United States: Updates to the 409A Rules

The Treasury Department and the IRS last week proposed changes to final and proposed regulations under Section 409A of the Internal Revenue Code. Compliance with 409A is required to avoid disadvantageous federal income tax treatment for a broad range of nonqualified deferred compensation arrangements. While not dramatically altering how the 409A rules work, the proposed changes offer generally helpful clarification in some areas and added flexibility in others.

Below is a summary of the most significant changes.

When is a "Payment" Made?

Current regulations do not contain a uniform rule for determining when a "payment" is made: some taxable events are treated as a "payment" for some purposes and not others, and the treatment of other payments is unclear. The proposal introduces a single rule, applicable for all purposes, that looks generally to when an event results in currently taxable income. Under the proposed rules, for example, a deferred amount subject to Section 457(f) of the Code (relevant to tax-exempt and governmental employers) will count as a "payment" on the vesting date and not the actual payout date for purposes of determining both whether the arrangement is exempt from 409A as a "short-term deferral" and whether, if it is not exempt, it satisfies 409A's detailed timing-of-payment rules. Under the proposed rules, a transfer of unvested property (e.g., restricted stock) is not a "payment" unless the service provider makes a so-called "83(b) election" to include the value in current income.

Payments upon Death

Existing 409A rules permit payment, including acceleration of payment, in the event of death, but in practice administration of the rules can present timing difficulties because the employer may not know that death has occurred until long after the 409A payment deadline. The proposed rules address this problem by allowing a payment at death to be paid at any time designated by the payor or payee up to and including December 31 of the calendar year following the calendar year in which death occurs. Employers may amend plans to provide for this new flexibility (or administer unamended plans consistent with the new rule) without having to comply with the rules under 409A governing changes to the timing of payments.

Separately, the proposed rules would extend the payment-at-death rules to payments upon the death of a beneficiary and would similarly permit payments to a beneficiary to be made in connection with the beneficiary's disability or an unforeseeable emergency.

Stock Rights

Forfeited stock rights. Current 409A rules contain an exemption for stock options and stock appreciation rights (stock rights) that satisfy specified requirements, among them a requirement that the exercise price not be less than the grant-date fair market value of the underlying stock and a corollary requirement that, with limited exceptions, the underlying stock not be subject to a mandatory repurchase obligation based on a measure other than fair market value. Some practitioners worried that the prohibition against mandatory repurchases other than at fair market value might bar forfeitures and claw-backs – e.g., for a violation of a noncompete. The proposed rules alleviate this concern for situations where the triggering event is a for-cause termination or a condition within the service provider's control such as the breach of certain restrictive covenants, if less than fair market value is paid.

Granting stock rights to prospective employees. Currently, the provision described above that exempts stock rights from the reach of 409A applies only to a stock right granted to someone providing direct services to the issuer or a subsidiary on the date of grant. The proposed rules would exempt grants to someone not yet at work if the grantee is reasonably expected to start work within 12 months and actually does so. In practice this change may have only a limited impact, because the securities laws limit a company's ability to offer equity to prospective employees, and the "incentive stock option" (ISO) tax rules, where relevant, separately require that a grantee be employed on the date of grant.

Transaction-based compensation. The parties to acquisition transactions often want to re-set payment terms for the target's incentive pay arrangements, in particular those tied to stock value. One reason is to align the treatment of awards based on stock or stock value (so-called "transaction-based compensation") with the treatment of actual shareholders in the transaction. For transaction-based compensation subject to 409A, the "re-set" may not fit neatly within the limitations 409A imposes generally on changes in payout terms for deferred amounts. Existing 409A regulations address this problem for change in ownership transactions by treating revised payout terms (for transaction-based compensation) as 409A-compliant to the extent they do not push payments out more than five years beyond the transaction, if they also mirror the payout terms for shareholders. It was not clear from the existing regulations whether this relief also covered otherwise exempt stock rights, which are subject to more punitive treatment in the case of impermissible extensions. The proposed rules make it clear that the relief applies in this case also. However, it does not provide the broader flexibility that a number of practitioners had hoped to see addressed explicitly in the regulations – for example, the flexibility to restructure stock rights as unvested cash-out promises or restricted stock units that yield payments, if at all, over the original vesting term of the award rather than on the same terms that apply to shareholders.

