[Federal Register Volume 72, Number 73 (Tuesday, April 17, 2007)]
[Rules and Regulations]
[Pages 19234-19325]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 07-1820]
[[Page 19233]]
-----------------------------------------------------------------------
Part II
Department of the Treasury
-----------------------------------------------------------------------
Internal Revenue Service
-----------------------------------------------------------------------
26 CFR Part 1
Application of Section 409A to Nonqualified Deferred Compensation
Plans; Final Rule
Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules
and Regulations
[[Page 19234]]
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9321]
RIN 1545-BE79
Application of Section 409A to Nonqualified Deferred Compensation
Plans
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations regarding the
application of section 409A to nonqualified deferred compensation
plans. The final regulations are necessary to clarify and explain the
rules governing the application of section 409A to nonqualified
deferred compensation plans. The regulations affect service providers
receiving amounts of deferred compensation and the service recipients
for whom the service providers provide services.
FOR FURTHER INFORMATION CONTACT: Stephen Tackney, (202) 927-9639 (not a
toll-free number).
DATES: Effective Date: These regulations are effective April 17, 2007.
Applicability Dates: For dates of applicability, see Sec. 1.409A-
6(b).
SUPPLEMENTARY INFORMATION:
Background
Section 409A was added to the Internal Revenue Code (Code) by
section 885 of the American Jobs Creation Act of 2004, Public Law 108-
357 (118 Stat. 1418). Section 409A generally provides that unless
certain requirements are met, amounts deferred under a nonqualified
deferred compensation plan for all taxable years are currently
includible in gross income to the extent not subject to a substantial
risk of forfeiture and not previously included in gross income. Section
409A also includes rules applicable to certain trusts or similar
arrangements associated with a nonqualified deferred compensation plan,
where such arrangements are located outside of the United States or are
restricted to the provision of benefits in connection with a decline in
the financial health of the sponsor.
On December 20, 2004, the IRS issued Notice 2005-1 (published as
modified on January 6, 2005, in 2005-1 CB 274), setting forth initial
guidance with respect to the application of section 409A, and supplying
transition guidance pursuant to a statutory directive. A notice of
proposed rulemaking (REG-158080-04, 2005-2 CB 786 [70 FR 57930]) was
published in the Federal Register on October 4, 2005. See Sec.
601.601(a)(3). A public hearing was conducted on January 25, 2006. In
addition, the IRS received written and electronic comments responding
to the notice of proposed rulemaking. After consideration of all the
comments, the proposed regulations are adopted as amended by this
Treasury decision. The amendments are discussed in this preamble.
The Treasury Department and the IRS have also issued six additional
notices providing transition guidance with respect to section 409A: (1)
Notice 2005-94, 2005-2 CB 1208 (transition guidance with respect to
2005 reporting and withholding obligations); (2) Notice 2006-4, 2006-3
IRB 307 (transition guidance with respect to certain outstanding stock
rights); (3) Notice 2006-33, 2006-15 IRB 754 (transition guidance with
respect to the application of section 409A(b)); (4) Notice 2006-64,
2006-29 IRB 88 (interim guidance regarding payments necessary to meet
Federal conflict of interest requirements); (5) Notice 2006-79, 2006-43
IRB 763 (additional transition relief); and (6) Notice 2006-100, 2006-
51 IRB 1109 (transition guidance with respect to 2005 and 2006
reporting and withholding obligations). See Sec. 601.601(d)(2). For a
discussion of the continued applicability of these notices, see the
Effect on Other Documents section of this preamble.
Explanation of Provisions and Summary of Comments
I. Structure and Format of Regulations
The final regulations generally adopt the structure and format of
the proposed regulations. A table of contents has been included in the
final regulations, as well as several additional sets of examples
addressing various topics.
II. Definition of Nonqualified Deferred Compensation Plan
A. Excluded Plans
The final regulations exclude the types of plans described in
section 409A(d)(1) from the definition of a nonqualified deferred
compensation plan, as well as certain other arrangements that were also
set forth in the proposed regulations. Accordingly, the final
regulations generally provide that a nonqualified deferred compensation
plan for purposes of section 409A does not include a qualified plan, a
bona fide sick leave or vacation plan, a disability plan, a death
benefit plan, or certain medical expense reimbursement arrangements.
The final regulations clarify that the exemption from coverage
under section 409A for certain welfare plans does not apply to medical
expense reimbursements that constitute taxable income to the service
provider. The coverage exemption applies only to arrangements that
provide benefits that are excludable from gross income under section
105 or section 106.
Several commentators requested clarification of when a leave
program will be treated as a bona fide sick leave or vacation leave
plan for purposes of section 409A. Another commentator requested a
clarification of the definition of a compensatory time plan. Because
the definitions of these terms may raise issues and require
coordination with the provisions of section 451, section 125, and, with
respect to certain taxpayers, section 457, the final regulations do not
address these issues.
Notice 2005-1, Q&A-6 provides that, until further guidance,
taxpayers whose participation in a nonqualified deferred compensation
plan would be subject to section 457(f) may rely on the definitions of
bona fide vacation leave, sick leave, compensatory time, disability
pay, or death benefit plan applicable for purposes of section 457(f) as
also being applicable for purposes of section 409A. Until further
guidance, such taxpayers may continue to rely on such definitions for
purposes of section 409A.
One commentator requested that a qualified employer plan for
purposes of the exclusion from section 409A include certain plans
covered by section 402(d) (certain plans with a foreign-situs trust
treated as qualified plans with respect to the taxation of the
participants and beneficiaries) and retirement plans described in
section 1022(i)(2) of the Employee Retirement Income Security Act of
1974, as amended (certain Puerto Rican retirement plans). The final
regulations adopt this suggestion.
B. Section 457 Plans
The final regulations provide that section 409A is not applicable
to an eligible deferred compensation plan under section 457(b), but may
be applicable to a deferred compensation plan that is subject to
section 457(f). Commentators requested clarification of the application
of the exception in the proposed regulations from the definition of
deferred compensation referred to as the short-term deferral rule
(described in section III.C.1 of this preamble) to a section 457(f)
plan. As discussed below, a right to deferred compensation
[[Page 19235]]
generally refers to a legally binding right in one taxable year to
compensation that is or may be payable in a subsequent taxable year.
For purposes of determining the time of payment, the term ``payment''
generally refers to an actual or constructive payment of cash or
property. However, the final regulations provide that for purposes of
the short-term deferral rule, an amount is treated as paid when it is
included in income under section 457(f) whether or not an actual or
constructive payment occurs. Accordingly, where the income inclusion
under section 457(f) stems from the lapse of a substantial risk of
forfeiture that is also treated as a substantial risk of forfeiture for
purposes of section 409A, the amount included in income will be
considered a short-term deferral for purposes of section 409A. However,
the right to earnings on amounts that have previously been included
under section 457(f) will be deferred compensation for purposes of
section 409A unless the right to the earnings independently satisfies
the requirements for an exclusion.
C. Arrangements With Independent Contractors
The final regulations provide that section 409A generally does not
apply to an amount deferred under an arrangement between a service
provider and an unrelated service recipient if during the service
provider's taxable year in which the service provider obtains a legally
binding right to the deferred amount the service provider is actively
engaged in the trade or business of providing services (other than as
an employee or as a director of a corporation), and provides
significant services to two or more service recipients to which the
service provider is not related and that are not related to one
another.
The final regulations retain the safe harbor in the proposed
regulations, under which a service provider is deemed to be providing
significant services to two or more such service recipients for this
purpose if the revenues generated from the services provided to any
service recipient or group of related service recipients during such
taxable year do not exceed 70 percent of the total revenues generated
by the service provider from the trade or business of providing such
services. Commentators expressed concern that the safe harbor did not
permit independent contractors to know in advance whether the
arrangements under which an independent contractor deferred
compensation during a taxable year would be subject to section 409A.
Commentators requested certain look-back periods, including the ability
to use averaging over the previous three to five years, or to satisfy
the 70 percent threshold over a certain portion of the previous three
to five years. The Treasury Department and the IRS are concerned that
the suggested rules would allow service providers to engage in
strategic behavior to ensure that activity in certain years would be
exempt from section 409A. Accordingly, the final regulations adopt an
additional safe harbor that provides that a service provider that has
actually met the 70 percent threshold in the three immediately previous
years is deemed to meet the 70 percent threshold for the current year,
but only if at the time the amount is deferred the service provider
does not know or have reason to anticipate that the service provider
will fail to meet the threshold in the current year.
In response to comments, the final regulations provide that if an
independent contractor qualifies for the safe harbor for exclusion from
coverage under section 409A with respect to arrangements with unrelated
service recipients, an arrangement between the independent contractor
and a service recipient related to the independent contractor will not
be subject to section 409A if the arrangement, and the practices under
the arrangement, are bona fide, arise in the ordinary course of
business, and are substantially the same as the arrangements and
practices (such as billing and collection practices) applicable to one
or more unrelated service recipients to whom the independent contractor
provides substantial services and that produce a majority of the total
revenue that the independent contractor earns from the trade or
business of providing such services during the year.
The final regulations further clarify that if at the time the
legally binding right to the payment arose, the arrangement was not
subject to section 409A because the service provider was an independent
contractor that was eligible for this exclusion from coverage under
section 409A, the amount deferred under the arrangement during that
taxable year (and earnings credited to the deferred amount) will not
become subject to section 409A in a later year if the service provider
becomes an employee, independent contractor, or other type of service
provider subject to the rules of section 409A.
Commentators also requested that a service recipient be permitted
to rely upon a representation of an independent contractor that the
independent contractor meets the exclusion requirements, so that a
service recipient will know whether it is subject to the reporting
requirements with respect to amounts deferred subject to section 409A.
The Treasury Department and the IRS are continuing to study this issue.
D. Anti-Abuse Rule
If a principal purpose of a plan is to achieve a result with
respect to a deferral of compensation that is inconsistent with the
purposes of section 409A, the Commissioner may treat the plan as a
nonqualified deferred compensation plan for purposes of section 409A.
III. Definition of Nonqualified Deferred Compensation Plan
A. In General
The final regulations provide that a nonqualified deferred
compensation plan is a plan that provides for the deferral of
compensation. The final regulations further provide that a plan
generally provides for the deferral of compensation if, under its terms
and the relevant facts and circumstances, a service provider has a
legally binding right during a taxable year to compensation that,
pursuant to its terms, is or may be payable to (or on behalf of) the
service provider in a later year. For this purpose, an amount generally
is payable at the time the service provider has a right to currently
receive a transfer of cash or property, including a transfer of
property includible in income under section 83, the economic benefit
doctrine or section 402(b). Accordingly, a taxable transfer of an
annuity contract is treated as a payment for purposes of section 409A.
The definition of deferral of compensation in the final regulations
excludes the condition that the amount not be actually or
constructively received and included in income during the taxable year,
because that language might cause confusion with respect to the
applicable rules governing deferral elections and the prohibition on
the acceleration of payments. For example, if a service provider has
made an irrevocable election to defer an amount of his or her salary to
a future year, that amount is treated as deferred compensation
regardless of whether the service recipient actually pays such amount
to the service provider during the year in which the services are
performed. Any early payment of the deferred compensation (or any right
to receive such an early payment) generally would constitute an
impermissible acceleration of the payment of the deferred amount.
[[Page 19236]]
For this purpose, a plan will be treated as providing for a payment
to be made in a subsequent year whether the plan explicitly so provides
(including through a service provider election) or the deferral
condition is inherent in the terms of the contract. Where the parties
have agreed that a payment will be made upon an event that could occur
after the year in which the legally binding right to the payment
arises, the plan generally will provide for a deferral of compensation
(unless otherwise excluded under a specific exception, such as the
short-term deferral rule).
For example, if a plan provides a service provider a right to a
payment upon separation from service, the plan generally will result in
a deferral of compensation regardless of whether the service provider
separates from service and receives the payment in the same year as the
grant, because under the plan the payment is conditioned upon an event
that may occur after the year in which the legally binding right to the
payment arises. Similarly, if an arrangement such as a stock option or
stock appreciation right not otherwise excluded from coverage under
section 409A provides a right to a payment for a term of years where
the payment could be received during the short-term deferral period or
a subsequent period but is not otherwise includible in income until
paid, the arrangement will provide for deferred compensation even
though the service provider could receive the payment during the short-
term deferral period (for example, by exercising the stock option or
stock appreciation right). However, where a plan does not specify a
payment date, payment event or term of years (or specifies a date or
event certain to occur during the year in which the services are
performed), the plan generally will not provide for the deferral of
compensation if the service provider actually or constructively
receives the payment within the short-term deferral period.
The proposed regulations provided that earnings on deferred amounts
are generally treated as deferred compensation for purposes of section
409A. Under the final regulations, whether a deferred amount
constitutes earnings on an amount deferred, or actual or notional
income attributable to an amount deferred, is determined under the
principles defining income attributable to the amount taken into
account under Sec. 31.3121(v)(2)-1(d)(2).
A commentator requested clarification of whether a payment for a
noncompetition agreement could be subject to section 409A. Because such
a payment would occur in connection with the performance or
nonperformance of services, and a covenant not to compete does not
create a substantial risk of forfeiture for purposes of section 409A, a
legally binding right obtained in one year to a payment in a subsequent
year in connection with a noncompetition agreement generally would
constitute deferred compensation.
B. Legally Binding Right
The regulations define deferral of compensation in the context of a
legally binding right to a payment of compensation in a future taxable
year. Commentators requested clarification of the standard that would
be used to determine whether a service provider has a legally binding
right. A legally binding right includes a contractual right that is
enforceable under the applicable law or laws governing the contract. A
legally binding right also includes an enforceable right created under
other applicable law, such as a statute.
One commentator suggested that no legally binding right exists
where the payment is made only upon the realization of gain from a
particular investment. For example, the commentator argued that a bonus
payable based upon the amount that a service provider obtains in
selling property should not be treated as granting the service provider
a legally binding right to the payment until the property is sold. In
such a situation, however, the requirement that the property be sold is
a condition to the right to the payment, but the right to the payment
is still a legally binding right. The service recipient could not
simply revoke the promise, sell the property, and not pay the bonus.
However, the condition that the property be sold before the service
provider becomes entitled to payment may constitute a substantial risk
of forfeiture, depending on the specific facts and circumstances.
C. Short-Term Deferrals
1. In General
Subject to the modifications described in this section III.C of the
preamble, the final regulations generally adopt the short-term deferral
rule that was contained in the proposed regulations. Under the short-
term deferral rule, a deferral of compensation does not occur for
purposes of section 409A if the arrangement under which a payment is
made does not provide for a deferred payment and the payment is made no
later than the 15th day of the third month following the later of the
end of the service provider's taxable year or the end of the service
recipient's taxable year in which occurs the later of the time the
legally binding right to the payment arises or the time such right
first ceases to be subject to a substantial risk of forfeiture (subject
to certain extensions for unforeseeable events). For this purpose, an
arrangement provides for a deferred payment if it provides for a
payment that will be made or completed after a date or an event that
will or may occur later than the end of the 2\1/2\ month period
described in the preceding sentence, either because of an affirmative
election on the part of the service provider or service recipient or a
deferral condition inherent in the terms of the contract (for example,
that the amount will be paid upon the service provider's separation
from service, which may occur in a future year).
Several commentators requested that additional flexibility be
provided to allow payments to be short-term deferrals. By analogy to
the rules in the proposed regulations concerning when payments of
deferred compensation amounts are considered timely for purposes of the
payment date rules, the commentators suggested that payments should
qualify as short-term deferrals if made by the end of the year after
the year in which a substantial risk of forfeiture lapses, rather than
by the 15th day of the third month of that year. The final regulations
do not adopt this suggestion. The short-term deferral rule is based on
the historical treatment of certain payments paid within a short period
following the end of a taxable year as not constituting deferred
compensation. See Sec. 1.404(b)-1T, Q&A-2(b). That short period has
been defined as ending on the 15th day of the third month following the
end of the year, subject to certain extensions for unforeseeable
events. Extending the payment date by which a short-term deferral could
be paid would be inconsistent with this approach and the legislative
history of section 409A (H.R. Conf. Rep. No. 108-755, at 735 (2004)),
and accordingly is not adopted in the final regulations. However, the
final regulations liberalize the standard under which a payment can be
a short-term deferral even if it is delayed due to unforeseeable
events. The proposed regulations provided generally that payment could
be delayed if the payment would jeopardize the service recipient's
solvency and such insolvency was unforeseeable at the time the service
provider obtained the right to the payment. By contrast, the final
regulations provide generally that payment may be delayed where the
[[Page 19237]]
payment would jeopardize the ability of the service recipient to
continue as a going concern.
Commentators asked how the short-term deferral rule applies to a
series of payments scheduled to commence following the lapse of a
substantial risk of forfeiture. The final regulations provide that the
short-term deferral rule applies separately to each payment, applying
the technical definition of ``payment'' set out in the regulations,
provided that the entire payment is made during the short-term deferral
period. Accordingly, where a payment has been designated as a separate
payment, it may qualify as a short-term deferral (and thus not deferred
compensation) even where the service provider has a right to subsequent
payments under the same arrangement. In contrast, where a payment has
not been designated as a separate payment (such as, for example, a life
annuity payment or a series of installment payments treated as a single
payment), any initial payments in the series will not be treated as a
short-term deferral even if paid within the short-term deferral period.
For a discussion of the definition of payment, see Sec. 1.409A-3.
Commentators suggested that a right to a reimbursement be treated
as potentially subject to the short-term deferral rule, arguing that
the right to the reimbursement payment is subject to a substantial risk
of forfeiture that the service provider will not incur the expense.
Commentators argued that the short-term deferral rule then could apply
if the reimbursement payment were made within a short period following
the occurrence of the expense. Generally, the risk that a service
provider will fail to incur a reimbursable expense will not qualify as
a substantial risk of forfeiture, so the short-term deferral rule will
not be applicable. However, the final regulations provide considerable
additional flexibility with regard to structuring reimbursement
arrangements to meet the requirements of section 409A. For a discussion
of these provisions, see section VII.B.2 of this preamble.
