Definition of "applicable covered employee"

[Guest W Waldan Lloyd]

Anyone have a sense of how IRS and Treasury interpret “applicable covered employee” for purposes of applying the restriction on deferred compensation under a plan sponsored by an employer with a DB plan in at-risk status? Here the employer is a wholly-owned U.S. subsidiary of a foreign parent where the parent’s stock is traded on a foreign exchange.

There are 2 issues – which employees are affected? – and what is the restricted period?

The statute says a covered employee is an individual either described in 162(m)(3) or subject to 16(a) reporting under the ’34 Act. 162(m)(3) says a covered employee is the CEO or one of the 4 highest paid individuals subject to reporting under the ’34 Act. Of course, 162(m) is the compensation limitation for certain employees of publicly traded companies (i.e., subject to registration under the ’34 Act). Here neither the U.S. subsidiary nor its foreign parent is subject to reporting under the ’34 Act – but is the statutory definition for DC purposes intended to be broad enough to at least cover the CEO, regardless of ’34 Act registration status of the employer? If so, wouldn’t this also extend the restriction rule to closely held companies?

The restricted period is defined by reference to Code §430 – which suggests the at-risk/restriction period begins as of the next plan year after the year of certification and runs for the entire year, unlike the limitation on lump sums from the DB plan which is at risk.

I can find no official guidance other than the statutory language. Thoughts?

[Everett Moreland]

The following is from the 2009 IRS Q&As of the ABA Joint Committee on Employee Benefits:

29. § 409A – Prefunding of Nonqualified Deferred Compensation Plans

Do Section 409A(b)(3)’s restrictions on prefunding nonqualified deferred compensation of covered employees during a restricted period with respect to qualified single-employer defined benefit plan apply to the CEO of a non-public entity? This question arises because Section 409A(b)(3)(D)(ii) defines covered employee as including individuals described in Section 162(m)(3). Section 162(m)(3)(A) provides: “For purposes of this subsection, the term ‘covered employee’ means any employee of the taxpayer if ... as of the close of the taxable year, such employee is the chief executive officer of the taxpayer or is an individual acting in such a capacity.” While Section 162(m) only applies to public companies, this text could be read as subjecting CEOs of all entities, including privately held companies and not-for-profit entities, to the prefunding restriction in Section 409A(b)(3).

Proposed Response: Section 409A(b)(3)’s restrictions on prefunding nonqualified deferred compensation of covered employees during a restricted period with respect to qualified single employer defined benefit plan apply only to covered employees of public companies.

IRS Response: The Service representative indicated that there is not an answer on this question and that it is an issue that is under study.

[Ron Snyder]

First- welcome to the Board from an old friend.

The statute says a covered employee is an individual either described in 162(m)(3) or subject to 16(a) reporting under the ’34 Act. 162(m)(3) says a covered employee is the CEO or one of the 4 highest paid individuals subject to reporting under the ’34 Act. Of course, 162(m) is the compensation limitation for certain employees of publicly traded companies (i.e., subject to registration under the ’34 Act).

Can the statute be interpreted as "reporting under the '34 Act or comparable statute"?

Here neither the U.S. subsidiary nor its foreign parent is subject to reporting under the ’34 Act – but is the statutory definition for DC purposes intended to be broad enough to at least cover the CEO, regardless of ’34 Act registration status of the employer? If so, wouldn’t this also extend the restriction rule to closely held companies?

Not necessarily. Congressional intent not to apply the statute to closely-held companies is clear. Don't you think that the SEC would respond to a ruling request on this issue?