Proposed Income Inclusion Rules

A separate portion of the release adjusts 409A proposed regulations issued in late 2008 (but not yet finalized) that prescribe how to measure the income required to be taken into account in the case of noncompliance with 409A. The new proposal does not revamp the 2008 proposed rules generally but makes several important changes or clarifications. The 2008 proposed rules provided that accelerated income inclusion could be avoided for an unvested arrangement out of compliance with 409A if the arrangement was brought into compliance before the beginning of the year in which vesting occurred, although the 2008 proposed rules also contained an anti-abuse provision intended to limit the scope of this relief. The new proposal gives examples of objectionable patterns and practices that will render the relief unavailable. It also makes it clear that parties cannot use the relief provision as the basis for changing payout terms that were not themselves the source of noncompliance. Finally, and perhaps most importantly, the new proposal requires taxpayers to follow existing correction rules (issued by the IRS outside of the regulations) if available.

Separation Pay Plans

Current 409A rules contain an exemption for severance that does not exceed the lesser of two dollar amounts, one of which turns on the individual's prior-year pay. The "prior year" rule makes the exemption unavailable for someone hired and terminated in the same calendar year. The proposed rules address this case by permitting annualized current-year pay to be used if the terminated individual had no prior-year pay from the employer.

Short-Term Deferrals

The proposed rules provide that payment under an otherwise qualifying arrangement can continue to qualify as an exempt short-term deferral even if made after the applicable 2½ month period if the employer reasonably anticipated that making the payment on its original schedule would have violated federal securities laws or other applicable law.

Plan Terminations

The proposed rules further clarify that, with respect to the plan termination rules that require plans of the same type to be terminated, an employer must terminate and liquidate all plans of the same 409A category that the employer sponsors, and not only those plans in which an affected service provider actually participates. They also clarify that in the case of a plan termination that currently requires that a new plan not be adopted for three years following plan termination, the employer cannot adopt a new plan that would be aggregated with the old, regardless of which service providers participate in the new plan. The proposed rules also fixed an erroneous citation to a provision of the Bankruptcy Code.

Other Provisions

The proposed rules also provide, in some cases by way of clarification, that:

  • The rules under 409A apply separately and in addition to those under Section 457A and Section 457(f), with respect to plans subject to those sections.
  • When a separation from service occurs depends on the level of continuing services, even in the case of an employee who transitions to independent contractor status or vice versa. (The existing regulations were susceptible of being read to mean that an employee who becomes an independent contractor does not have a separation from service until he or she is neither an employee nor an independent contractor.)
  • A plan under which a service provider has a right to payment of reasonable attorneys' fees and other expenses incurred to enforce a bona fide legal claim against an employer with respect to his or her service relationship does not provide for a deferral of compensation.
  • A stock purchase treated as a deemed asset sale under Section 338 is not treated as an asset sale for purposes of determining when a service provider has a separation from service.
  • Recurring part-year compensation (relevant, for example, to teachers) that meets certain requirements will not provide for a deferral of compensation.
  • A plan can provide for an offset to the extent reasonably necessary to comply with federal laws regarding debt collection with respect to federal claims.
  • Nonqualified deferred compensation may be accelerated without regard to the source of the compensation (U.S. or non-U.S.) if reasonably necessary to comply with a bona fide foreign ethics or conflicts of interest law.
  • For purposes of the provisions dealing with stock rights, a service provider can be an entity as well as an individual.

Effective Date

The proposed rules would apply only when finalized, but taxpayers may rely on them before that date.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions