Compliance June 23, 2016

Application of 409A to NQDC Plans: Proposed Rules

The proposed regulations include a withdrawal of a specific provision of the notice of proposed rulemaking published in December 2008 regarding the calculation of amounts includible in income under Section 409A(a)(1) and replaces that provision with revised proposed regulations.
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The Internal Revenue Service (IRS) has proposed regulations that would clarify or modify certain specific provisions of the final regulations under section 409A.

This proposal also withdraws a specific provision of the notice of proposed rulemaking published in the Federal Register on December 8, 2008, regarding the calculation of amounts includible in income under Section 409A(a)(1) and replaces that provision with revised proposed regulations.                

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The proposed regulations clarify that the rules under Section 409A apply to nonqualified deferred compensation (NQDC) plans separately and in addition to the rules under Section 457A. They also clarify that a stock right that does not otherwise provide for a deferral of compensation will not be treated as providing for a deferral of compensation solely because the amount 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, is based on a measure that is less than fair market value.

Other clarifications include:

  • Certain separation pay plans that do not 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 Section 338 is not a sale or other disposition of assets for purposes of determining whether a service provider has a separation from service.
  • A service provider who ceases providing 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 employment status, the level of services reasonably anticipated to be provided after the change would result in a separation from service under the rules applicable to employees.
  • The rules for transaction-based compensation apply to stock rights that do not provide for a deferral of compensation and statutory stock options.
  • Clarify the provision permitting payments upon the termination and liquidation of a plan in connection with bankruptcy and other rules permitting payments in connection with the termination and liquidation of a plan.
  • A service provider can be an entity as well as an individual.
NEXT: Modifications and other provisions

The proposed regulations clarify and modify Section 1.409A– 4(a)(1)(ii)(B) of the proposed income inclusion regulations regarding the treatment of deferred amounts subject to a substantial risk of forfeiture for purposes of calculating the amount includible in income under section 409A(a)(1).

They also include modifications of the short-term deferral rule to permit a delay in payments to avoid violating Federal securities laws or other applicable law; the definition of the term “eligible issuer of service recipient stock” to provide that it includes a corporation (or other entity) for which a person is reasonably expected to begin, and actually begins, providing services within 12 months after the grant date of a stock right; the rules regarding recurring part-year compensation; the rules applicable to amounts payable following death; and the conflict of interest exception to the prohibition on the acceleration of payments to permit the payment of all types of deferred compensation (and not only certain types of foreign earned income) to comply with bona fide foreign ethics or conflicts of interest laws.                         

The proposed regulations provide that a plan under which a service provider has a right to payment or reimbursement of reasonable attorneys’ fees and other expenses incurred to pursue a bona fide legal claim against the service recipient with respect to the service relationship does not provide for a deferral of compensation.

It provides a rule that is generally applicable to determine 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. In addition, a plan may accelerate the time of payment to comply with Federal debt collection laws.

The IRS says taxpayers may rely on these proposed regulations immediately, but the agency is accepting comments until September 20.

Text of the proposed regulations is here.

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