Transaction bonus not linked to employment status

[Lawful Citizen]

Hi everyone, great to be here and apologies in advance if I haven't put this question in the correct place.

I'm trying to provide a family member with some guidance on a compensation issue they are having with their employer.

The short background is that my family member (who I'll refer to as "Jane") has played a key role in building a company from $0 to a significant current day value.

Because of early-stage company challenges, it never executed Jane's equity agreement when she first joined the company. Because she generally operates in good faith, she didn't push for the issue to be dealt with (until now).

The company is now proposing a change of control bonus (% of sale proceeds) to fix the situation.

Jane is receiving conflicting information on the following aspects of the agreement and I'd appreciate any thoughts on these issues -

1. Does Jane need to be actively employed by the company when it sells for any 409A or other tax/compliance reasons? Technically she would have already 'vested' the right to this bonus if it were equity and so doesn't seem right that she be held hostage for an unknown amount of time for something she has technically earned/vested.

2. Given that there is some possibility she may not be at the company when it sells (let's say in 3-4 years), does this have the characteristics of a top hat agreement and therefore touch on ESIRA?

3. Are there any other concerns/considerations from a tax, compliance or other perspective that she should be considering?

[QDROphile]

Sorry, 409A is just too touchy for me to be make off-the-cuff comments based on incomplete information.

I do wonder if the “fix” takes into account the difference between capital gain income, which could have been a feature of an appropriate and timely equity arrangement and ordinary income, which is the norm for deferred compensation.

[EBECatty]

As QDROphile says, 409A is touchy, so a small tweak to the circumstances, language, definitions, etc. in the agreement can make a big difference. 

In my very general and not-fact-specific view:

1. Under 409A, the employee is not required to be employed when the sale happens if the "change in control" definition is 409A-compliant, but this is a common requirement in practice in any event. If the definition of "change in control" is not 409A-compliant, usually continued employment would be required to make the arrangement a short-term deferral as a corporate transaction that does not qualify as a "change in control" under the 409A definition is not an independent permissible payment event. 
2. If it's a single payment for one person that is triggered only on a change in control, usually it's not treated as an ERISA-covered top-hat plan. If you layer in things like a payment on "the earlier of a change in control or retirement at or after age 65" etc. it becomes more fact-specific. 
3. From a tax perspective, nothing happens until a change in control, then one taxable payment is made. From a compliance perspective, 409A exemption/compliance for sure. Make sure there is nothing in the agreement that could be construed as funding the plan. The application of FICA can depend on how the plan is structured as well.

[david rigby]

Maybe it's just me, but it seems Jane might want (in addition to the "due on sale" aspect discussed above) some other reward, soon, perhaps even an annual cash bonus.  Perhaps Jane could engage the services of a good compensation consultant (one who is selling only his/her expertise, rather than a product), or an ERISA attorney.  

[Lawful Citizen]

On 3/5/2024 at 2:18 AM, EBECatty said:

As QDROphile says, 409A is touchy, so a small tweak to the circumstances, language, definitions, etc. in the agreement can make a big difference. 

In my very general and not-fact-specific view:

1. Under 409A, the employee is not required to be employed when the sale happens if the "change in control" definition is 409A-compliant, but this is a common requirement in practice in any event. If the definition of "change in control" is not 409A-compliant, usually continued employment would be required to make the arrangement a short-term deferral as a corporate transaction that does not qualify as a "change in control" under the 409A definition is not an independent permissible payment event. 
2. If it's a single payment for one person that is triggered only on a change in control, usually it's not treated as an ERISA-covered top-hat plan. If you layer in things like a payment on "the earlier of a change in control or retirement at or after age 65" etc. it becomes more fact-specific. 
3. From a tax perspective, nothing happens until a change in control, then one taxable payment is made. From a compliance perspective, 409A exemption/compliance for sure. Make sure there is nothing in the agreement that could be construed as funding the plan. The application of FICA can depend on how the plan is structured as well.

Thanks EBECatty!

1. The definition used for change of control appears to be in alignment with 409A

2. Correct, payment would only be triggered on change of control, period.

3. Thank you for highlighting this aspect

 

[Lawful Citizen]

On 3/5/2024 at 3:05 AM, david rigby said:

Maybe it's just me, but it seems Jane might want (in addition to the "due on sale" aspect discussed above) some other reward, soon, perhaps even an annual cash bonus.  Perhaps Jane could engage the services of a good compensation consultant (one who is selling only his/her expertise, rather than a product), or an ERISA attorney.  

Agreed. Unfortunately, at this stage, it is not even clear that the company is going to honor what they offered Jane to entice her to join.

I'm hoping it doesn't end up becoming a cautionary tale like many others.