2. Application to Event-Based Payments
Some commentators asked whether any payments based on a legally
binding right arising in the year of a separation from service are
excluded from coverage under section 409A, if paid by the end of the
relevant short-term deferral period. For example, where an employee had
accrued benefits under a defined benefit supplemental executive
retirement plan (SERP) during his career that was payable immediately
upon a separation from service, including an amount accrued in the year
of separation from service, commentators asked whether the payment of
the portion of the benefits accrued in that final year is excluded from
coverage under section 409A if paid by March 15 of the year following
the separation from service, because the amount is paid within a short
period following the year the service provider obtains a vested legally
binding right to the additional benefit accrual. (This generally would
be of most concern to specified employees subject to the requirement of
a six-month delay in payment following a separation from service.)
The analysis that applies in this situation is similar to that
applied to the general definition of deferral of compensation,
discussed in section III.A of this preamble. The short-term deferral
rule does not provide an exclusion from the requirements of section
409A for such current-year benefit accruals because the rule does not
apply to amounts of compensation subject to a deferral election. For
this purpose, an election to defer includes either an affirmative
election on the part of the service provider or a deferral condition
inherent in the terms of the contract. Where the parties have agreed
that a payment will be made upon an event that does not necessarily
coincide with the lapsing of the substantial risk of forfeiture, and
could occur at a time beyond the short-term deferral period, the
arrangement provides for a deferral election such that the short-term
deferral rule does not apply. Accordingly, in this example, because the
benefits accrued in the final year of the SERP could have been paid
upon an event occurring after the short-term deferral period (if, for
example, the individual had not separated from service until a later
year), the payment of the benefit accrued in the final year is subject
to section 409A and is not a short-term deferral, even if paid by March
15 of the year following the separation from service.
Also, for example, if a plan that is not subject to section 457(f)
provides that an amount is subject to a substantial risk of forfeiture
until the completion of three years of service, and is payable upon a
separation of service following the three years of service, the right
to the amount is not a short-term deferral even if the service provider
separates from service immediately after vesting in the right, because
under the plan the payment is based upon an event other than the
lapsing of the substantial risk of forfeiture and such event may occur
in a year subsequent to the year in which the risk of forfeiture
lapses.
Conversely, where a plan specifies no payment date or payment
event, or specifies only the date at which the substantial risk of
forfeiture lapses, the plan may qualify for the short-term deferral
rule if the payment is made within the applicable short-term deferral
period. However, such a plan generally would violate section 409A if
the payment were made after the short-term deferral period.
As discussed in this preamble with respect to the general
definition of deferred compensation, to implement the statutory scheme,
including the applicable reporting and form requirements, taxpayers
generally must be able to determine whether an arrangement provides for
a deferral of compensation at the time the service provider obtains a
legally binding right to the compensation. Although a plan need not
specify a payment date to be a short-term deferral that is excluded
from coverage under section 409A, the short-term deferral exclusion
does not apply if the payment event or date is specified and will or
may occur after the end of the short-term deferral period.
The preamble to the proposed regulations explained that where a
plan requires that a payment be made on a date within the short-term
deferral period, but the payment is made after the specified date and
after the end of the short-term deferral period, the arrangement will
be treated as a nonqualified deferred compensation plan, but the
payment date will be treated as a specified date. Thus, under such an
arrangement, if the service provider receives the payment after the
specified date, but not later than the end of the year in which the
specified date occurs, the payment generally will comply with section
409A. However, taxpayers should note that a provision requiring only
that a payment be made on or before the end of the short-term deferral
period may not qualify as a permissible specified date for this
purpose, if under the facts and circumstances the payment could have
been made in more than one taxable year. For a discussion of the
application of the definition of a specified payment date to this type
of plan, see section VII.B of this preamble.
For a discussion of when rights to compensation upon a separation
from service for good reason may be treated as rights to compensation
upon an involuntary termination, and the potential application of the
short-term deferral exception to these arrangements, see section
III.J.3 of this preamble.
[[Page 19238]]
D. Stock Options and Stock Appreciation Rights
1. In General
Subject to the modifications described in this preamble, the final
regulations adopt the provisions of the proposed regulations excluding
from coverage under section 409A statutory stock options and certain
other stock rights. Generally under the regulations, nondiscounted
stock options and nondiscounted stock appreciation rights issued on
service recipient stock that do not include any additional deferral
feature are excluded from section 409A.
2. Statutory Stock Options
The final regulations adopt the exclusion from coverage under
section 409A for statutory stock options, including incentive stock
options described in section 422 of the Code and options granted under
an employee stock purchase plan described in section 423 of the Code.
This exclusion applies regardless of whether the statutory stock option
would be excluded if the same option were not treated as a statutory
stock option. For example, an employee stock purchase plan described in
section 423 offering a discounted purchase price is not a deferred
compensation plan for purposes of section 409A.
Commentators requested clarification, however, of the treatment of
a statutory stock option that is modified, or otherwise becomes
ineligible to be treated as a statutory stock option. The final
regulations adopt the rule set forth in the proposed regulations, and
provide that at the time of such modification or event, the
modification or other event is treated as the grant of a new option, or
causes the option to be treated as having had a deferral feature from
the date of grant, as applicable, for purposes of section 409A only if
such modification or other event would have been so treated had the
option been a nonstatutory stock option immediately before such
modification or other event. For example, where an incentive stock
option is modified through an extension of the option's term, the
extended option will be treated as having had an additional deferral
feature from the date of grant for section 409A purposes only if the
same extension of a nonstatutory stock option would have resulted in
such treatment.
Commentators also requested that the exclusion from coverage under
section 409A for certain stock rights issued under plans meeting the
requirements of section 423 (employee stock purchase plans) be extended
to employee stock purchase plans offered by foreign employers that do
not meet such requirements, where the shares are made available for
purchase at a discount and substantially all of the participants are
nonresident aliens. The legislative history does not provide a basis
for extending the exception applicable to options meeting the
requirements of section 423 to grants of discounted stock options not
meeting the requirements of section 423. Accordingly, this suggestion
is not adopted in the final regulations.
3. Definition of Service Recipient Stock
The final regulations adopt the requirement in the proposed
regulations that for the exclusion for certain stock rights to apply,
the stock right must relate to service recipient stock. Commentators
criticized the definition of service recipient stock contained in the
proposed regulations as too restrictive. Generally such criticisms
centered on two different aspects of the definition of service
recipient stock in the proposed regulations--the classes of stock that
may qualify as service recipient stock, and the issuer or issuers whose
stock may constitute service recipient stock, where the service
recipient is comprised of more than one entity.
a. Classes of Stock That May Qualify as Service Recipient Stock
Commentators requested clarification and expansion of the classes
of stock of a corporation that may constitute service recipient stock.
Commentators generally focused on two issues. First, with respect to
stock of a particular service recipient corporation, commentators
requested that the stock right be permitted to relate to any class of
common stock, regardless of whether another class of common stock of
that corporation was publicly traded, and regardless of whether that
class of common stock had the greatest aggregate value of all classes
of common stock issued by that corporate entity. Subject to the
restrictions governing certain preferences as to distributions, the
final regulations generally provide that any class of common stock may
be used, regardless of whether another class of common stock that could
qualify as service recipient stock is publicly traded or has a higher
aggregate value outstanding, and regardless of whether the class of
stock is subject to transferability restrictions or buyback rights
(provided such buyback rights reflect the fair market value of the
stock at the time of purchase).
Second, commentators suggested narrowing the types of preferences
on a class of common stock that would prohibit that class from being
treated as service recipient stock. One commentator requested that the
classes of stock permitted as service recipient stock include any class
of stock that is widely held by non-service recipients. While it may be
unlikely that a widely-held class of stock was created to facilitate an
abusive avoidance of section 409A, it does not follow that service
recipient stock rights issued on such stock necessarily would be
consistent with the intended application of section 409A if, for
example, holders of such class enjoyed preferences that would make such
stock rights a suitable substitute for nonqualified deferred
compensation.
To be treated as service recipient stock under the final
regulations, a class of stock must qualify as common stock under
section 305 of the Code. Accordingly, the final regulations provide
that stock that is not common stock under section 305 is not service
recipient stock for purposes of section 409A. However, the mere
classification of a class of stock as common stock under section 305 is
not sufficient for such stock to be treated as service recipient stock
for purposes of section 409A. The Treasury Department and the IRS are
concerned that classes of stock that are common stock under section 305
may provide preferences that could permit stock rights with respect to
such stock to resemble traditional nonqualified deferred compensation,
such that exclusion of such stock rights would permit the avoidance of
section 409A.
Commentators suggested that a preference with respect to
liquidation rights, without any other preferences such as a
preferential right to dividends, should be permitted under the
definition of service recipient stock. A holder of this class of stock
would not be guaranteed any return, but rather would simply be
guaranteed preferred distribution rights upon a complete liquidation of
the service recipient. The final regulations generally adopt this
suggestion.
With respect to other preferential rights, commentators were unable
to provide a workable standard under which permissible preferences
could be distinguished from impermissible preferences. Accordingly, the
final regulations do not treat any stock including such preferences as
service recipient stock. However, the Treasury Department and the IRS
continue to study this area, and the final regulations authorize the
publication of other additional guidance, should a workable standard be
developed.
[[Page 19239]]
b. Entities the Stock of Which May Qualify as Service Recipient Stock
Commentators also requested an expansion of the class of entities
the stock of which can qualify as service recipient stock where the
service recipient is comprised of multiple entities. The Treasury
Department and the IRS believe that the stock right exception under
section 409A was intended to cover stock rights directly reflecting the
enterprise value of the entity for which the service provider is
providing services. Consistent with this approach, the final
regulations provide that service recipient stock may include the stock
of the corporation for which the service provider was providing
services at the date of grant. In addition, the final regulations
provide that service recipient stock may include stock of any
corporation in a chain of organizations all of which have a controlling
interest in another organization, beginning with the parent
organization and ending with the organization for which the service
provider was providing services at the date of grant of the stock
right. Similarly to the proposed regulations, the final regulations
provide that the term ``controlling interest'' has the same meaning as
provided in Sec. 1.414(c)-2(b)(2)(i), except that where that
regulation requires at least an 80 percent interest, the final
regulations generally require only a 50 percent interest. In addition,
where the use of such stock with respect to the grant of a stock right
to such service provider is based upon legitimate business criteria,
the final regulations generally require only a 20 percent interest. For
purposes of determining ownership of an interest in an organization,
the attribution rules of Sec. 1.414(c)-4 apply, and the exclusion
rules of Sec. 1.414(c)-3 also apply. For example, under the final
regulations, with respect to an employee of a subsidiary corporation,
the common stock of the ultimate parent corporation, or of a subsidiary
corporation anywhere in the chain of corporate ownership between the
subsidiary that employed the employee and the ultimate parent
corporation (a higher tier subsidiary), could qualify as service
recipient stock for purposes of determining whether a stock right
issued to such employee with respect to such stock was excluded from
coverage under section 409A, provided that the 50 percent or 20 percent
ownership standard, as applicable, was satisfied by each corporation in
the chain.
The proposed regulations contained many requirements for using an
ownership level of less than 50 percent. Commentators requested several
simplifications of these requirements. In response, the final
regulations no longer require a formal election by any corporation.
Rather, each individual grant of a stock right is analyzed to determine
whether the stock qualifies as service recipient stock with respect to
a service provider at the time the stock right is granted. If a
corporation owns at least 50 percent of the stock of one corporation
and owns less than 50 percent of the stock of another corporation, and
it intends to treat its stock as service recipient stock with respect
to employees of both corporations, there is no requirement that a
legitimate business criteria exist with respect to the issuance of
stock rights on the parent corporation stock to service providers of
the first such corporation. The legitimate business criteria standard
applies only to stock rights issued to service providers of
subsidiaries that are not majority-owned, because the test of
legitimate business criteria relates to the actual issuance of a stock
right to a particular service provider. Accordingly, a subsidiary may
have more than one shareholder corporation the stock of which qualifies
as service recipient stock with respect to a subsidiary employee such
as, for example, where three entities each own a one-third interest in
the subsidiary. However, with respect to each grant of a stock right on
stock of a particular non-majority shareholder corporation to a service
provider of a particular subsidiary, there must exist legitimate
business criteria for issuing such a stock right. Even if legitimate
business criteria exist with respect to the issuance of a stock right
on stock of a particular shareholder corporation to a particular
service provider, legitimate business criteria may or may not exist
with respect to the issuance of a stock right to the same service
provider on stock of another shareholder corporation.
The legitimate business criteria requirement is a facts and
circumstances test, focusing generally on whether there is sufficient
nexus between a particular service provider and the entity, the stock
of which underlies the stock right granted to the service provider, for
the grant to serve a legitimate non-tax business purpose. As provided
in the preamble to the proposed regulations, if a corporation issued a
stock right on its stock to a current employee of a joint venture in
which the corporation was a venturer, and the employee was a former
employee of the corporate venturer, generally the issuance would be
based on legitimate business criteria. Similarly, if the corporate
venturer issued such a right to an employee of the joint venture who it
reasonably expected would become an employee of the corporate venturer
in the future, generally the legitimate business criteria requirement
would be met. By contrast, where an employee has no real nexus with a
corporate venturer, such as generally happens when the corporate
venturer is a passive investor in the service recipient, the use of the
investor corporation stock as the stock underlying a stock right grant
to that employee generally would not be based upon legitimate business
criteria. Similarly, where a corporation holds only a minority interest
in an entity that in turn holds a minority interest in the entity for
which the employee performs services, such that the corporation holds
only an insubstantial indirect interest in the entity receiving the
services, legitimate business criteria generally would not exist for
issuing a stock right on the corporation's stock to the employee.
The Treasury Department and the IRS remain concerned that the
manipulation of the structure of a related group of corporations may be
used to allow stock options or stock appreciation rights to mimic the
characteristics of nonqualified deferred compensation, by compensating
holders based on predictable amounts and investment returns unrelated
to the enterprise value of an operating entity. Accordingly, the
exception contained in the proposed regulations under which the stock
of a corporation serving as investment vehicle is not considered
service recipient stock has been retained. In addition, an anti-abuse
rule has been added to address corporate structures, transactions, or
stock right grants, a principal purpose of which is the avoidance of
the application of section 409A to an arrangement otherwise providing
deferred compensation. These corporate structures, transactions, and
stock right grants generally will occur where the structure,
transaction, or grant is intended to provide enhanced security for the
value of the stock right as a means of providing deferred compensation,
rather than as compensation related to an increase in the true
enterprise value of the service recipient. The regulations provide that
if an entity becomes a member of a group of corporations or other
entities treated as a single service recipient, and the primary source
of income or value of such entity arises from the provision of
management services to other members of the service recipient group, if
any stock rights are issued with respect to such entity it is presumed
that such
[[Page 19240]]
structure was established for purposes of avoiding the application of
section 409A.
c. Equity Interests in Certain Non-Corporate Entities
The final regulations permit certain equity interests in a non-
stock mutual company to be treated analogously to equity interests in a
corporation. Commentators requested that the definition of service
recipient stock be expanded to cover interests in cooperatives and
interests in the value of an Indian tribal enterprise. The regulations
do not include such interests in the definition of service recipient
stock, but provide the IRS authority to provide guidance expanding the
definition of service recipient stock. For a discussion of the
application of the exclusion for certain stock rights to rights issued
on equity interests in entities taxed as partnerships, see section
III.G of this preamble.
4. Valuation
a. In General
The final regulations provide that for the exclusion for stock
rights to apply, the stock right must specify an exercise price of the
stock right that may never be less than the fair market value of the
underlying stock on the date the stock right is granted. For purposes
of this discussion and the final regulations, the exercise price of a
stock appreciation right refers to the base stock value from which the
appreciation is measured for purposes of determining the compensation
payable under the stock appreciation right (for example, a stock
appreciation right providing for a payment of the excess of the fair
market value of 100 shares over $100 would have a $1 per share exercise
price).
Several commentators expressed concerns regarding the determination
of the fair market value of the underlying stock. Some commentators
requested that the valuation rules applicable to incentive stock
options be applied for purposes of the exclusion from section 409A.
Under those rules, if the stock option would otherwise fail to be an
incentive stock option solely because the exercise price was less than
the fair market value of the underlying stock as of the date of grant,
generally the option is treated as an incentive stock option if the
issuer attempted in good faith to set the exercise price at fair market
value. See section 422(c)(1). The Treasury Department and the IRS
believe that this is not the appropriate standard for determining
whether stock rights are subject to section 409A. Incentive stock
options are subject to strict limitations on the amount of such options
that may be granted to a particular employee. See section 422(d). In
contrast, there are no such limits applicable to nonstatutory stock
options, and grants of nonstatutory stock options often far exceed the
limitation applicable to incentive stock options. In addition, section
422(c)(1) explicitly provides for the good faith standard with respect
to incentive stock options, while no such provisions exist within
section 409A or its legislative history.
Commentators requested clarification of the consistency standard
with respect to the use of a valuation method. Specifically,
commentators asked whether one valuation method could be used for
purposes of establishing the exercise price while another method could
be used for purposes of determining the fair market value of the stock
at the time of the payment (for example, to determine the amount of
payment in the case of a stock appreciation right or a stock option
where the stock is subject to repurchase by the service recipient). The
final regulations clarify that consistency is not required, provided
that each valuation method used otherwise meets the requirements of the
final regulations. Accordingly, a service recipient may use one
valuation method for purposes of establishing an exercise price, but
another valuation method for purposes of establishing the payment
amount (in the case of a stock appreciation right) or the buyback
amount (in the case of a stock option where the underlying stock is
subject to a buyback arrangement). However, once an exercise price has
been established, the exercise price may not be changed through the
retroactive use of another valuation method. In addition, where after
the date of grant, but before the date of exercise, of the stock right,
the service recipient stock to which the stock right relates becomes
readily tradable on an established securities market, the service
recipient must use a valuation method for stock readily tradable on an
established securities market for purposes of determining the payment
amount (in the case of a stock appreciation right) or the buyback
amount (in the case of a stock option where the underlying stock is
subject to a buyback arrangement).
b. Valuation--Stock Readily Tradable on an Established Securities
Market
The final regulations adopt the rules under the proposed
regulations governing valuation of stock readily tradable on an
established securities market, generally requiring that the valuation
of such stock be based upon the contemporaneous prices established in
the securities market, subject to the modifications discussed in this
preamble. Some commentators requested additional guidance with respect
to when a stock will be treated as readily tradable. The final
regulations adopt the same standard as that set forth in Sec. 1.280G-
1, Q&A-6(e), that stock is treated as readily tradable if it is
regularly quoted by brokers or dealers making a market in such stock.
