United States: IRS Issues Supplemental Guidance On Deferred Compensation Plans

Christopher Buch is an Associate in Holland & Knight's Chicago office
Robert Friedman is a Partner in Holland & Knight's Miami office
Victoria Zerjav is a Partner in Holland & Knight's Stamford office

HIGHLIGHTS:

  • The Internal Revenue Service (IRS) has published its long-awaited proposed rules on nonqualified deferred compensation plans under Section 409A of the Internal Revenue Code of 1986, as amended (Section 409A).
  • The proposed regulations aim to clarify or modify specific provisions of the current regulations issued under Section 409A, which have been in place since 2007, and also make changes to the proposed income inclusion regulations published in December 2008.

The Internal Revenue Service (IRS) on June 21, 2016, published long-awaited proposed rules on nonqualified deferred compensation plans under Section 409A of the Internal Revenue Code of 1986, as amended (Section 409A). These proposed regulations aim to clarify or modify specific provisions of the current regulations issued under Section 409A, which have been in place since 2007. These proposed regulations also make changes to the proposed income inclusion regulations that were published in December 2008. This Holland & Knight alert is intended to provide a summary of the proposed regulations. We will publish additional alerts to describe the changes made by the proposed regulations in more detail.

Overview of Changes to Final Regulations

During the past nine years, a number of inquiries have been posed regarding the meaning of certain provisions of the final regulations under Section 409A, and the IRS and the Treasury Department concluded that certain clarification and modifications to the final regulations would be needed. The IRS stated that the proposed regulations were not intended to provide a general revision of, or broad changes to, the final regulations.

The proposed regulations provide additional guidance in a number of areas, broadly divided into the following categories:

  • deferrals of compensation
  • the definition of a separation from service
  • references to payments being made
  • permissible payments
  • the prohibition on the acceleration of payments
  • amounts includible in income under Section 409A
  • individual and entity service providers

The proposed regulations go into great detail on many of the following items:

  • the rules under Section 409A also apply to nonqualified deferred compensation plans that may be subject to Code Sections 457(f) and 457A
  • stock rights that do not otherwise provide for a deferral of compensation are not treated as providing a deferral of compensation solely because the amounts payable under the stock right, upon an involuntary separation from service for cause or the occurrence of a condition within the service provider's control, are based on a measure that is less than fair market value
  • certain separation pay plans that do not otherwise provide for a deferral of compensation may apply to a service provider who had no compensation from the service recipient during the year preceding the year in which a separation from service occurs
  • a stock purchase treated as a deemed asset sale under Code Section 338 is not a sale or other disposition of assets for purposes of determining whether a service provider has incurred a separation from service
  • a service provider who stops performing services as an employee and begins providing services as an independent contractor is treated as having a separation from service if, at the time of the change in status, the level of services reasonably anticipated to be provided following the change would result in a separation from service under the rules applicable to other employees
  • the rules for transaction-based compensation apply to stock rights that do not provide for a deferral of compensation and statutory stock options
  • the provisions permitting payments upon the termination and liquidation of a plan in connection with bankruptcy or otherwise
  • a service provider can be an entity as well as an individual

Modifications of Current Rules

In addition, the proposed regulations modify current rules under Section 409A, including with respect to:

  • the short-term deferral rule by permitting a payment delay to avoid certain federal securities or other laws
  • the definition of "eligible issuer of service recipient stock" by stating that the definition includes an entity for which a person is reasonably expected to begin, and actually begins, providing services within 12 months of the date such person receives a stock right
  • recurring part-year compensation
  • amounts payable following the death of service providers and their beneficiaries
  • the conflict of interest exception to the prohibition on the acceleration of payments to permit the payment of all types of deferred compensation to comply with bona fide foreign ethics or conflicts laws.

New Items Included

The proposed regulations also address certain new items, including providing that:

  • a plan under which a service provider has a right to payment or reimbursement of attorneys' fees and other expenses to pursue a bona fide claim against a service recipient with respect to the service relationship is not a deferred compensation plan subject to Section 409A
  • there is a rule of general applicability with respect to determining when a "payment" has been made for purposes of Section 409A
  • the addition of the death, disability or unforeseeable emergency of a beneficiary who has become entitled to a payment due to a service provider's death as a potentially earlier or intervening payment event will not violate the prohibition on the acceleration of payments
  • a plan may accelerate the time of payment to comply with federal debt collection laws

Although the IRS is accepting comments on the proposed regulations outlined above, the proposed regulations state that taxpayers may rely on the proposed regulations immediately.

Changes to Proposed Income Inclusion Regulations

The proposed regulations also clarify and modify the proposed income inclusion regulations regarding the treatment of amounts subject to a substantial risk of forfeiture for purposes of calculating the amount includable in a service provider's income. Under the current proposed income inclusion regulations, the IRS noted that the anti-abuse rules may allow for plan provisions to be corrected in a manner that fails to comply with Section 409A.

The new income inclusion regulations limit the ability to make changes to an unvested benefit without penalty. Amounts deferred under a plan that are otherwise subject to a substantial risk of forfeiture will no longer be treated as being subject to a substantial risk of forfeiture when there is a change in a plan provision that is not otherwise permitted under Section 409A and that affects the time or form of payment of such amounts if: 1) there is no reasonable, good faith basis for concluding that the original provision failed to meet the requirements of Section 409A and 2) the change is necessary to bring the plan into compliance with the requirements of Section 409A. The proposal also provides examples of changes that may run afoul of the rules, such as whether a service recipient has taken commercially reasonable measures to identify and correct substantially similar failures promptly upon discovery or whether substantially similar failures appear intentional, are numerous or repeat common past failures that have since been corrected, among others. Finally, the proposal sets forth the correction method that a service recipient must use when correcting certain types of compliance failures.

The proposed income inclusion regulations will be applicable on or after the date that they are published as final regulations.

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.

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