mid-2006; ER chose to and gave notice in 2006; but before payout during the 90 days occurred--and yet in 2006--EE exercised right to defer the repurchase on the 30 shares per the 6-months-for-every-12-months provision. This extends payment to 2009.

No material (or other) modifications have been made to the arrangement, either before or after October 3, 2004.

This looks to me to be discounted stock appreciation rights.

Q1: Does appreciation in the value of the 30 shares of stock after 2004 count as compensation earned and vested after 2004, which would then be subject to 409A?

Q2: Does 409A apply regardless of the dates because it is discounted stock rights?

Q3: Does the ER choosing to give notice of repurchase in 2006 rather than in a later year constitute an exercise that makes payment an impermissible one subject to 409A taxes?

Q4: Does the EE exercising the right to defer after a post-employment notice from the ER, and the repurchase price otherwise became payable in 2006, trigger application of 409A to the arrangement either at that time or back to 1/1/2005?

[Everett Moreland]

Is your statement that this looks like discounted stock appreciation rights based on the buy-sell agreement? My reaction to your post is that this is restricted stock to which 409A does not apply unless there is a compensation element in the buy-sell agreement.

[J Simmons]

Thanks, Everett. Yes, I think there is a compensation element. The ER's motive in making it was to entice the EE to remain employed and providing services. The stock grant basically gave the EE the right to appreciation of stock while he would yet remain employed. True, the ER could have delayed the post-termination notice and thus delayed the repurchase obligation, extending the time that the former EE would be entitled to appreciation on the stock. The EE could, and did, extent the time of the repurchase (and thus period of appreciation) by 6 months for every 12 full months worked. However, both repurchase triggering events have their roots in employment ending, by death or otherwise.

Also, contemporaneous with the stock grant, the ER and EE signed an 'employment agreement' that basically amounted to an agreement by the EE to keep the ER's trade secrets confidential.

[Everett Moreland]

Some time ago I had to sort out whether a buy-sell agreement could have a compensation element for 409A purposes. My memory of where I came out is that so long as none of the sale proceeds is properly taxable as compensation (i.e. to the extent they are sale proceeds), 409A does not apply. I was concerned that the 409A regs on stock rights might aggregate a buy-sell agreement with the related stock rights if the buy-sell agreement has any compensation element, so I decided that the safe course is to scour the buy-sell agreement for possible compensation elements (such as whether the buy-sell agreement is structured to pay more than fair market value, either in the purchase price or by using too high of an interest rate for installment payments) and eliminate them. My guess (based of course on no facts) is that all the purchase price under the buy-sell agreement you are dealing with is all sale proceeds and so 409A does not apply.

[J Simmons]

Per Treas Reg sec. 1.409A-1(b)(5)(i)(B), it would appear that the arrangement I'm dealing with is a stock appreciation right that does not meet the three prong test to avoid being 'deferred compensation'.

Any input on the OP questions?

[Everett Moreland]

At the risk of continuing to be unhelpful to you, I don't think 1.409A-1(b)(5)(i)(B) defines what you describe as a stock appreciation right. That regulation starts:

"A right to COMPENSATION based on the appreciation in value of a specified number of shares of service recipient stock occurring between the date of grant and the date of exercise of such right (a stock appreciation right) . . . ."

My understanding of the law is that generally the price the issuing corporation pays under a buy-sell agreement to buy back vested resticted stock is taxed as capital gain, not compensation, and so the buy-sell agreement does not create a right to compensation and so is not a stock appreciation right.