With respect to the rules governing the valuation of stock that is
readily tradable on an established securities market, commentators
generally focused on the provision of the proposed regulations
permitting the use of an average selling price during a specified
period that is within 30 days before or 30 days after the date of
grant. Specifically, comments concentrated on the requirement that the
commitment to grant the stock right with an exercise price set using
such an average selling price be irrevocable before the beginning of
the specified period. Commentators questioned both the purpose of the
requirement of the commitment to the valuation method, as well as the
actions required to satisfy the rule if averaging were being used.
The rule was intended to prohibit the use of an average price, set
on a look-back basis, to ensure a discounted exercise price. For
example, if a corporation decided to grant a stock option on July 1,
and it could set the exercise price using an average selling price for
any period falling within the prior 30 days without having had a prior
commitment to a specific averaging period, the corporation could simply
look for the lowest price that occurred during the prior June.
Furthermore, if the corporation were not committed to grant the stock
option on July 1, the corporation could wait until its stock price
began to rise and then grant an option using the selling price on a
given day during the previous 30 days to provide a particular discount.
Accordingly, the final regulations require that the commitment to grant
the stock right with an exercise price set using such an average
selling price be irrevocable before the beginning of the specified
period. To satisfy this requirement, the service recipient must
designate the recipient of the stock option, the number of shares the
stock option will permit the holder of the stock option to purchase,
and the method for determining the exercise price including the period
over which the averaging will occur, before the beginning of the
specified averaging period.
[[Page 19241]]
One commentator stated that the requirement of an irrevocable
commitment to the averaging period could not be met under French law,
because French law requires that the stock option exercise price be set
based on the average trading price over the preceding 20 days and the
commitment to the grant before the beginning of the period may be
viewed as violating that requirement. The final regulations provide
that where applicable foreign law requires that the compensatory stock
right granted by the issuer must be priced based upon a specific price
averaging method and period, a stock right granted in accordance with
such applicable foreign law will be treated as meeting the requirement,
provided that the averaging period may not exceed 30 days.
c. Valuation--Stock Not Readily Tradable on an Established Securities
Market
i. In General
The final regulations adopt the provisions in the proposed
regulations relating to the valuation of stock not readily tradable on
an established securities market, subject to the modifications
discussed in this section III.C.4.c. Accordingly, a valuation of stock
based upon a reasonable application of a reasonable valuation method is
treated as reflecting the fair market value of the stock. To meet this
standard, it is not necessary that a taxpayer demonstrate that the
value was determined by an independent appraiser. Where the taxpayer
can otherwise demonstrate that the valuation was determined by the
reasonable application of a reasonable valuation method, the standard
will be met.
One commentator requested that the factors to be considered in
determining the fair market value of the stock should be modified to
include consideration of any recent equity sales made by the
corporation in arm's-length transactions. The final regulations adopt
this suggestion.
The final regulations continue to require that in the case of a
stock right issued with respect to stock that was not publicly traded
at the time the right was issued, but becomes publicly traded before
the right is exercised, the stock value for purposes of calculating the
payment amount (in the case of a stock appreciation right) or the
buyback amount (in the case of a stock option where the underlying
stock is subject to a buyback agreement) must be based upon the rules
governing stock that is publicly traded. This does not mean that the
initial exercise price determined under the rules governing stock that
is not publicly traded must be reset. Rather, this means only that the
value at the time of exercise used to determine the payment amount or
the buyback amount must be determined under the rules governing stock
that is publicly traded. For example, if a service provider holds an
excluded stock appreciation right with an exercise price of $1 that was
fixed based on a valuation of the closely-held corporate stock at the
time of grant, and before exercise the stock becomes readily tradable
on an established securities market, the amount payable upon exercise
must be the excess of the value of the stock based on its trading price
over the $1 exercise price.
ii. Safe Harbor Presumptions
The final regulations adopt a presumption in specified
circumstances that, for purposes of section 409A, a valuation of stock
reflects the fair market value of the stock, rebuttable only by a
showing that the valuation is grossly unreasonable. The presumption
applies where the valuation is based upon an independent appraisal, a
generally applicable repurchase formula (applicable for both
compensatory and noncompensatory purposes) that would be treated as
fair market value under section 83, or, in the case of illiquid stock
of a start-up corporation, a valuation by a qualified individual or
individuals applied at a time that the corporation did not otherwise
anticipate a change in control event or public offering of the stock.
Many of the comments with respect to these presumptions related to
the presumption applicable to illiquid stock of start-up corporations.
As set forth in the proposed regulations, the start-up corporation
presumption would not apply if the service recipient or service
provider could reasonably anticipate, as of the time the valuation is
applied, that the service recipient would undergo a change in control
event or make a public offering of securities within the 12 months
following the event to which the valuation is applied. Commentators
suggested that a 12-month period is too long, because changes occur so
rapidly in the business world that it often is difficult or impossible
to predict so far in advance whether such an event will occur.
Commentators suggested that the service provider should retain the
benefit of the presumption unless the issuing corporation entered into
a definitive agreement or filed its registration statement with the
Securities and Exchange Commission within a period of 15 or 30 days
after issuing the stock right.
The Treasury Department and the IRS believe that a 15-day or a 30-
day period is too short. Although there is always a risk that a public
offering will fail or that a corporate transaction will not occur, the
Treasury Department and the IRS also believe that a person should
reasonably be able to anticipate whether such a transaction will occur
during a reasonable period before the transaction.
Accordingly, the final regulations provide that the start-up
corporation presumption will not apply if at the time the valuation is
made, the service recipient or service provider may reasonably
anticipate that the service recipient will undergo a change in control
event in the next 90 days or an initial public offering within the next
180 days. As under the proposed regulations, the rule in the final
regulations is concerned with what the parties may reasonably
anticipate at the time the stock right is issued.
Other comments requested examples of persons with sufficient
knowledge, experience, and skill in valuing illiquid stock of a start-
up corporation. Because knowledge, skill, and training may be obtained
in different ways, the final regulations do not provide specific
examples. However, the regulations clarify that the standard to be
applied is whether a reasonable individual, upon being apprised of such
person's relevant knowledge, experience, education, and training, would
reasonably rely on the advice of such person with respect to valuation
in deciding whether to accept an offer to purchase or sell the stock
being valued. The final regulations also clarify that significant
experience generally means at least five years of relevant experience
in business valuation or appraisal, financial accounting, investment
banking, private equity, secured lending, or other comparable
experience in the line of business or industry in which the service
recipient operates.
With respect to the presumption based upon a generally applicable
buyback formula, some commentators requested that the presumption apply
where the formula is applicable to all compensatory stock transactions,
but not also applicable to all noncompensatory stock transactions. The
final regulations do not adopt this suggestion. However, the final
regulations clarify that to meet the requirements of the presumption,
the buyback formula is required to be applicable to compensatory and
noncompensatory transactions with the issuer or a person owning 10
percent or more of the stock of the issuer, but is not
[[Page 19242]]
required to be applicable to transactions with other persons or
transactions that are part of an arm's length transaction constituting
the sale of all or substantially all of the stock of the issuer to an
unrelated purchaser.
5. Modification of a Stock Right
The final regulations continue to apply certain rules addressing
modifications, extensions and renewals of stock rights. Although these
rules in many respects resemble the rules applicable to statutory stock
options, the rules are not intended to incorporate the rules applicable
to statutory stock options except where explicitly provided.
The final regulations generally retain the rules in the proposed
regulations that generally treat extensions of the exercise period of a
stock right as an additional deferral feature as of the date of grant
of the right, with an exception for certain limited extensions
following a separation from service. Commentators characterized these
rules as unnecessarily restrictive. Specifically, commentators argued
that the extension of a stock option upon the occurrence of a
separation from service (often in connection with a program of layoffs)
or a corporate transaction is a common practice, and that often these
extensions cover periods longer than the limited period provided in the
proposed regulations. In addition, commentators argued that the same
substantive results could be obtained by specifying a longer term for
the stock right and providing the service recipient the discretion to
shorten the term, rather than providing discretion to extend a shorter
term, and that the former approach would be permissible under the
proposed regulations. In response, the final regulations provide that
the extension of an option exercise period generally is not treated as
an additional deferral feature or a modification of the stock option
for section 409A purposes if the exercise period is not extended beyond
the earlier of the original maximum term of the option or 10 years from
the original date of grant of the stock right.
Many commentators also requested that the extension of the exercise
period of a stock right not be treated as an additional deferral
feature for purposes of section 409A, where at the time of the
extension the fair market value of the underlying stock does not exceed
the exercise price (an ``underwater'' option). Because the issuance of
an otherwise identical option with an exercise period ending after the
end of the exercise period of the underwater option would be excluded
from coverage under section 409A, the final regulations provide that
such an extension does not constitute an additional deferral feature.
The final regulations adopt the provisions in the proposed
regulations regarding substitution or assumption of stock rights due to
a corporate transaction, which are generally in accordance with the
corresponding provisions governing incentive stock options. The final
regulations clarify that the applicable corporate transactions for this
purpose include only those transactions described in Sec. 1.424-
1(a)(3). One commentator requested that the provision permitting
substitutions of stock options be modified to reflect that a holder of
a nonstatutory stock option is not required to be employed by the
successor entity. The final regulations adopt this suggestion, so that
a substituted nonstatutory stock option may be treated as a
continuation of the initial option even where the holder of the option
is not employed or otherwise providing services to the successor
entity, provided the substitution otherwise meets the rules provided in
the regulations.
6. Other Stock Right Issues
The final regulations adopt certain definitions from the
regulations governing statutory stock options, modified as appropriate
for purposes of applying the rules under section 409A. These include
the time and date of grant of an option (Sec. 1.421-1(c)), and the
definitions of option (Sec. 1.421-1(a)), stock (Sec. 1.421-1(d)),
exercise price (Sec. 1.424-1(e)), exercise (Sec. 1.421-1(f)), and
transfer (Sec. 1.421-1(g)). These definitions apply by analogy to
stock appreciation rights.
The final regulations adopt the rule that a right to a payment of
accumulated dividend equivalents at the time of the exercise of a stock
right generally will be treated as a reduction in the exercise price of
the stock right, causing the stock right to be deferred compensation
subject to the requirements of section 409A. The final regulations
provide that an arrangement to accumulate and pay dividend equivalents
the payment of which is not contingent upon the exercise of a stock
right may be treated as a separate arrangement for purposes of section
409A. Such an arrangement generally will be required to comply with
section 409A (unless it independently qualifies for an exception from
coverage under section 409A), but will not affect whether the related
stock right qualifies for the exclusion from coverage under section
409A. The right to the dividend equivalents may be set forth within the
stock right plan or the individual stock right grant, or in a separate
document, as long as the payment of the dividend equivalents is not
contingent upon the exercise of the stock right.
Commentators also asked whether the exclusion of stock rights from
coverage under section 409A would apply to tandem rights, meaning a
stock right that combines a stock option right and a stock appreciation
right, exercisable on an alternative basis. Similarly, commentators
asked whether the substitution of a stock option for a stock
appreciation right, or vice versa, where all the terms except the mode
of payment upon exercise are similar, would be treated as a
modification of a stock right. The application of section 409A
generally is not affected by the medium of a taxable payment (for
example, cash or stock). Accordingly, whether a stock right is
expressed as a tandem arrangement under which the exercise of one right
terminates the other right, or there is a substitution of a stock
appreciation right for a stock option identical in all respects except
for the medium of payment, generally does not impact whether the
arrangement is excluded from coverage under section 409A.
Commentators requested further clarification of the application of
section 409A to stock option gain deferrals. The ability to defer gain
upon the exercise or exchange (including a purported forfeiture) of a
stock right is incompatible with the exclusion of certain stock rights
from the requirements of section 409A because such exclusion is
predicated on the option not having any additional deferral feature.
Accordingly, if an arrangement provides for a potential to defer the
payment of cash or property upon the exercise or exchange of a stock
right beyond the year the right is exercised or beyond the original
term of the stock right, the arrangement provides for a deferral
feature and must comply with the requirements of section 409A from the
time the legally binding right granted by the award arises.
Because a stock option with a deferral feature is subject to
section 409A regardless of whether the deferral feature is actually
utilized, an option that includes a provision permitting deferral of
option gain generally will not satisfy the time and form of payment
rules under section 409A if the service provider can exercise the
option in more than one taxable year. If a deferral feature is added to
a preexisting option, the option will be treated as having included a
deferral feature as of the original date of grant, generally resulting
in a violation of section 409A.
[[Page 19243]]
However, the final regulations provide that a stock right will not
be treated as having a deferral feature where the service recipient
delays a payment because the making of the payment would violate
applicable Federal, state, local, or foreign law or jeopardize the
ability of the service recipient to continue as a going concern.
Although these provisions permit the delay for purposes of section
409A, no inference should be drawn as to the Federal tax consequences
of such a delay under any other section of the Code or Federal tax
doctrine such as section 83, section 451, the constructive receipt
doctrine, or the economic benefit doctrine.
Commentators requested that the definition of service recipient
stock be expanded to include the stock of a corporation for which a
service recipient provides substantial services, at least with respect
to a service provider of the service recipient that is providing
services to the corporation. The legislative history does not support
such a broad interpretation of service recipient stock, and the final
regulations do not adopt this suggestion.
E. Restricted Property
The final regulations provide, as did the proposed regulations,
that a grant of restricted property generally will not constitute a
deferral of compensation for purposes of section 409A. Commentators
requested that the regulations clarify that a vested right to receive
nonvested property in a future year does not constitute deferred
compensation. Commentators argued that a right to receive nonvested
property is not truly vested. For example, commentators argued that a
right to receive restricted stock that will be subject to a substantial
risk of forfeiture until the service provider completes three years of
future services cannot be a vested right. The final regulations adopt
this suggestion, so long as the risk of forfeiture to which the stock
is subject constitutes a substantial risk of forfeiture for purposes of
section 409A.
Commentators specifically requested clarification of the
circumstances under which a service provider may elect to be paid a
bonus or other payment in the form of restricted stock, rather than
cash. Generally an election between compensation alternatives, none of
which provides for a deferral of compensation within the meaning of
section 409A, will not cause the election to be subject to the section
409A timing restrictions. Thus, a choice between an award of restricted
stock or stock options that are not subject to section 409A will not be
governed by the section 409A election timing rules. However, where any
of the alternatives involves a deferral of compensation subject to
section 409A, the election must comply with the provisions of section
409A. In addition, no inference should be drawn as to the Federal tax
consequences of such an election provision under any other section of
the Code or Federal tax doctrine such as section 83, section 451, the
constructive receipt doctrine, or the economic benefit doctrine.
F. Section 402(b) Trusts
The final regulations continue to except from coverage under
section 409A transfers of a beneficial interest in a trust, or a
transfer to or from a trust, to the extent such a transfer is subject
to section 402(b). The final regulations further clarify that a right
to compensation required to be included in income under section
402(b)(4)(A) (alternative taxation of highly compensated employees of a
section 402(b) trust that fails to meet the requirements of section
401(a)(26) or section 410(b)) also is not a deferral of compensation.
However, a right to receive a benefit formulated as a right to a future
contribution to a section 402(b) trust is similar to a right to receive
property in a future taxable year, and generally would constitute
deferred compensation.
G. Arrangements Between Partnerships and Partners
The proposed regulations did not address the application of section
409A to arrangements between partnerships and partners, and these final
regulations also do not address such arrangements. The statute and the
legislative history of section 409A do not specifically address
arrangements between partnerships and partners providing services to a
partnership and do not explicitly exclude such arrangements from the
application of section 409A. Commentators raised a number of issues,
relating both to the scope of the arrangements subject to section 409A
and the coordination of the provisions of subchapter K and section 409A
with respect to those arrangements that are subject to section 409A.
The Treasury Department and the IRS are continuing to analyze the
issues raised in this area. Notice 2005-1, Q&A-7 provides interim
guidance regarding the application of section 409A to arrangements
between partnerships and partners. Until further guidance is issued,
taxpayers may continue to rely on Notice 2005-1, Q&A-7 and section
II.E. of the preamble to the proposed regulations.
Notice 2005-1, Q&A-7 provided that until further guidance is issued
for purposes of section 409A, taxpayers may treat the issuance of a
partnership interest (including a profits interest) or an option to
purchase a partnership interest, granted in connection with the
performance of services under the same principles that govern the
issuance of stock. For this purpose, taxpayers may apply the principles
applicable to stock options or stock appreciation rights under these
final regulations, as effective and applicable, to equivalent rights
with respect to partnership interests.
Taxpayers also may continue to rely upon the explanation in the
preamble to the proposed regulations regarding the application of
section 409A to guaranteed payments for services described in section
707(c). As stated in that preamble, until further guidance is issued,
section 409A will apply to guaranteed payments described in section
707(c) (and rights to receive such guaranteed payments in the future),
only in cases where the guaranteed payment is for services and the
partner providing services does not include the payment in income by
the 15th day of the third month following the end of the taxable year
of the partner in which the partner obtained a legally binding right to
the guaranteed payment or, if later, the taxable year in which the
right to the guaranteed payment is first no longer subject to a
substantial risk of forfeiture.
Commentators raised issues concerning the application of the
provision in Notice 2005-1, Q&A-7 stating that until further guidance
is issued, taxpayers may treat arrangements providing for payments
subject to section 736 (payments to a retiring partner or a deceased
partner's successor in interest) as not being subject to section 409A,
except that an arrangement providing for payments that qualify as
payments to a partner under section 1402(a)(10) is subject to section
409A. Section 1402(a)(10) provides for an exception from the Self-
Employment Contributions Act (SECA) tax for payments to a retired
partner, provided that certain conditions are met. Specifically, the
payments must be made pursuant to a written plan of the partnership,
must be on account of the partner's retirement and must continue at
least until the partner's death. In addition, to qualify for the
exception, the partner must not have rendered services during the
partnership's taxable year ending within or with the partner's taxable
year in which the amounts were received, as of the close of the
partnership's taxable year no obligation
[[Page 19244]]
must exist from the other partners to such retired partner except with
respect to retirement payments under such plan, and before the end of
the partnership's taxable year such retired partner's share, if any, of
the capital of the partnership must have been paid to him in full.
Commentators questioned the appropriateness of the inclusion of
such arrangements under section 409A, because neither the statute nor
the legislative history refers to section 1402(a)(10). However, the
Treasury Department and the IRS believe it is appropriate for such
arrangements to be subject to section 409A because such arrangements
are purposefully created to provide deferred compensation, and do not
raise issues regarding the coordination of the provisions of section
409A with the provisions of section 736, specifically the rules
governing the classification of payments to a retired partner under
section 736(a) (payments considered as distributive share or guaranteed
payments) and section 736(b) (payments for interest in partnership).
However, further clarification and relief is provided concerning
the application of the deferral election timing rules to these
payments. Until further guidance is issued, for purposes of section
409A, taxpayers may treat the legally binding right to the payments
excludible from SECA tax under section 1402(a)(10) as arising on the
last day of the partner's taxable year before the partner's first
taxable year in which such payments are excludible from SECA tax under
section 1402(a)(10), and the services for which the payments are
compensation as performed in the partner's first taxable year in which
such payments are excludible from SECA tax under section 1402(a)(10).
Accordingly, for purposes of section 409A, the time and form of payment
of such amounts generally may be established, including through an
election to defer by the partner, on or before the final day of the
partner's taxable year immediately preceding the partner's first
taxable year in which such payments are excludible from SECA tax under
section 1402(a)(10). However, this interim relief does not apply a
second time where an amount paid under an arrangement in one year has
been excluded from SECA tax under section 1402(a)(10), and an amount
paid in a subsequent year has not been excluded from SECA tax under
section 1402(a)(10) because, for example, the partner performed
services in that subsequent year.
H. Foreign Plans
1. Plans Covered by an Applicable Treaty
The proposed regulations provided an exclusion from the definition
of a nonqualified deferred compensation plan for any scheme, trust, or
arrangement maintained with respect to an individual where
contributions made by or on behalf of such individual to such scheme,
trust or arrangement are excludable for Federal income tax purposes
under an applicable income tax treaty. The final regulations retain
that exclusion and clarify that the exclusion applies to the extent
contributions made by or on behalf of such individual to such scheme,
trust, arrangement or plan, or credited allocations, accrued benefits,
or earnings or other amounts constituting income, of such individual
under such scheme, trust, arrangement or plan, are excludable by such
individual for Federal income tax purposes pursuant to any bilateral
income tax convention to which the United States is a party.
2. Exclusion for Benefits Earned Under a Broad-Based Foreign Retirement
Plan
The proposed regulations contained an exclusion from coverage under
section 409A for amounts deferred under a broad-based foreign
retirement plan, subject to certain conditions, including that the
service provider not be eligible to participate in a qualified employer
plan, and that if the person is a U.S. citizen or lawful permanent
resident, the exception only applies to nonelective deferrals of
foreign earned income (as defined in section 911(b)(1)) that do not
exceed the limits under section 415(b) and (c) that would be applicable
if the plan were a qualified plan. Deferrals by participants that are
nonresident aliens are not subject to the limitation based on section
415. The final regulations adopt this provision, subject to certain
modifications.
Many of the commentators requested expansion of the exclusion for
broad-based foreign retirement plans. One commentator requested that
the exclusion apply to U.S. citizens working in the United States for a
foreign employer. The Treasury Department and the IRS do not believe
such an exception is justified. However, the exception for U.S.
citizens or lawful permanent residents has been expanded to cover
nonelective deferrals of foreign earned income as defined in section
911(b)(1) without regard to section 911(b)(1)(B)(iv) and without regard
to the requirement that the income be attributable to services
performed during the period described in section 911(d)(1)(A) or (B).
Accordingly, the exception may now cover certain participation by a
U.S. citizen or lawful permanent resident who works overseas during
only part of a year, and therefore is not a bona fide resident of a
foreign country for an uninterrupted period that includes an entire
taxable year, or is not present in the foreign country at least 330
full days during a period of 12 consecutive months.
The regulations have also been modified to address nonqualified
deferred compensation plans covering bona fide residents of a U.S.
possession. Under the regulations a bona fide resident of a possession
who participates in a broad-based foreign retirement plan is not
subject to section 409A with respect to participation in such plan. In
addition, a plan substantially all of the participants in which are
bona fide residents of a possession is eligible to be treated as a
broad-based foreign retirement plan, so that U.S. citizens and resident
aliens (other than bona fide residents of a possession) who participate
in such a plan may be eligible for the more limited exclusion for
participation in a broad-based foreign retirement plan.
Another commentator requested that the exclusion apply to a plan
that otherwise meets the requirements for the exclusion, regardless of
whether the plan is sponsored by a foreign or U.S. employer. This
suggestion has been adopted in the final regulations.
Other commentators requested further clarification and revision of
certain of the requirements to qualify for the exclusion. One
commentator requested a safe harbor treating any plan granted favorable
tax treatment under the laws of a foreign jurisdiction as qualifying
for the exclusion. The Treasury Department and the IRS believe this
standard is both too broad and not administrable, and this suggestion
has not been adopted in the final regulations.
Another commentator requested that the regulations provide a safe
harbor percentage for determining whether substantially all of a
foreign plan's participants are nonresident aliens. The final
regulations do not adopt such a provision. However, the final
regulations clarify that in determining whether substantially all of a
foreign plan's participants are nonresident aliens or bona fide
residents of a possession, only active participants are considered. For
this purpose, active participants include individuals who, under the
terms of the plan and without further amendment or action by the plan
sponsor, are eligible to make or receive contributions or accrue
benefits under
[[Page 19245]]
the plan (even if the individual has elected not to participate in the
plan).
A similar standard applies to the requirement that the individual
not be eligible to participate in a qualified employer plan. The final
regulations provide that a service provider will be treated as eligible
to participate in a qualified employer plan if, under the plan's terms
and without further amendment or action by the plan sponsor, the
service provider is eligible to make or receive contributions or accrue
benefits under the plan (even if the service provider has elected not
to participate in the plan).
The final regulations also clarify that the exclusion for United
States citizens and lawful permanent residents applies to nonelective
deferrals even if elective deferrals are permitted under the same plan,
provided that the amounts deferred through nonelective deferrals and
earnings on such amounts are distinguishable from amounts deferred
through elective deferrals and earnings on such amounts, such as
through the use of separate accounts.
3. Tax Equalization Payments
The proposed regulations excluded from coverage under section 409A
certain arrangements, referred to as tax equalization arrangements,
that provide for payments intended to compensate the service provider
for the excess of taxes actually imposed by a foreign jurisdiction on
the compensation paid over the taxes that would be imposed if the
compensation were subject solely to United States Federal income tax,
subject to certain requirements. The final regulations adopt these
provisions, subject to modifications. Based upon the comments received,
the final regulations generally expand the exclusion in two respects.
First, the final regulations extend the tax equalization payments
exception to cover reimbursements of U.S. taxes that exceed foreign
taxes. Second, the final regulations provide that the payment must be
made by the end of the second taxable year of the service provider
following the latest of the deadline for filing a U.S. Federal tax
return or the deadline for filing foreign tax returns (or if a foreign
return is not required to be filed, the due date for foreign tax
payments) reflecting the compensation for which the tax equalization
payment is provided.
Commentators also asked how such reimbursement agreements could
address the potential for an audit or other tax controversy, both in
the U.S. and abroad. The same issue arises with respect to tax gross-up
payments in general. For a discussion of the treatment of the right to
such payments, see section VII.B.4 of this preamble.
4. Certain Limited Deferrals by Nonresident Aliens
The proposed regulations provided an exception for amounts deferred
by a nonresident alien under a foreign plan maintained by a foreign
service recipient, to the extent the amounts deferred during the year
did not exceed $10,000. The final regulations adopt this provision,
subject to the modifications described in this preamble. In response to
comments, the final regulations clarify that the exception applies to
amounts deferred in that taxable year up to the specified limit,
regardless of whether additional amounts are deferred. In making this
modification, the exclusion provision has been moved from the section
providing a definition of nonqualified deferred compensation plan
(Sec. 1.409A-1(a)) to the section providing a definition of an amount
deferred (Sec. 1.409A-1(b)). In addition, the final regulations
clarify that this exception applies to earnings on amounts deferred
that were subject to the exception, provided that the taxpayer can
identify both the deferred amounts excepted and the applicable
earnings. Finally, in response to comments requesting that the limit be
increased and indexed, the final regulations increase the limit for the
small deferral exception to the limit provided for elective deferrals
under section 402(g).
The small deferral exception is intended to provide relief to
service providers that are not U.S. citizens or lawful permanent
residents, are participating in a foreign plan, and perform services in
the U.S. for which they are compensated. In such cases, the nonresident
alien may inadvertently defer a relatively small amount of compensation
that would otherwise be subject to U.S. Federal income tax. This may
occur where the service provider defers the compensation that the
service provider would otherwise have been paid for a brief period of
service in the United States, or where the service provider receives
service or compensation credit for a brief period of service in the
United States under a benefit formula of a nonqualified deferred
compensation plan.
Some commentators requested that the exemption be extended to cover
all amounts deferred by nonresident aliens under foreign plans to the
extent the nonresident alien provides only temporary services in the
U.S. Where the compensation earned by such a nonresident alien would be
subject to U.S. income tax if paid when earned, the Treasury Department
and the IRS do not believe that such a broad exception is warranted.
5. Other Foreign Plans
The final regulations adopt the exclusion in the proposed
regulations for deferrals of amounts that would be excluded as foreign
earned income under section 911 if the amounts had been paid out when
earned. The final regulations clarify that the amount is limited to an
amount equal to or less than the difference between the maximum section
911 exclusion for the year and the amount actually excluded for the
year. Commentators requested that the exception for the deferral of
amounts that would be excluded under section 911 be relaxed, so that
U.S. expatriates who return for periods longer than 30 days or who earn
compensation for services performed in the U.S. that is not excluded as
foreign earned income, may also take advantage of the exception. This
exception was not intended to address such plans. Rather, the provision
was intended to provide relief from the section 409A requirements for
U.S. expatriates who intend to work full-time outside the U.S. for
compensation that is less than the exclusion amount under section 911,
because it would severely disadvantage such workers to expect them to
request that their potential foreign employers modify standard plans to
accommodate them, or to expect such workers to otherwise be able to
determine how to avoid or comply with section 409A.
Commentators pointed out, however, that earnings on deferred
amounts, including increases in amounts deferred under a nonaccount
balance plan solely due to the passage of time, may not be treated as
earned income under section 911 and argued that, nonetheless, such
amounts should not lower the amount otherwise available to be deferred
under the exception. The final regulations generally provide that
rights to earnings credited on amounts that qualify for this exception
are also excepted from coverage under section 409A, provided that the
earnings satisfy the definition of earnings in Sec. 1.409A-1(o).
I. Indemnification Arrangements
The final regulations generally provide that the right to the
payment of contingent amounts pursuant to a service recipient's
indemnification for expenses incurred as a result of a legal claim for
damages related to the service provider's performance as a service
provider, to the extent permissible under applicable law, will not be
treated as the right to deferred compensation. Similarly, a right to
liability insurance
[[Page 19246]]
coverage providing for such payments in the event of such a suit also
will not be treated as providing for a deferral of compensation.
J. Separation Pay Plans
1. In General
The final regulations generally adopt the provisions addressing
separation pay plans set forth in the proposed regulations, subject to
certain modifications. The final regulations clarify that separation
pay refers only to compensation to which the service provider's right
is conditioned upon a separation from service (including a separation
from service due to death or disability) and not to compensation the
service provider could receive without separating from service (such as
an amount also payable upon a change in control, as a result of an
unforeseeable emergency, or on a date certain). For example, the right
to a gross-up payment for taxes payable due to the application of
section 280G will constitute separation pay if a separation from
service is required to obtain the payment. The final regulations also
clarify that a separation pay plan for purposes of section 409A,
including for purposes of the plan aggregation rules, refers only to
plans providing for payments of amounts of deferred compensation
(disregarding the exceptions from the definition of deferred
compensation for certain types of separation pay) where one of the
conditions to the right to the payment is a separation from service. A
right to a payment upon a separation from service that is not deferred
compensation does not become subject to section 409A under the plan
aggregation rule. For example, the accelerated vesting due to a
separation from service of stock options excluded from coverage under
section 409A would not constitute a separation pay plan or otherwise
become subject to section 409A under the plan aggregation rules.
The final regulations generally retain and supplement the various
exceptions from the definition of deferred compensation for certain
types of separation pay, providing exceptions for (1) certain bona fide
collectively bargained arrangements, (2) certain arrangements providing
separation pay due solely to an involuntary separation from service or
participation in a window program in limited amounts and for a limited
period of time, (3) certain foreign separation pay arrangements, (4)
certain reimbursement arrangements providing for expense reimbursements
or in-kind benefits for a limited period of time following a separation
from service, and (5) certain rights to limited amounts of separation
pay. These exceptions from coverage under section 409A for specified
separation pay plans may be used in combination. For example, the
rights of an employee to the maximum amount available under the
exception for separation payments made solely due to involuntary
separation from service or participation in a window program, to
reimbursements for reasonable moving expenses and outplacement expenses
that meet the requirement for exclusion from coverage under section
409A, and to rights to payments that do not exceed the limit on
elective deferrals under section 402(g) and accordingly qualify for the
limited payment exception, may all be excluded from coverage under
section 409A due to application of the various exceptions.
The final regulations continue to provide that any amount, or
entitlement to any amount, that acts as a substitute for, or
replacement of, amounts deferred under a separate nonqualified deferred
compensation plan constitutes a payment of deferred compensation or
deferral of compensation under the separate nonqualified deferred
compensation plan. Commentators asked how this would apply where the
service provider would otherwise forfeit a payment upon separation from
service but a payment is made anyway, in whole or in part.
The regulations provide that if a separation from service is
voluntary, it is presumed that the payment results from an acceleration
of vesting followed by a payment of the deferred compensation that is
subject to section 409A. Accordingly, any change in the payment
schedule to accelerate or defer the payments would be subject to the
rules of section 409A. The presumption that a right to a payment is not
a new right, but is instead a right substituted for an existing
nonvested right, may be rebutted by demonstrating that the service
provider's right to the payment after the separation from service would
have existed regardless of the forfeiture of the nonvested right.
Factors indicating that a right would have existed regardless of the
forfeiture include that the amount to which the service provider
obtains a right is materially less than the present value of the
forfeited amount multiplied by a fraction, the numerator of which is
the period of service the service provider actually completed, and the
denominator of which is the full period of service the service provider
would have been required to complete to receive the full amount of the
payment. Another factor is that the payment consists of a type of
payment customarily made to service providers who separate from service
with that service recipient and do not forfeit nonvested rights to
deferred compensation (for example, a payment of accrued but unused
leave or a payment for a release of potential claims).
2. Separation Pay Due Solely to Involuntary Separation From Service or
Participation in a Window Program
The final regulations generally continue the exception from
coverage under section 409A in the proposed regulations for rights to
payments available only upon an involuntary separation from service or
participation in a window program, payable no later than the end of the
second taxable year of the service provider following the year of the
separation from service, and limited to an amount that is generally the
lesser of two times the service provider's annual compensation or two
times the limit on compensation set forth in section 401(a)(17). This
exception only applies where the payment is available solely due to an
involuntary separation from service of the service provider, or the
service provider's participation in a window program, and not to a plan
providing for a payment upon a voluntary separation from service or
other event. For a discussion of when a separation from service for
good reason may be treated as an involuntary separation from service,
see section III.J.3 of this preamble.
Commentators requested that the exclusion continue to apply to
payments up to the limit, even where the entire amount of the
separation payments exceeds the limit. The final regulations adopt this
rule. Accordingly, where a service provider is entitled to a payment
that qualifies for the exception except that it exceeds the limit, only
the excess over the limit will be subject to section 409A. The right to
the payment up to the applicable limit will not be subject to section
409A, including the requirement that the payment be delayed for six
months in the case of a specified employee, provided that such limited
payment is otherwise required to be made, and is made, no later than
the end of the second taxable year following the service provider's
taxable year in which the separation from service occurs.
The final regulations clarify that for purposes of applying the
section 401(a)(17) limit, the statutory limit applicable for the year
of the separation from service occurs applies. The final
[[Page 19247]]
regulations also clarify that for purposes of determining the service
provider's annual rate of pay for the taxable year preceding the
taxable year in which the separation from service occurs, an annual
rate of pay based upon the service provider's taxable year immediately
preceding the service provider's taxable year in which the separation
from service occurs is used, adjusted for any increase during the year
that was expected to continue indefinitely if the service provider had
not separated from service. One commentator requested that the limit be
set at twice the amount of compensation set forth under section
401(a)(17), regardless of the service provider's actual income. This
suggestion has not been adopted in the final regulations.
3. Definition of Involuntary Separation From Service
The proposed regulations provided an exclusion from coverage under
section 409A that applied only to certain amounts paid solely because
of an actual involuntary separation from service or participation in a
window program. Many comments asked how to determine whether a
separation from service is involuntary for this purpose. The final
regulations contain a definition of involuntary separation from service
and also apply this definition for purposes of the definition of a
substantial risk of forfeiture, pursuant to which a payment that will
not be made unless the service provider experiences an involuntary
separation from service is subject to a substantial risk of forfeiture
for purposes of section 409A. (See section V of this preamble.)
The final regulations provide that whether a separation from
service is involuntary is determined based on all the facts and
circumstances. For this purpose, any characterization of the separation
from service as voluntary or involuntary by the service provider and
the service recipient in the documentation relating to the separation
from service is rebuttably presumed to properly characterize the nature
of the separation from service. For example, if a separation from
service is characterized as voluntary, the presumption may be rebutted
by demonstrating that absent the voluntary separation from service the
service recipient would have terminated the service provider's
services, and that the service provider had knowledge that the service
provider would be so terminated.
Commentators requested that a separation from service for good
reason be treated as an involuntary separation from service. The final
regulations provide that where the right to a payment is contingent
upon a voluntary separation from service following an occurrence that
constitutes good reason for the service provider to terminate his or
her services, the right may be treated as payable only upon an
involuntary separation from service where the good reason condition is
such that the service provider's separation from service effectively is
an involuntary separation for purposes of section 409A. To be treated
as an involuntary separation for purposes of section 409A, the
avoidance of the requirements of section 409A must not be a purpose of
the inclusion of any good reason condition in the plan or of the
actions by the service recipient in connection with the satisfaction of
a condition. In addition, such good reason condition must require
actions taken by the service recipient resulting in a material negative
change in the employment relationship, such as a material negative
change in the duties to be performed, the conditions under which such
duties are to be performed, or the compensation to be received.
Additional factors that may be relevant to whether a purported
separation from service for good reason is the result of a bona fide
good reason condition not having as a principal purpose the avoidance
of section 409A include the extent to which the payments upon a
separation from service for good reason are in the same amount and are
made at the same time and in the same form as payments available upon
an actual involuntary separation from service, and whether the service
provider is required to give the service recipient notice of the
existence of the good reason condition and a reasonable opportunity to
remedy the condition. Where a good reason condition is sufficient to be
treated for purposes of section 409A as a condition requiring an
involuntary separation from service, an amount payable on account of a
separation from service for good reason will be treated the same as an
amount payable on account of an actual involuntary separation from
service.
The final regulations also provide a safe harbor under which a
provision for a payment upon a voluntary separation from service for
good reason will be treated for purposes of section 409A as providing
for a payment upon an actual involuntary separation from service. Those
conditions include that the amount be payable only if the service
provider separates from service within a limited period of time not to
exceed one year following the initial existence of the good reason
condition, and that the amount, time and form of payment upon a
voluntary separation from service for good reason be identical to the
amount, time and form of payment upon an involuntary separation from
service. In addition, the service provider must be required to provide
notice of the existence of the good reason condition within a period
not to exceed 90 days of its initial existence, and the service
recipient must be provided a period of at least 30 days during which it
may remedy the good reason condition. For these purposes, a good reason
condition may consist of one or more of the following conditions
arising without the consent of the service provider: (1) A material
diminution in the service provider's base compensation; (2) a material
diminution in the service provider's authority, duties, or
responsibilities; (3) a material diminution in the authority, duties,
or responsibilities of the supervisor to whom the service provider is
required to report, including a requirement that a service provider
report to a corporate officer or employee instead of reporting directly
to the board of directors of a corporation (or similar entity with
respect to an entity other than a corporation); (4) a material
diminution in the budget over which the service provider retains
authority; (5) a material change in geographic location at which the
service provider must perform the services; or (6) any other action or
inaction that constitutes a material breach of the terms of an
applicable employment agreement.
4. Collectively Bargained Plans
Commentators requested an exception from coverage under section
409A to address certain plans providing for payments upon a voluntary
separation from service, in the context of a collective bargaining
agreement covering services performed for multiple employers. The
Treasury Department and the IRS believe these issues are better
addressed in the definition of separation from service. See section
VII.C.2.b of this preamble.
5. Treatment as a Separate Plan
For purposes of the plan aggregation rules, the final regulations
provide for separate treatment of plans providing for separation pay
solely due to an involuntary separation from service or participation
in a window program. This exception is intended to apply only where the
amounts are payable solely due to an involuntary separation from
service or participation in a window program, and not where the amounts
may also become payable for some other reason, even where such payments
actually are made due to an involuntary
[[Page 19248]]
separation from service or participation in a window program.
Accordingly, any amount that would be paid as a result of a voluntary
separation from service will not be included in this category. An
arrangement that does not provide for deferred compensation will not be
aggregated with a deferred compensation plan under this rule, merely
because the arrangement not providing for deferred compensation
accelerates vesting or payment upon an involuntary separation from
service (for example, the acceleration of the vesting of a stock option
or stock appreciation right that is excluded from coverage under
section 409A).
6. Reimbursement and Fringe Benefit Plans
a. In General
The proposed regulations provided that certain plans under which a
service recipient reimburses certain types of expenses (for example,
reasonable moving expenses or reasonable outplacement expenses directly
related to a termination of the service provider's services) actually
incurred by a service provider (including certain in-kind benefits
provided to the service provider) following a separation from service
are not nonqualified deferred compensation plans for purposes of
section 409A, if such reimbursements are available only for expenses
incurred, and the reimbursements are made during a limited period
(generally not after the second taxable year of the service provider
following the separation from service).
In response to questions from commentators, the final regulations
clarify that a right to a benefit that is excludible from income will
not be treated as a deferral of compensation for purposes of section
409A. Accordingly, for example, an arrangement to provide health
coverage excludible from income under section 105 generally would not
be subject to section 409A.
Many commentators requested increased flexibility to provide for
reimbursement arrangements upon a separation from service, including
certain requests to exempt broad categories of such arrangements, such
as the continuation of any plan in which the service provider
participated while performing services. The Treasury Department and the
IRS believe that an exemption from coverage under section 409A is not
appropriate in such circumstances, because such plans may provide for
rights to significant amounts of deferred compensation over lengthy
periods of time. However, the final regulations extend the limited
period during which taxable reimbursements of medical expenses may be
provided, to cover the period during which the service provider would
be entitled (or would, but for such arrangement, be entitled) to
continuation coverage under a group health plan of the service
recipient under section 4980B (COBRA) if the service provider elected
such coverage and paid the applicable premiums. In addition, the final
regulations contain several provisions governing reimbursement plans
(including plans providing in-kind benefits) that constitute
nonqualified deferred compensation plans for purposes of section 409A,
so that taxpayers will be able to design such arrangements to comply
with the payment timing requirements of section 409A. For a discussion
of these provisions, see section VII.B.2 of this preamble.
b. Specific Exceptions for Post-Separation Reimbursement Plans
The final regulations continue to exclude from coverage under
section 409A the reimbursement of certain expenses such as reasonable
outplacement expenses and reasonable moving expenses for a limited
period of time due to a separation from service, whether the separation
from service is voluntary or involuntary. The final regulations, like
the proposed regulations, require that the eligible expense must be
incurred by the service provider no later than the end of the second
year following the year in which the separation from service occurs. In
response to questions from commentators, the final regulations clarify
that the exception applies to the qualifying reimbursements available
during the limited period of time, even if the plan extends beyond the
limited period of time.
Several commentators requested that the limited period of time
refer solely to the time the expense is incurred, and not the time the
expense is reimbursed, to reflect the need for time to process the
reimbursement request. Although the final regulations do not adopt this
suggestion, the final regulations extend the period during which a
service provider can receive a reimbursement payment by providing that
such payments must be made not later than the end of the third year
following the separation from service. This extension applies only to
reimbursements of expenses incurred by the service provider. Where the
service recipient provides in-kind benefits (as defined in the
regulations), or the service recipient pays a third party to provide
in-kind benefits, such benefits must be provided by the end of the
second year following the separation from service.
Commentators also requested that the final regulations clarify the
treatment of rights to a reimbursement of any loss incurred due to a
sale of a residence. The regulations clarify that for this purpose,
reasonable moving expenses include the reimbursement of an amount
related to a loss incurred due to a sale of a primary residence,
provided that the reimbursement does not exceed the loss actually
incurred.
7. Limited Payments of Separation Pay
The final regulations provide that, if not otherwise excluded, a
taxpayer may treat a right or rights under a separation pay plan to a
payment or payments of an aggregate amount not to exceed the applicable
dollar amount under section 402(g)(1)(B) for the year of the separation
from service as not providing for a deferral of compensation.
Commentators raised questions concerning the calculation of the
excluded amount, and requested an increase in the amount. The limited
payment exception is intended to avoid the application of section 409A
to incidental benefits often provided upon a separation from service,
where the parties may not realize that the benefits are nonqualified
deferred compensation. The exception is not intended to address
extended or significant benefits. Accordingly, the final regulations do
not substantially increase the amount of the exclusion. However, to
permit the excluded amount to automatically reflect cost-of-living
increases, the maximum exclusion now equals the maximum amount of an
elective deferral permitted under section 402(g) for the year of the
separation from service.
The aggregate amount refers to the aggregate amount of payments to
which the service provider has a right or rights. The exclusion may be
applied to any type of separation pay plan, but may apply only once
with respect to amounts paid by a service recipient to a service
provider. So, for example, if a service provider treats a right to a
payment of separation pay equal to the applicable limit under section
402(g) in the first year following a separation from service as an
excluded right, the right to the amount is not treated as a deferral of
compensation regardless of when the amount is actually paid (though
other provisions of the Code and the constructive receipt doctrine
continue to apply). However, once the right is treated as excluded, the
service provider may not treat any other right with respect to the
service recipient, such as an additional right to a payment equal to
the applicable limit under
[[Page 19249]]
section 402(g) in the second year following the separation from
service, as excluded under this exception.
K. Non-Taxable Benefits
The final regulations clarify that a legally binding right to
receive a nontaxable benefit does not provide for a deferral of
compensation for purposes of section 409A, unless the service provider
has received the right in exchange for, or has the right to exchange
the right for, an amount that will be includible in income (other than
due to participation in a cafeteria plan described in section 125). In
addition, because such benefits do not provide for a deferral of
compensation, the plan aggregation rules will not result in taxation of
other benefit plans merely because the terms of such nontaxable benefit
arrangements would not comply with section 409A if the arrangement were
covered by section 409A. For a discussion of the requirements for a
taxable reimbursement plan to satisfy the payment timing requirements
of section 409A, see section VII.B.2. of this preamble.
L. Legal Settlements
Commentators requested clarification of the application of section
409A to amounts paid pursuant to litigation between the service
provider and service recipient, including both court awards and bona
fide settlements, and including amounts characterized as wages or
otherwise treated as replacing compensation. The Treasury Department
and the IRS believe that section 409A was not intended to govern
settlements or awards resolving bona fide legal claims based on
wrongful termination, employment discrimination, the Fair Labor
Standards Act, or worker's compensation statutes, regardless of whether
such claims arise under Federal, state, local, or foreign laws, even
where settlements or awards pursuant to such claims are treated as
compensation for Federal tax purposes. The final regulations generally
treat such arrangements as not providing for deferred compensation for
purposes of section 409A. In addition, the final regulations generally
provide that section 409A does not apply to the payment of, or
reimbursement for, attorney's fees incurred in connection with the
enforcement of such a claim. However, the exception covers only rights
arising from the bona fide claim, and is not intended to allow such
settlements or awards to act as substitutes for, or to allow for the
restructuring of, preexisting deferred compensation subject to section
409A. For example, a change to the timing of the payment of a pre-
existing amount of deferred compensation as part of such a settlement
would be subject to the rules governing accelerated payments and
subsequent deferral elections. In addition, the payment of an amount
upon the execution of a waiver of any or all of such claims does not
necessarily indicate that the amounts are paid as an award or
settlement of an actual bona fide claim. Rather, to qualify for the
exception under this provision, the amounts must be paid with respect
to an actual bona fide claim for damages under the applicable law. For
a discussion of the treatment of settlements of bona fide disputes
regarding the right to preexisting deferred compensation subject to
section 409A, see section VIII.G of this preamble.
M. Split-Dollar Life Insurance Arrangements
Some commentators requested that split-dollar life insurance
arrangements be excluded from coverage under section 409A. Split-dollar
life insurance arrangements are often used as a method of providing
deferred compensation and there is no indication in the statute or
legislative history of any legislative intent that such arrangements be
excluded from coverage under section 409A. In addition, like a promise
to transfer property in the future, a promise to transfer an economic
benefit in the future may provide for deferred compensation.
Accordingly, a split-dollar life insurance arrangement may provide for
deferred compensation, and whether a split-dollar life insurance
arrangement provides for deferred compensation must be determined
through application of the general rules defining deferred compensation
and a nonqualified deferred compensation plan. In response to requests
for additional guidance, the Treasury Department and the IRS anticipate
issuing a notice addressing the application of section 409A to split-
dollar life insurance arrangements.
Commentators raised issues concerning the interplay between the
modifications that may be needed to satisfy the requirements of section
409A and the effective date rules applicable to split-dollar life
insurance arrangements under Sec. 1.61-22(j). Commentators pointed out
that the modifications necessary to meet the requirements of section
409A and these regulations may cause the arrangement to be treated as a
new arrangement under Sec. 1.61-22(j) and requested relief. The notice
will also address this issue.
N. Educational Benefits
Commentators requested an exclusion from coverage under section
409A for promises to provide future taxable educational benefits to
service providers. These benefits typically would be provided as an
inducement to provide a period of services. Commentators expressed
concern that the amount and timing of the payment of such benefits
would be difficult to ascertain, because the amount and timing of the
payments would depend upon the service provider's decisions with
respect to further education. The final regulations generally provide
an exception from coverage under section 409A for rights to educational
benefits, where the benefits consist solely of educational assistance
(as defined for purposes of section 127(c)) provided solely for the
education of the service provider.
IV. Definition of Plan
A. Plan Aggregation Rules
The proposed regulations generally provided that all amounts
deferred with respect to a service provider under all plans of a
service recipient falling within a particular category would be treated
as deferred under a single plan. The enumerated categories included
amounts deferred under account balance plans, amounts deferred under
nonaccount balance plans, amounts deferred under separation pay plans
providing payments due solely to an involuntary termination or
participation in a window program, and amounts deferred under any other
plan. The final regulations adopt these provisions, subject to certain
modifications described in this preamble.
The final regulations provide that the bifurcation rules applicable
to plans under Sec. 31.3121(v)(2)-1(c)(1)(iii)(B), which are
permissive for purposes of the application of section 3121(v)(2), must
be applied for purposes of the plan aggregation rules under section
409A. Accordingly, a portion of a nonqualified deferred compensation
plan is a separate account balance plan if that portion otherwise
qualifies as an account balance plan and the amount payable to service
providers under that portion is determined independently of the amount
payable under the other portion of the plan.
The final regulations also provide additional categories of plans
for purposes of the aggregation rules. One category covers split-dollar
life insurance arrangements. Another category is comprised of
reimbursement plans, providing for the reimbursement of expenses
incurred or the provision of
[[Page 19250]]
in-kind benefits (as defined in the regulations), to the extent the
right to such benefits or reimbursements, separately or in the
aggregate, does not constitute a substantial portion of the overall
compensation earned by the service provider for performing services for
the service recipient, or the overall compensation received due to a
separation from service. Stock rights that constitute nonqualified
deferred compensation for purposes of section 409A also comprise a
separate category.
The final regulations further provide for account balance plans to
be subdivided into a category for elective plans and a category for
nonelective plans. Plans will only be subdivided in this manner to the
extent the amounts deferred under an elective deferral arrangement (and
earnings on such amounts) may be separately identified. For this
purpose, a right to a match on an elective deferral will not be treated
as an elective deferral arrangement.
In an additional category, any amounts deferred under a foreign
plan may be treated as deferred under a separate plan from any amounts
deferred under a domestic plan, provided that the deferrals under the
plan are deferrals of amounts that would be treated as modified foreign
earned income (meaning foreign earned income as defined under section
911(b)(1) without regard to section 911(b)(1)(B)(iv) and without regard
to the requirement that the income be attributable to services
performed during the period described in section 911(d)(1)(A) or (B))
if paid to the service provider at the time the amount is first
deferred, and provided further that the foreign plan is not
substantially identical to a domestic plan in which the service
provider participates. For this purpose, a foreign plan is a plan that
the service recipient provides primarily to nonresident aliens or
resident aliens classified as resident aliens solely under section
7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)).
B. Written Plan Requirement
Commentators requested clarification and simplification of the
provisions required to be included in writing in plan documents to
comply with section 409A. As a general rule, the final regulations
provide that to satisfy the requirement that a plan be in writing, the
document or documents constituting the plan must specify, at the time
an amount is deferred, the amount to which the service provider has a
right to be paid (or, in the case of an amount determinable under an
objective, nondiscretionary formula, the terms of such formula), and
the payment schedule or payment triggering events that will result in a
payment of the amount.
A plan must provide for the six-month delay requirement applicable
to payments to specified employees upon a separation from service no
later than the time the provision may become applicable to a separation
from service of the specified employee. Accordingly, the plan must
contain the provision by the time at which the employee becomes a
specified employee (either because the stock of a component of the
service recipient becomes publicly traded, or because the specified
employee effective date has been reached for a list of specified
employees that includes the employee). A provision applicable to a plan
sponsored by a service recipient or a plan in which a specified
employee participates is effective with respect to a specified employee
only to the extent the provision is binding on the employee.
With respect to a deferral election, whether an initial or
subsequent deferral election, the plan must specify no later than the
time by which that election is required to be irrevocable the
conditions under which that election may be made. With respect to
permitted accelerations of a payment, the plan need not specify the
conditions under which the accelerated payment will be made except as
explicitly required in these regulations. However, the taxpayer must
demonstrate that the acceleration of the payment complies with the
requirements of section 409A and these regulations.
Commentators also requested clarification regarding whether the
requirement that a plan be in writing also means that the plan must be
contained in a single document. For purposes of this rule, the plan
consists of all documents that together define the service provider's
rights to the compensation. Accordingly, the terms of a plan document
may be contained in more than one document including, for example, a
deferral election document.
Commentators asked whether a savings clause would be sufficient to
ensure compliance with section 409A, where the savings clause provides
that each provision of the plan will be interpreted to be consistent
with the requirements of section 409A and that any provision of the
plan that does not satisfy such requirements will be of no force or
effect. The final regulations provide that for purposes of determining
the terms of a plan, general provisions of the plan that purport to
nullify noncompliant plan terms, or to supply required specific plan
terms, are disregarded. Accordingly, if a plan contains terms that do
not meet the requirements of section 409A and these regulations, or
fails to contain a plan term necessary to meet the requirements of
section 409A and these regulations, the plan will violate the
requirements of section 409A and these regulations regardless of
whether the plan contains such a savings clause.
Several commentators requested that the Treasury Department and the
IRS publish model amendments. Due to the complex and varied universe of
deferred compensation plans, the Treasury Department and the IRS do not
believe that it is feasible to publish model amendments at this time.
V. Definition of Substantial Risk of Forfeiture
A. In General
The final regulations generally adopt the definition of substantial
risk of forfeiture set forth in the proposed regulations. Several
commentators requested that the definition of substantial risk of
forfeiture be the same as the definition of substantial risk of
forfeiture in Sec. 1.83-3(c). However, the definition of substantial
risk of forfeiture for purposes of compensatory transfers of property
under section 83 reflects different policy concerns from those involved
in section 409A, and there are also practical differences between
transfers of restricted property and promises to pay deferred
compensation. This is reflected in the provisions of section
409A(e)(5), directing the Secretary of the Treasury Department to issue
regulations disregarding a substantial risk of forfeiture in cases
where necessary to carry out the purposes of section 409A. Accordingly,
the final regulations do not adopt this suggestion.
A right to an amount deferred may be subject to the satisfaction of
two or more different conditions that each independently would be a
substantial risk of forfeiture. In that case, the substantial risk of
forfeiture generally would continue until all of such conditions had
been met. Alternatively, a right to an amount deferred may be subject
to the satisfaction of any of two or more different conditions that
each independently would constitute a substantial risk of forfeiture.
In that case, the substantial risk of forfeiture generally would lapse
as soon as one of the conditions had been met.
The final regulations explicitly provide that a payment conditioned
on an involuntary separation from service without cause may be treated
as subject
[[Page 19251]]
to a substantial risk of forfeiture if there is a substantial risk that
the service provider will not be involuntarily separated from service
without cause. Many of the comments relating to the definition of a
substantial risk of forfeiture requested also that a benefit available
only upon a separation from service for good reason be treated as
subject to a substantial risk of forfeiture. Under the definition of an
involuntary separation from service provided in the final regulations,
the right to a payment upon a separation for service for good reason
may, in certain circumstances, be treated as a right to a payment upon
an involuntary separation from service. For a discussion of the
definition of an involuntary separation from service, see section
III.J.3 of this preamble.
Commentators requested that a requirement that an employee sign a
release of claims to receive a benefit be treated as a substantial risk
of forfeiture. Generally, conditions under the discretionary control of
the service provider (other than the decision whether or not to
continue providing services) are not treated as creating a substantial
risk of forfeiture. Accordingly, the final regulations do not adopt
this suggestion.
One commentator suggested that any right to a payment be treated as
subject to a substantial risk of forfeiture until the amount of the
payment is readily determinable, at least where the payment could be
zero. The Treasury Department and the IRS do not believe that this
standard is appropriate.
B. Election Between Vested and Nonvested Rights
The final regulations provide that an amount will not be considered
subject to a substantial risk of forfeiture after the date or time at
which the recipient otherwise could have elected to receive the amount
of compensation, unless the present value of the amount purportedly
subject to a substantial risk of forfeiture (disregarding, in
calculating the present value, the risk of forfeiture) is materially
greater than the present value of the vested amount the recipient
otherwise could have elected to receive. For example, if a service
provider can elect to receive, in lieu of a payment of current
compensation, a bonus based upon a formula that would otherwise subject
the bonus to a substantial risk of forfeiture, the bonus will be
subject to a substantial risk of forfeiture for purposes of section
409A only if the present value of the amount of the bonus (disregarding
the risk of forfeiture) is materially greater than the present value of
the current compensation amount.
Some commentators asked whether this exception addressed the
extension of a substantial risk of forfeiture as part of the negotiated
extension of an employment contract. Commentators argued that rights a
service provider obtains under a new or extended employment contract
could be viewed as a right to an amount materially greater than the
amount the service provider otherwise could have received. The final
regulations clarify that for purposes of this rule, compensation the
service provider would receive for continuing to perform services
regardless of whether the service provider elected to receive the
vested payment is not taken into account for purposes of determining
whether the present value of the right to the nonvested payment is
materially greater.
VI. Initial Deferral Election Rules
A. In General
The final regulations adopt the provisions contained in the
proposed regulations relating to initial deferral elections, subject to
the modifications described in this preamble.
The proposed regulations generally provided that in a nonelective
plan, a service recipient may designate the time and form of payment on
or before the date the service provider obtains a legally binding right
to the payment. Commentators requested clarification of how the service
recipient's discretion to designate a time and form of payment related
to the requirement in the proposed regulations that a service
provider's deferral election be irrevocable by the applicable deadline.
Specifically, commentators requested that a deferral election by a
service provider be treated as irrevocable, even if during the period
during which the service recipient could have set the time and form of
payment (that is, through the date the service recipient grants the
service provider a legally binding right to the payment), the service
recipient retains the right to override the service provider's deferral
election and provide for deferral of a lesser or greater amount. The
final regulations do not adopt this suggestion. If a service provider
may make an initial deferral election, including an election as to the
time and form of payment, the election must be irrevocable as of the
date required under the rules governing such service provider
elections. Accordingly, a plan may not provide for such an override,
unless such override cannot occur after the deadline by which the
service provider's election must be effective.
Many commentators requested a clarification of the rules with
respect to a deferral of a discretionary bonus, where the legally
binding right to the bonus does not arise until a year subsequent to
the year in which services are performed. For example, an employer
announces in 2010 that it will be awarding discretionary bonuses for
services performed in 2011, and will decide which employees will
receive bonuses and in what amounts at the beginning of 2012. Section
409A(a)(4) generally provides that compensation for services performed
during a taxable year may be deferred at the service provider's
election only if the election to defer such compensation is made not
later than the close of the taxable year preceding the year in which
the services are rendered. Accordingly, even where the bonus is
discretionary such that the legally binding right to the bonus does not
arise until after the period of services for which the bonus is paid
has begun, a service provider's deferral election must occur before the
year in which the period of services begins absent some other
applicable exception (such as, for example, the deferral election rules
related to performance-based compensation). The determination of the
period of services for which compensation is earned is based on all the
facts and circumstances, but may include periods of service before the
date the service provider obtains a legally binding right to the
compensation. Although not necessarily determinative, one of the
factors taken into account in that determination is a designation by
the service recipient of the period of services for which the
compensation is earned.
B. Nonelective Deferrals
Commentators pointed out that under the proposed regulations, a
service recipient might be required to designate a time and form of
payment with respect to a nonelective deferral at an earlier date than
the service provider would have to make such a designation if an
election had been provided to the service provider. Commentators
requested that the service recipient be provided the same flexibility
as the service provider in such cases. The final regulations generally
adopt this suggestion, so that if the service provider has no election
as to the time and form of payment of an amount of deferred
compensation, the service recipient may set the time and form of
payment on any date on or before the later of the latest date the
service provider would have been permitted under these regulations to
elect such time and form of payment if an election had been provided to
the service
[[Page 19252]]
provider, or the date the service recipient grants the legally binding
right to the compensation. So, for example, where compensation is
performance-based compensation, and the service recipient retains the
discretion to establish the time and form of the payment, the plan
generally could permit the service recipient to establish the time and
form of the payment on or before the date six months before the end of
the relevant performance period.
C. Performance-Based Compensation
The final regulations generally adopt the definition of
performance-based compensation contained in the proposed regulations,
subject to the modifications described in this preamble. The final
regulations clarify that where a portion of an award would qualify as
performance-based compensation if the portion were the sole amount
available under the plan, that portion of the award will not fail to
qualify as performance-based compensation merely because another
portion of the award does not qualify as performance-based
compensation, if the portion that would qualify as performance-based
compensation is designated separately or otherwise separately
identifiable under the terms of the plan and each portion is determined
independently of the other.
Commentators asked whether in order to use the deferral rules
regarding performance-based compensation, a service provider must be
required to perform services during the entire performance period, or
from the date the performance criteria are set through the end of the
performance period. Commentators argued that because a payment cannot
be substantially certain to be made at the time of the deferral
election under the deferral election rules applicable to performance-
based compensation, a service provider's ability to manipulate the
timing of income inclusion under a performance-based compensation
arrangement is limited. The final regulations require only that the
service provider provide services from the later of the date the
performance period starts or the date the performance criteria are
established through the date the initial deferral election is made.
Commentators suggested that a provision in a plan for automatic
payment to occur upon death, disability, or a change in control event
(as defined for purposes of section 409A) should not result in a
failure of the arrangement to qualify as performance-based
compensation. The final regulations adopt this suggestion, provided
that where such an event occurs before a deferral election has been
made, the right to the payment will no longer be treated as
performance-based compensation so that a deferral election may not be
effective unless made in accordance with another applicable deferral
election rule.
In response to comments, the requirement that a deferral election
under the rule applicable to performance-based compensation be made
before the compensation has become substantially certain to be paid has
been modified, and now requires that the election be made before the
amount is readily ascertainable. Where the right to a specified amount
is subject to a performance requirement being met (for example, a right
to a payment of $10,000 if a certain profit level is attained), the
amount is treated as readily ascertainable when it is substantially
certain that the performance requirement will be met. With respect to
the right to an amount of compensation that varies based upon the level
of performance, the payment, or any portion of the payment, is treated
as readily ascertainable to the extent the amount or the payment is
calculable and the performance requirement is substantially certain to
be met. For this purpose, a right to a payment is bifurcated between
the amount that is readily ascertainable and the amount that is not
readily ascertainable. Accordingly, any minimum amount that is
calculable and for which the performance requirement entitling the
service provider to the payment is substantially certain to be met
generally will be treated as readily ascertainable.
For example, a service recipient agrees to pay $100 for every
additional widget meeting certain quality requirements that is produced
in a calendar year in excess of 100 widgets. At the end of the six
months, 125 widgets have been produced and no election to defer has
been made. As of that date, the performance-based compensation with
respect to which an election to defer can be made does not include the
$2500 ((125-100) multiplied by $100) that is calculable and for which
the performance requirement is substantially certain to be met. In
addition, the performance-based compensation does not include any
additional amount that the service provider is substantially certain to
earn based on the number of additional widgets that the service
provider is substantially certain to produce before the end of the
year. However, the payment is bifurcated so that any additional amount
that is not substantially certain to be paid may be treated as
performance-based compensation such that an election to defer such
compensation may be made.
Commentators requested clarification of the circumstances under
which compensation, the amount of which is determined by reference to
the value of service recipient stock, may qualify as performance-based
compensation. The fair market value of stock at any given time
generally incorporates the market's perception of the probability that
the stock will increase or decrease in value. Accordingly, compensation
payable for a service period that is equal to the value of a
predetermined number of shares of stock, and is variable only to the
extent that the value of such shares appreciates or depreciates,
generally will not be performance-based compensation. However, if the
right to such compensation is subject to a performance-based vesting
requirement, such compensation may be performance-based compensation.
Also, the attainment of a prescribed value for the service recipient
(or a portion thereof), or a share of stock of the service recipient,
may be used as a performance-based criterion, if it is a condition for
receiving the compensation and the other requirements are met.
D. Initial Eligibility
Section 409A(a)(4)(B)(ii) provides that in the case of the first
year in which a service provider becomes eligible to participate in the
plan, an initial deferral election may be made within 30 days after the
date the service provider becomes eligible to participate in the plan,
with respect to compensation for services to be performed subsequent to
the election. The final regulations adopt the provisions implementing
the initial eligibility deferral election rules set forth in the
proposed regulations, subject to the following modifications.
Many of the commentators on the initial eligibility deferral
election rule expressed concerns about the application of the plan
aggregation rules. The proposed regulations provided that the plan
aggregation rules would apply in determining whether a service provider
was newly eligible for a plan, so that if a service provider was
already participating in an arrangement that is required to be
aggregated with the arrangement for which the service provider is
initially eligible, the service provider would not be able to take
advantage of the initial eligibility deferral election rule. Some
commentators requested that the plan aggregation rules not apply for
this purpose. However, the Treasury Department and the IRS believe that
such a rule would result in the potential
[[Page 19253]]
for the adoption of serial plans as a means to claim repeated initial
eligibility and the ability thereby to make late deferral elections. In
addition, such a rule would require difficult determinations of whether
one plan was sufficiently dissimilar from another plan to qualify as a
separate plan.
Other commentators requested that the plan aggregation rules apply,
but that plans allowing elections between current and deferred
compensation, or the part of a plan allowing such elections, be treated
separately from nonelective plans or nonelective benefits in each
category. The final regulations generally adopt this rule through the
modifications to the plan aggregation rules described in section IV.A
of this preamble.
Other comments focused on the application of the initial
eligibility deferral election rule in the case of a rehire or a change
in position within a service recipient. Commentators pointed out that
under the standard in the proposed regulations, if an employee had not
received a distribution after the initial termination of employment, or
had transferred to a position not participating in the plan without
receiving a distribution and then transferred back to a position
participating in the plan, the rehired or returning employee would
still retain the right to benefits under the plan and thus would not be
able to use the initial eligibility deferral election rules. The final
regulations provide that the initial eligibility deferral election
rules are applicable to a service provider provided that the service
provider has not been an active participant in the plan (applying the
plan aggregation rules) for at least 24 months. For this purpose, a
service provider is an active participant in the plan if, under the
plan's terms and without further amendment or action by the plan
sponsor, the service provider is eligible to accrue benefits under the
plan (even if the service provider has elected not to participate in
the plan), other than earnings on amounts previously deferred.
Commentators requested relief with respect to the timing rules for
initial elections establishing the time and schedule of payments under
nonelective excess benefit plans. Commentators noted that under such
plans, a service provider often automatically becomes a participant
when the service provider's benefits under the qualified plan become
limited under the rules governing qualified plans. Because determining
whether a service provider is a participant requires calculations,
commentators observed that both the service provider and the service
recipient may be unaware that the service provider has become a
participant in the plan for some time after the service provider
actually first becomes eligible. The final regulations generally
provide that with respect to a nonelective excess benefit plan, a
service provider is treated as initially eligible to participate in the
plan as of the first day of the service provider's taxable year
immediately following the first year the service provider accrues a
benefit under such plan, so that an initial deferral election with
respect to the time and form of payment may be effective for benefits
accrued under the plan based on services performed during the taxable
year immediately preceding the year in which the election is made. This
rule may only be used once with respect to a service provider's
participation in a plan.
E. Initial Deferral Elections With Respect to Certain Forfeitable
Rights
The proposed regulations provided a rule for initial deferral
elections with respect to certain forfeitable rights, generally
intended to address ad hoc awards. Under the rule in the proposed
regulations, if a legally binding right to a payment in a subsequent
year is subject to a forfeiture condition requiring the service
provider's continued services for a period of at least 12 months from
the date the service provider obtains the legally binding right, an
election to defer such compensation may be made on or before the 30th
day after the service provider obtains the legally binding right to the
compensation, provided that the election is made at least 12 months in
advance of the earliest date at which the forfeiture condition could
lapse. The final regulations retain this rule, subject to the
modifications described in this preamble.
Commentators suggested that the requirement of at least a 12-month
service period following the deferral election during which the right
could be forfeited due to a separation from service be shortened to 11
months, because the combination of the 30-day election period plus the
12-month service period requirement generally resulted in a requirement
of at least a 13-month performance period. The requirement of a 12-
month service period after an election is made ensures that the
election occurs while at least an entire year (12 months) of services
is still required. This conforms in many respects to the general rule
that the deferral election must be made in the year before the year in
which the services are performed. Any shorter period would permit
service providers to make deferral elections in the same taxable year
in which all of the services are performed. The Treasury Department and
the IRS do not believe that such a rule is consistent with the
legislative intent.
The final regulations also provide that this rule is available even
if the right to the compensation may vest earlier than 12 months
following the election due to the service provider's death or
disability, or due to a change in control event (as defined for
purposes of section 409A) with respect to the service recipient.
However, if death, disability, or a change in control event occurs and
the condition lapses before the end of such 12-month period, a deferral
election may be given effect only if the deferral election is permitted
under the regulations without regard to this rule.
F. Initial Deferral Election With Respect to Fiscal Year Compensation
The final regulations retain the initial deferral election rule
with respect to fiscal year compensation that was in the proposed
regulations. The final regulations clarify that the rule with respect
to the deferral of fiscal year compensation is based upon the service
recipient's taxable year, regardless of whether the service recipient's
taxable year is the calendar year or some other period. Accordingly,
where a service recipient with a calendar year taxable year is
providing fiscal year compensation to a service provider based upon a
calendar year, a service provider with a non-calendar year taxable year
generally could take advantage of the rule to defer such fiscal year
compensation on or before the December 31 preceding the calendar year
upon which the fiscal year compensation is based.
G. Initial Deferral Elections With Respect to Commissions
The final regulations continue to provide a special deferral
election rule with respect to commission payments. These rules are
intended to address concerns that, for many commission arrangements, it
is difficult to determine when the services related to a particular
commission payment began, so that it is difficult to apply the general
rule that requires that a deferral election be made before the year in
which any services are performed. This rule is not intended to address
whether, absent such a deferral election, a particular commission
arrangement would result in deferred compensation. Whether a commission
arrangement otherwise provides for deferred compensation must be
determined through the
[[Page 19254]]
application of the general rules defining deferred compensation.
However, where a commission arrangement requires that the service
provider be providing services at the time of the payment to be
entitled to the payment, the commission is paid in the normal course,
and neither the service provider nor the service recipient has a right
to specify a payment date, the arrangement generally will not provide
for the deferral of compensation.
The final regulations generally adopt the deferral election rule
set forth in the proposed regulations treating the services related to
a commission payment as performed in the year in which the customer
remits payment to the service recipient. For this purpose, the proposed
regulations provided that commissions include only compensation
contingent upon the service recipient receiving payment from an
unrelated customer for the product or services provided.
Commentators asked that this rule be extended to cover arrangements
under which the service recipient paid the commission based upon
consummation of a transaction, regardless of whether the customer paid
the service recipient for the service or good purchased from the
service recipient. For example, commentators stated that in some
industries the service recipient pays a salesperson commissions based
on the amount of sales recorded, even though the customer is not
obligated to pay the service recipient until a later date. The final
regulations generally adopt this suggestion by permitting the taxable
year in which the sale occurs to be substituted for the year in which
the customer remits payment. However, to avoid manipulation of the
deferral election timing rules, the taxable year of the sale may be
used only if it is applied consistently to all similarly situated
service providers.
Commentators also asked that this rule be extended to commissions
earned due to the increase in value, or maintenance of overall value,
of a pool of assets or accounts. In response, the final regulations
provide that, for purposes of the initial deferral election rules, the
services with respect to investment commission compensation are deemed
to be performed over the 12 months immediately preceding the date as of
which the overall value of the assets or asset accounts is determined
for purposes of the calculation of the investment commission
compensation. For this purpose, investment commission compensation
means compensation earned by a service provider if a substantial
portion of the services provided by such service provider to a service
recipient consists of sales of financial products or the provision of
other direct customer services to an unrelated customer with respect to
customer assets or customer asset accounts. For this purpose, amounts
will only be treated as investment commission compensation if the
customer retains the right to terminate the customer relationship and
transfer or withdraw the assets or asset accounts without undue delay
(which may be subject to a reasonable notice period), the compensation
paid by the service recipient to the service provider consists of a
portion of the value of the overall assets or asset account balance, an
amount substantially all of which is calculated by reference to the
increase in the value of the overall assets or account balance during a
specified period, or both, and the value of the overall assets or
account balance and investment commission compensation is determined at
least annually.
Commentators also requested that the exception for commissions be
expanded to address arrangements involving customers related to either
the service provider or the service recipient. The Treasury Department
and the IRS are concerned that where arrangements involve related
parties, there is the potential for manipulation of the timing of the
payment and the commission, but also understand that many of such
arrangements may not involve abuse. Therefore, the final regulations
provide that the special rules with respect to commissions apply to
arrangements involving a customer related to the service provider or
the service recipient provided that substantial sales or substantial
services occur between the service recipient and a significant number
of unrelated customers, and the sales or service arrangement and the
commission arrangement with respect to a customer related to either the
service recipient or the service provider are bona fide and arise in
the ordinary course of business, and both the terms and practices are
substantially the same as the terms and practices applicable to
customers to whom the service provider and service recipient are not
related, and to whom, either individually or in the aggregate, the
service recipient has made substantial sales or provided substantial
services.
H. Involuntary and Voluntary Separations From Service
The final regulations provide that with respect to separation pay
paid upon an actual involuntary separation from service, where the
service provider had no prior right to such separation pay, and where
the separation pay is the subject of bona fide, arm's length
negotiations, the initial deferral election may be made at any time
before the service provider obtains a legally binding right to the
payment. The final regulations expand this rule to include voluntary
separations from service as well as involuntary separations, as long as
all of the other conditions in the previous sentence are met. The
exception addresses both a choice between a current and a deferred
payment, and the establishment of the time and form of payment of
deferred compensation.
The exception is intended to address legally binding rights to
deferred compensation arising as part of the process of separating from
service and not based upon previously existing legally binding rights.
The exception is intended to alleviate concern that where such rights
are expressed or calculated based on prior compensation or service, any
election by the service provider as to the timing of the payment during
the negotiation process could be viewed as a late initial deferral
election made during or after the year in which the services were
performed, and to avoid the potential for the plan aggregation rules to
eliminate the ability to make an initial eligibility deferral election.
The Treasury Department and the IRS have become aware that certain
taxpayers have attempted to apply this provision to existing deferred
compensation plans, believing that the exception allows new elections
provided that the separation pay was the subject of bona fide
negotiations. This application is inconsistent with the explicit
provision of the proposed regulations and these final regulations. The
provision does not address preexisting legally binding rights to
deferred compensation, including legally binding rights that are
subject to a substantial risk of forfeiture. Any change in the time and
form of payments under those arrangements would be required to meet the
rules governing subsequent deferral elections and accelerated payments
(including any applicable relief provided during the transition
period). For a discussion of the treatment of benefits forfeitable upon
the separation from service, see section III.J.1 of this preamble.
I. Elections To Annualize Recurring Part-Year Compensation
Commentators asked how the deferral election rules would apply to
an election by certain employees providing services over less than a
12-month period to receive payments for services on an annualized
basis. For example, teachers performing services during a school year
running from September of
[[Page 19255]]
one year through June of the next year often are provided an election
to receive the compensation on an annualized basis over 12 months
instead of during only the school year. This raises issues under the
general initial deferral election rules under section 409A because the
teacher is permitted to elect after the beginning of the calendar year
to defer some of the compensation that would be paid in September
through December of that year to a period in the subsequent year.
The final regulations provide that with respect to recurring part-
year compensation, an election to defer all or a portion of the
compensation to be earned during a particular period of service may be
made at any time before the period of service begins, provided that no
amounts are deferred under the election to a date after the last day of
the 13th month following the first day of the performance period. For
this purpose, recurring part-year compensation is defined as
compensation paid for services rendered in a capacity that the service
recipient reasonably anticipates will continue in subsequent years on
similar terms and conditions, and will require services to be provided
over successive service periods of less than 12 months, each of which
begins in one taxable year of the service provider and ends in the next
such taxable year. For example, a teacher earning compensation from
September 15 of one year through June 30 of the subsequent year could
elect to defer compensation earned during such period on any date on or
before September 15 of the first year, provided that no amount deferred
in accordance with this rule is deferred beyond October 31 of the
following year. This exception may be applied to a particular amount of
compensation only once, so that an amount deferred under this exception
may not be deferred a second time through treatment of the amount as
earned in a subsequent service period.
J. USERRA
The final regulations provide that the initial deferral election
rules are deemed satisfied to the extent that a deferral election
provided to a service provider is necessary to satisfy the requirements
of the Uniformed Services Employment and Reemployment Rights Act of
1994, as amended, 38 U.S.C. 4301-4334. Similar relief has been provided
with respect to changes in the time and form of payment and
accelerations of payments.
VII. Time and Form of Payment
A. In General
The final regulations clarify that except as explicitly provided
otherwise, a single time and form of payment must be designated with
respect to each payment that is payable upon a payment event. For
example, a plan must designate how an amount will be paid upon a change
in control event, and generally cannot provide one time and form of
payment upon a particular type of change in control event, and another
time and form of payment upon another type of change in control event.
The final regulations retain the rule, however, that permits a plan to
provide for a different time and form of payment, depending upon
whether the permissible payment event occurs before or after a
specified date. In addition, the final regulations also provide for a
limited ability to designate different times and forms of payment based
upon the conditions under which a service provider's separation from
service occurs. See section VII.C.5. of this preamble for a discussion
of payments upon a separation from service.
The proposed regulations provide that for purposes of applying the
payment rules, a payment will be treated as made on a fixed date or on
a fixed schedule if the payment or payments are made by the end of the
calendar year in which a specified fixed payment date, or due date of a
payment under a fixed schedule, occurs or, if later, the 15th day of
the third month following such fixed date or due date. The final
regulations clarify that the same flexibility applies to making a
payment on account of a payment event. So, for example, where a payment
is scheduled to be made upon the death of a service provider whose
taxable year is the calendar year, the payment is timely if made on or
before the later of December 31 of the calendar year in which the death
occurs, or the 15th day of the third month following the date of death.
If the service provider's taxable year is not the calendar year, the
final regulations specify that the service provider's taxable year is
used for purposes of this rule.
Commentators also requested that where a payment is scheduled to be
made on a fixed date, a service recipient be permitted to pay at any
preceding date within the same calendar year. Commentators argued that
if the regulations permitted a payment to be made later within the same
calendar year because the amount would be reflected on the same income
tax return in the case of an individual service provider, then the same
rationale should permit payments to be made earlier in the same
calendar year. Because the adoption of this provision would conflict
with the administration of the rules governing subsequent deferrals,
the final regulations do not adopt this suggestion.
The subsequent deferral rules require that any election to extend
the deferral period must not be effective for at least one year after
the date the payment is due. If a payment due on a specified date
during a calendar year could always be made on January 1 or any
subsequent date during the calendar year, then the one-year waiting
period would have to begin to run on the previous January 1, regardless
of the actual payment date the plan specified.
For example, if a plan specified December 31 as the payment date,
but the payment could be made on January 1, then any subsequent
deferral election would need to be made on or before January 1 of the
preceding calendar year, making the deadline for a subsequent deferral
election almost two years before the actual specified payment date.
Such a rule would unduly burden service providers who cannot actually
receive a payment before the date specified in the plan. However, to
lower the potential for unintentional violations, the final regulations
provide that a payment will be deemed made at the scheduled time of
payment if made not earlier than 30 days before the scheduled date,
provided that the service provider is not permitted, directly or
indirectly, to designate the taxable year of the payment.
In addition, the final regulations continue to provide that a plan
may designate an entire taxable year of the service provider, rather
than a specific date, as the specified date of payment. If a plan
provides only for the taxable year of payment, the payment may be made
at any time during such year. For purposes of the subsequent deferral
rules, the payment will be treated as scheduled to be paid on the first
day of the service provider's taxable year.
Commentators also requested clarification of the treatment of
deadlines for payment, where the plan does not designate a specific
payment date or taxable year of the service provider. For example,
commentators asked whether a provision requiring payment as soon as
administratively feasible but in no event later than the 15th day of
the third month following the end of the year would be treated as
having a fixed date of payment. The final regulations provide that such
a provision will be a specified payment
[[Page 19256]]
date only if the period during which such payment may be made is
restricted either to a specified taxable year of the service provider
or a period of not more than 90 days and the service provider is not
provided an election as to the taxable year of the payment. If a
specific payment date is not established, the first possible date on
which a payment could be made under the plan is the specified payment
date for purposes of the rules relating to subsequent deferral
elections. For example, a payment scheduled to be made at any time on
or after January 1, 2008, and on or before July 1, 2008, to a service
provider whose taxable year is the calendar year will be deemed to have
a fixed payment date. For purposes of the subsequent deferral rules,
January 1, 2008, is the specified payment date.
By contrast, a payment scheduled to be made to such a service
provider at any time on or before July 1, 2008, would not be deemed to
have a fixed payment date, because the payment could be made before
January 1, 2008. In addition, a payment scheduled to be made to a
service provider, for example, within 180 days of a separation from
service generally will not provide for a specified time and form of
payment under the final regulations, because it specifies neither the
taxable year of the service provider in which the payment must be made
following the separation from service, nor a period of 90 days or less
following the separation from service in which the payment must be
made. Because such a payment schedule would not provide an objective
payment date based upon the separation from service event, the payment
also would not be eligible for the relief provided for payments made by
the later of the end of the taxable year of the service provider or the
15th day of the third month following the specified payment date.
However, a plan provision providing that the payment will be made
within 90 days of a separation from service generally will be treated
as a specified payment date, and for purposes of the subsequent
deferral rules the date of the separation from service will be treated
as the scheduled payment date.
B. Specified Time or Fixed Schedule of Payments
1. In General
The final regulations generally adopt the rules defining a
specified time or fixed schedule of payments, including the ability to
designate a service provider's taxable year as the year of payment
rather than a specific date. For example, a plan provision providing
for payment within the service provider's taxable year that includes
December 31, 2008, would be treated as a fixed date of payment.
2. Reimbursement and In-Kind Benefit Plans
Many commentators requested additional guidance regarding ways in
which rights to taxable reimbursements or in-kind benefits might be
structured to meet the definition of a fixed schedule of payments. In
response, the final regulations provide that a right to reimbursements
or in-kind benefits will meet the requirement of a fixed time and form
of payment if certain requirements are satisfied. For this purpose, a
reimbursement plan must provide for the reimbursement of expenses
incurred during an objectively prescribed period (including a period
beginning or ending based upon a service provider's death), where the
amount of reimbursable expenses incurred or in-kind benefits available
in one taxable year of the service provider cannot affect the amount of
reimbursable expenses or in-kind benefits available in a different
taxable year. In addition, the reimbursement payment must be made by no
later than the end of the service provider's taxable year following the
taxable year in which the expense is incurred. Such reimbursement or
in-kind benefit rights may not be subject to liquidation or exchange
for another benefit.
For example, a right to a reimbursement of membership fees incurred
for each of three specified and consecutive calendar years by a former
employee, where the former employee is entitled to reimbursement of the
expenses incurred each year without regard to the expenses incurred in
a different year, and where the former employee cannot exchange the
right for cash or any other benefit, generally will be treated as
providing for a fixed time and form of payment if the plan requires
that the reimbursement payment be made by no later than the end of the
calendar year following the year in which the expense is incurred. In
contrast, a right to reimbursement of membership fees of up to $30,000
over three years would not meet the requirement of a fixed time and
form of payment, because the extent to which the former employee
incurred the expense in the first year would affect the amount
available for reimbursement in a subsequent year.
This rule applies similarly to the provision of in-kind benefits,
such as a right to use a corporate vehicle or aircraft. The final
regulations also provide a special rule for arrangements reimbursing
medical expenses to permit certain aggregate limits on the benefits
provided, such as lifetime maximums.
3. Payment Schedules With Fixed or Formula Payment Limitations
Commentators asked whether payment schedules with fixed or
objective formula limitations on the amount that may be paid during any
particular period would meet the requirement of a fixed schedule or
time and form of payment. Where the fixed or formula limitation is
established on or before the date the time and form of payment is
otherwise required to be set, the fixed or formula limitation is based
on a fixed or nondiscretionary, objectively determinable formula
limitation on the amount that may be paid in a particular period where
all the factors relevant to the determination of such limit are beyond
the control of the service provider and not subject to any exercise of
discretion by the service recipient, and the plan specifies the time
and form of payment of any additional amount due in excess of the fixed
or formula limitation amount, the schedule will be deemed to be a fixed
schedule of payments because it is not subject to manipulation.
However, a change in the limits or a change in the allocation method
for the payment of the unpaid excess amounts that will be paid after
the original due dates due to application of the limit may constitute a
subsequent deferral election or the acceleration of a payment.
Similarly, where the total amount payable under a plan with multiple
participants is limited, the time and form of payment requirement may
be met if the plan specifies, from the date the time and form of
payment is otherwise required to be set, the following: (1) A fixed or
nondiscretionary, objectively determinable limit on the amount that may
be paid in a particular period such that none of the factors relevant
to the determination of such limit is in the control of the service
provider or subject to the exercise of any discretion by the service
recipient; (2) where there is an overall limitation on the aggregate
amount that may be paid to a group of service providers during a
specified period, a nondiscretionary, objectively determinable method
to allocate the payments that can be made in accordance with the
limitation among the service providers participating in the plan over
which neither the service recipient nor any service provider retains
control or discretion; and (3) the time and form of payment of any
amount that will be paid after its original due date because of the
formula limitation.
[[Page 19257]]
For example, a plan may provide that all payments to all
participants under the plan in a given year may not exceed $1 million,
provided that the plan must provide an objective, nondiscretionary
method of currently allocating the $1 million of payments if the
amounts otherwise payable exceed $1 million (such as proportionately to
each participant based on the amount otherwise payable to such
participant absent the limit), and specifies the time and form of
payment of any amount not paid currently because of the limitation
(such as at the earliest time possible without exceeding the applicable
limitation for any subsequent year). However, a change in the limits or
a change in the allocation method may constitute a subsequent deferral
election or an acceleration of a payment.
Commentators also asked whether the same analysis would apply where
the limit on a payment is calculated pursuant to a formula related to
business performance, such as a specified percentage of cash flow for
the period. A payment schedule may be conditioned on a formula
limitation if the formula limitation is specified at the time the
schedule of payments is otherwise required to be set, the limitation is
nondiscretionary and objectively determinable based on the business
performance of the service recipient, and the service provider retains
no control over the determination or application of the formula
limitation. For this purpose, a formula limitation based on profits or
other indicia of general business performance is not treated as
discretionary or in the control of the service recipient. Thus, a plan
providing that the maximum payment during a year will equal no more
than a set percentage of the service recipient's cash flow for the
previous year generally would meet the requirement of a fixed time and
form of payment. However, a change in the formula limitation may
constitute a subsequent deferral election or an acceleration of a
payment. For a discussion of schedules of payments based upon the
timing of payments received by the service recipient, see section
VII.B.6 of this preamble.
4. Tax Gross-Up Payments
Commentators requested clarification of how section 409A applies to
a right to a tax gross-up payment that provides the service provider
with the right to a payment of taxes otherwise payable by the service
provider as well as any additional taxes resulting from the service
recipient's payment of the taxes. The final regulations provide that a
right to a tax gross-up payment is a right to deferred compensation
that satisfies the requirement of a fixed time and form of payment if
the plan provides that the tax gross up payment will be made, and the
payment is made, by the end of the service provider's taxable year next
following the service provider's taxable year in which the related
taxes are remitted to the taxing authority.
In addition, the final regulations provide that a right to the
reimbursement of expenses incurred due to a tax audit or litigation,
whether Federal, state, local, or foreign, satisfies the requirement of
a fixed time and form of payment if the right to the reimbursement
provides that payment will be made, and the payment is made, by the
later of the end of the service provider's taxable year next following
the year in which the taxes that are the subject of the audit or
litigation are remitted to the taxing authority, or, if no taxes are to
be remitted, the end of the service provider's taxable year next
following the year in which the audit or litigation is completed.
Nothing in the provisions relating to tax gross-up payments modifies
the application of section 409A to any underlying compensation
arrangement that results in the taxes that are subject to the tax
gross-up arrangement.
5. Payment Schedules Based on Payments to the Service Recipient
Commentators requested guidance on payment schedules contingent on
the receipt of certain payments by the service recipient. For example,
commentators requested clarification whether a plan requiring an annual
payment equal to a percentage of certain accounts receivable collected
during the prior 12-month period would qualify as a fixed time and form
of payment. The ability to schedule payments based upon the time the
service recipient receives a customer's payment raises issues regarding
the ability to, in effect, create an impermissible event-based payment
through characterizing the payment as a schedule (for example, a
payment ``schedule'' that pays an amount every year if a specified
transaction occurs in that year actually pays based on whether and when
the transaction occurs, which is not a permissible payment event under
section 409A). In addition, these arrangements raise issues regarding
the ability of the service recipient (or service provider) to control
the timing of the payment of deferred compensation through an ability
to influence the timing of the payment by the customer. Accordingly,
the final regulations generally provide that a schedule based upon the
timing of payments to the service recipient is not a fixed schedule of
payments. However, the final regulations also provide certain
parameters under which such a plan may qualify as having a fixed time
and form of payment. First, if the service recipient is comprised of
more than one entity, the payments must be due from a person that is
not one of such entities (for example, not a payment due from a
subsidiary corporation to a parent corporation). Second, the payments
must stem from bona fide and routine transactions in the ordinary
course of business of the service recipient, and the service provider
must not at the time such payments are due retain effective control
over the service recipient, the person from whom the payments to the
service recipient are due, or the collection of the payments. Third,
the payment schedule must provide for a nondiscretionary, objective
method of identifying the customer payments to the service recipient
from which the amount of the payment is determined, and a
nondiscretionary, objective schedule under which payments of the
nonqualified deferred compensation will be made (for example, a payment
every March 1 of 10 percent of the accounts receivable collected during
the previous calendar year). Finally, the sales to which the payment
relates must be of a type that the service recipient is in the trade or
business of making and makes frequently, and either all such sales must
be taken into account or there must be a legitimate, nontax business
purpose for limiting the sales taken into account.
C. Separation From Service
1. In General
The final regulations generally adopt the provisions in the
proposed regulations defining the circumstances under which a
separation from service is deemed to occur, subject to the
modifications described in this preamble. Some commentators requested
that the parties to a nonqualified deferred compensation plan be
permitted to define when a separation from service occurs, at least if
they apply the definition consistently. The Treasury Department and IRS
believe that a definition of separation from service that is
objectively determinable, nondiscretionary and predictable, and not
subject to negotiations between the parties is necessary to properly
implement the legislative intent behind section 409A. The definitions
of separation from service suggested by the commentators do not meet
this standard. For example, a plan that defines separation from
[[Page 19258]]
service as the date a service provider is removed from a payroll would
leave to the parties the discretion to determine a payment date by an
action that may have little practical significance, especially when
compared to the effect on the service provider's deferred compensation
amounts. The Treasury Department and the IRS continue to believe that
the definition of separation from service should be based upon an
objective determination of whether the service provider continues to
provide significant services to the service recipient.
2. Employees
a. In General
The proposed regulations provided that an employee separated from
service with the employer if the employee died, retired, or otherwise
had a termination of employment with the employer. Whether a
termination of employment had occurred would be determined based on the
facts and circumstances. The proposed regulations provided that where
the facts and circumstances indicated that the employer and the
employee did not intend for the employee to provide more than
insignificant future services, the employee would be treated as having
a separation from service. For this purpose, an employer and employee
would not be presumed to have intended only insignificant services be
provided if the employee continued providing services at a rate equal
to at least 20 percent of the rate of the previous three years. Where
an employee continued providing services in another capacity (for
example, as an independent contractor), the employee would be deemed
not to have a separation from service if the service provider continued
providing services at a rate equal to at least 50 percent of the
services provided during the previous three years. Different rules were
provided for service providers who were not employees.
Commentators criticized this standard in various respects. The
proposed regulations applied one presumption where an employee
continued providing services as an independent contractor, and another
where an employee continued providing services as an employee.
Commentators asked why the same presumptions did not apply regardless
of whether the employee purports to continue service (or separate from
service) as an employee or purports to continue service (or separate
from service) as an independent contractor. Commentators also suggested
that the presumptions should be based on the intent of the employer and
employee at the time of the purported separation from service (or
purported continuation of services), rather than the actual subsequent
conduct. Commentators also argued that the employer and employee could
be found to have violated section 409A based on subsequent actual
conduct, even where the parties had a bona fide belief that a
separation from service had or had not occurred, but circumstances
changed.
In response to these comments, the final regulations provide a
simplified standard, applicable whether an employee continues to
provide services as an employee or as an independent contractor. The
general standard for determining whether the employee has terminated
employment is based on whether the facts and circumstances indicate
that the service recipient and employee reasonably anticipated either
that no further services would be performed after a certain date or
that the level of bona fide services the employee would perform after
such date (whether as an employee or as an independent contractor)
would permanently decrease to no more than 20 percent of the average
level of bona fide services performed over the immediately preceding
36-month period (or the full period in which the employee provided
services to the employer (whether as an employee or as an independent
contractor) if the employee has been providing services for less than
36 months). For this purpose, periods during which the employee is on
an unpaid bona fide leave of absence are disregarded (including for
purposes of determining the relevant 36-month period), and periods
during which the employee is on a paid bona fide leave of absence are
treated as periods during which the employee provided services at the
level at which the employee would have been required to perform
services to receive the compensation if not on a bona fide leave of
absence. Facts and circumstances to be considered in determining
whether the employee and employer reasonably anticipated that the
service provider's future services would be permanently reduced to less
than 20 percent of the average level of bona fide service provided
during the previous 36-month period include, but are not limited to,
whether the employee continues to be treated as an employee for other
purposes (such as continuation of salary and participation in employee
benefit programs), whether similarly situated service providers have
been treated consistently, and whether the employee is eligible to
perform services for, and realistically available to perform services
for, other employers in the same line of business.
To assist in applying this standard, certain rebuttable
presumptions are provided. An employee generally will be presumed to
have separated from service where the level of bona fide services
performed (whether as an employee or an independent contractor) changes
to a level equal to 20 percent or less of the average level of services
provided during the previous 36 months (whether as an employee or an
independent contractor). An employee will be presumed not to have
separated from service where the level of bona fide services rendered
continues at a level that is 50 percent or more of the average level of
services provided during the previous 36 months. No presumption applies
to a change to a level of services between 20 percent and 50 percent of
the average level of services provided during the previous 36 months.
For purposes of the presumption, the entire period during which the
employee has provided services to the employer is substituted for 36
months if the employee has been providing services to the employer for
less than 36 months, and periods during which the employee is on a bona
fide leave of absence are treated in the same manner as such periods
are treated for the general rule.
The presumptions are rebuttable, by demonstrating that the employer
and the employee reasonably anticipated that as of a certain date the
level of bona fide services would be reduced permanently to a level
less than or equal to 20 percent of the average level of services
provided during the immediately preceding 36-month period or full
period in which the employee has provided services if the employee has
been providing services to the employer for a period of less than 36
months (or that the level of bona fide services would not be so
reduced). For example, an employee may demonstrate that the service
recipient and employee anticipated that the employee would cease
providing services, but that (subsequent to the original cessation of
services) business circumstances such as termination of the employee's
replacement caused the employee to return to employment. Although the
employee's return to employment may cause the employee to be presumed
to have continued in employment because the rehired employee is
providing services at a rate equal to the rate at which he was
providing services before the termination of employment, the facts and
circumstances in this case
[[Page 19259]]
would demonstrate that at the time the employee terminated employment,
the employee and the service recipient reasonably anticipated that the
employee would not provide any services in the future.
Similarly, where the loss of a business client of the employer
results in a permanent reduction in the level of bona fide services
performed by the employee of more than 80 percent, so that the employee
would be presumed to have separated from service, the taxpayer may
rebut the presumption that a separation from service occurred by
showing that the employer and employee reasonably anticipated that the
level of services would not be so reduced. The separation from service
would then be deemed to occur at the time that the employer and
employee reasonably anticipated that such reduction would continue.
Commentators requested additional flexibility to treat certain
employees as having experienced a separation from service, even where
the employee continues to provide services in a reduced capacity. This
is often referred to as a phased retirement, in which an employee
obtains retirement benefits despite continuing to provide services on a
part-time or reduced basis. The Treasury Department and the IRS believe
that providing flexibility to alter the definition of a separation from
service after an amount has been deferred is inconsistent with the
statute and legislative intent, and could be subject to manipulation.
However, the final regulations permit certain flexibility for a
plan to define a separation from service as including a change to a
reduced level of bona fide services, if the definition is specified no
later than the time and form of payment are elected or otherwise
specified. Specifically, the final regulations provide that rather than
treating a separation from service as requiring an anticipated
permanent reduction in the level of bona fide services to 20 percent or
less of the average level of bona fide services provided in the
immediately preceding 36 months, a plan may treat another level of
anticipated permanent reduction in the level of bona fide services as a
separation from service, provided that the level of permanent reduction
required must be set forth in the plan as a specific percentage, and
the anticipated permanently reduced level of bona fide services must be
greater than 20 percent but less than 50 percent of the average level
of bona fide services provided in the immediately preceding 36 months.
The plan must specify the definition of separation from service on or
before the date at which a separation from service is designated as a
time of payment of an amount deferred, and once designated, any change
to the definition of separation from service with respect to such
amount deferred will be subject to the rules regarding subsequent
deferrals and the acceleration of payments.
For example, on or before the time at which a plan must designate a
time and form of payment for a deferred amount, the plan may specify
that a separation from service will be deemed to occur at any time that
the employee and employer reasonably anticipate that the bona fide
level of services the employee will perform (whether as an employee or
an independent contractor) will be permanently reduced to a level that
is less than 50 percent of the average level of bona fide services the
employee performed during the immediately preceding 36 months (or the
entire period the employee has provided services if the employee has
been providing services to the employer less than 36 months).
b. Identification of the Service Recipient
Commentators requested that the definition of the term service
recipient be expanded for purposes of determining whether a separation
from service has occurred. The final regulations generally adopt this
suggestion, so that for purposes of determining whether a service
provider has separated from service with an employer or other service
recipient, the service recipient is defined as including all entities
that would be treated as part of the group of entities comprising the
service recipient under section 414(b) and (c) and the accompanying
regulations, but substituting a 50 percent ownership level for the 80
percent ownership level in section 414(b) and (c) and the accompanying
regulations. A plan may specify that a higher or lower percentage
ownership level will be used, provided that the ownership level may not
be higher than 80 percent or lower than 20 percent, and provided
further that an ownership level of less than 50 percent may be used
only where such use is based on legitimate business criteria. As
discussed, the plan must specify the percentage on or before the date
at which a separation from service is designated as a time of payment
of the amount deferred, and where a plan changes the definition of
separation from service with respect to amounts previously deferred,
such a change will be subject to the rules governing changes to the
time and form of payment, including the anti-acceleration provisions.
Commentators also requested special treatment with respect to the
identification of the service recipient in instances where an amount is
deferred pursuant to a bona fide collective bargaining agreement
covering service with multiple employers, and the employee may be
expected to perform services covered by the bona fide collective
bargaining agreement for a number of different employers. Specifically,
commentators expressed concern that an employee not be treated as
having separated from service when a particular period of service with
an employer is completed, if the employee has made herself available to
perform services covered by the bona fide collective bargaining
agreement for another employer. The final regulations generally provide
that where the amount is deferred pursuant to a plan provided under a
bona fide collective bargaining agreement covering services with
multiple employers, and where service providers may reasonably
anticipate providing services for more than one of the participating
employers, the plan may define a separation from service in a manner
that treats the service provider as not having separated from service
when the service provider stops performing services for one employer
covered by the agreement and provides services for another employer
covered by the agreement. The final regulations also provide that the
plan may not treat a service provider as having separated from service
during periods where the service provider is not providing services but
has made herself available to perform services for a participating
employer, provided that the definition requires that the service
provider be deemed to have separated from service no later than the end
of any 12-month period in which the service provider has not provided
services covered by the bona fide collective bargaining agreement to
any employer.
c. Bona Fide Leave
Many of the comments with respect to the definition of separation
from service for an employee concerned the treatment of bona fide
leaves of absence. For purposes of determining whether a service
provider has separated from service (and not for purposes of
determining whether a vacation or sick leave plan is a bona fide
vacation or sick leave plan), a bona fide leave of absence refers to a
leave of absence where there is a reasonable expectation the service
provider will return to service with the service recipient. The final
regulations provide that an employment relationship is treated as
continuing while the individual is on sick leave, or
[[Page 19260]]
other bona fide leave of absence, if the period of such leave does not
exceed six months, or if longer, so long as the individual retains a
right to reemployment with the service recipient under an applicable
statute or by contract. For example, where a tenured professor takes a
leave of absence, but the professor retains a right to reemployment
with the university as part of the professor's tenured status, the
professor will not be deemed to have terminated from employment merely
due to the leave of absence from the university. If the period of leave
exceeds six months and the individual does not retain a right to
reemployment under an applicable statute or by contract, the employment
relationship is deemed to terminate on the first date immediately
following such six-month period. However, the final regulations modify
the provisions in the proposed regulations with respect to disability
leave. With respect to disability leave, the employment relationship
will be treated as continuing for a period of up to 29 months, unless
otherwise terminated by the employer or the employee, regardless of
whether the employee retains a contractual right to reemployment. For
this purpose, disability leave refers to leave due to the employee's
inability to perform the duties of his or her position of employment or
any substantially similar position of employment by reason of any
medically determinable physical or mental impairment that can be
expected to result in death or can be expected to last for a continuous
period of not less than six months.
d. Salary Continuation Programs and Terminal Leave
Commentators requested that salary continuation programs be
permitted to delay the occurrence of a separation from service, where
an employee continues to receive salary and benefits and is otherwise
treated as an employee, although not required to perform any further
meaningful services. Some commentators also requested this treatment
for terminal leave, or leave intended to bridge a service provider to a
separation from service date that would permit continuation of benefits
or accrual of additional benefits under, for example, a qualified plan.
The Treasury Department and the IRS believe that these types of actions
are subject to manipulation and should not delay the time when a
service provider is treated as having separated from service for
purposes of section 409A. Accordingly, the final regulations do not
recognize extensions of leave or salary and benefits as a means of
delaying the date of separation from service for purposes of section
409A. In addition, terminal leave with no intent to return generally
would not be treated as bona fide leave for purposes of the rule for
employees addressing bona fide leave.
Commentators expressed concern that the service recipient may wish
to continue providing certain employee benefits, including in-kind
benefits and reimbursement plans, during a salary continuation or
terminal leave period. With respect to the application of section 409A,
such plans generally may be structured to avoid providing for the
deferral of compensation, or to provide deferred compensation in
compliance with the requirements of section 409A. See sections III.J.6
and VII.B.2 of this preamble. The definition of separation from service
for purposes of section 409A is not applicable for purposes of other
Code provisions, such as those provisions governing qualified
retirement plans or non-taxable benefits.
e. Rehires and Suspensions of Benefits
Commentators also requested that the regulations address rehires,
and specifically whether payments of deferred compensation could be
suspended during a subsequent period of employment or other service
until a subsequent separation from service. Such a suspension generally
would violate the rules governing changes in the time and form of
payment because payments would be delayed in a manner that does not
satisfy the rules applicable to subsequent deferral elections. Neither
the statutory language of section 409A nor the legislative history
indicates any intent to permit such additional flexibility. Moreover,
the Treasury Department and the IRS believe that suspension of benefits
rules would add significant complexity to the administration of the
Code section. However, many of the desired results of a suspension of
benefits provision often may be obtained through deferrals of future
compensation after rehire.
f. Mergers and Acquisitions
Comments with respect to the application of the separation from
service standard in the case of a merger or acquisition generally
focused on two areas. First, commentators requested that the final
regulations adopt permissive use of the rule generally referred to as
the ``same desk'' rule, allowing the parties to an asset purchase
agreement to decide whether employees of the selling corporation that
continue in the same position with the purchaser of the assets will be
treated as separating from service. The final regulations adopt a rule
providing that where as part of a sale of assets by one service
recipient (seller) to an unrelated service recipient (buyer), a service
provider of the seller would otherwise experience a separation from
service with the seller, the seller and the buyer may specify whether a
service provider providing services to the seller immediately before
the asset purchase transaction and providing services to the buyer
after and in connection with the asset purchase transaction has
experienced a separation from service, provided that the asset purchase
transaction results from bona fide, arm's length negotiations, all
service providers providing services to the seller immediately before
the asset purchase transaction and providing services to the buyer
after and in connection with the asset purchase transaction are treated
consistently (regardless of position at the seller) for purposes of
applying the provisions of any nonqualified deferred compensation plan,
and such treatment is specified no later than the closing date of the
asset purchase transaction. For this purpose, a sale of assets refers
to a transfer of substantial assets, such as a plant or division or
substantially all of the assets of a trade or business.
Second, commentators requested clarification whether a spin-off of
a subsidiary could result in a separation from service of an employee
of the subsidiary, where the nonqualified deferred compensation plan
defines a separation from service as including any action resulting in
the employee no longer being an employee of the controlled group of
corporations including the parent corporation. Generally such a
transaction would not result in a termination of employment for an
employee of the subsidiary, because the employee is continuing
employment with the same employer both before and after the
transaction. However, the rules that provide a service recipient
discretion to terminate and liquidate a plan following a change in
control transaction afford taxpayers the flexibility to pay out their
deferred compensation liabilities in particular circumstances. See
section VIII.B of this preamble.
3. Directors
The final regulations provide generally that where a service
provider provides services to a service recipient both as an employee
and as an independent contractor, the service provider must separate
from service both as an employee and as an independent contractor to be
treated as having separated from service. But where a service provider
provides services both as an employee and a
[[Page 19261]]
member of the board of directors of a corporate service recipient, the
services provided as a director are not taken into account for purposes
of determining whether the service provider has a separation from
service as an employee for purposes of a nonqualified deferred
compensation plan in which the service provider participates in his or
her capacity as an employee that is not aggregated with any plan in
which the service provider participates as a director. Accordingly,
where an employee-director participates in a separate plan as an
employee, his or her termination of services as an employee will
constitute a separation from service for purposes of the employee plan,
regardless of whether he or she continues providing services as a
director (and vice versa). However, if a non-employee director is also
providing additional services as an independent contractor, he or she
cannot have a separation from service for purposes of section 409A
until he or she has separated from service both as a director and as an
independent contractor.
4. Delay for Specified Employees
Section 409A(a)(2)(B) provides that with respect to a specified
employee, a payment of nonqualified deferred compensation on account of
separation from service may not occur before the date that is six
months after the date of separation from service (or, if earlier, the
date of death of the employee). For this purpose, a specified employee
is a key employee of a corporation any stock of which is publicly
traded on an established securities market or otherwise. With respect
to identifying specified employees, the final regulations generally
adopt the provisions set forth in the proposed regulations, subject to
the modifications and clarifications described in this preamble.
a. Identification of Specified Employees
Several commentators asked whether an employee may be subject to
the six-month delay requirement if the service recipient stock is
publicly traded only on a foreign exchange or is traded on a U.S.
exchange only as American depositary receipts or American depositary
shares (ADRs). The final regulations define an established securities
market for purposes of the six-month delay rule by reference to the
rules in Sec. 1.897-1(m), which generally include foreign securities
markets. Accordingly, the six-month delay may apply to an employee of a
service recipient the stock of which is publicly traded solely on a
foreign exchange, or is traded on a U.S. exchange only as ADRs. In the
case of a service recipient comprised of multiple entities, this rule
would apply if one of the entities had stock that was publicly traded
on a foreign exchange.
Some commentators requested that the final regulations provide that
specified employees are limited to common law employees, and do not
include other individuals. Section 409A(a)(2)(B) defines a specified
employee as a key employee as defined in section 416(i) (without regard
to section 416(i)(5)). Accordingly, where an individual is treated as a
key employee for purposes of section 416(i), that individual generally
is a specified employee for purposes of section 409A.
Commentators requested clarification of how the definition of
compensation under section 415 applies for purposes of identifying the
key employees that may ultimately be specified employees. The final
regulations clarify that the general definition of compensation under
Sec. 1.415(c)-2(a), applied as if the service recipient were not using
any safe harbor provided in Sec. 1.415(c)-2(d), any of the special
timing rules provided in Sec. 1.415(c)-2(e), or any of the special
rules provided in Sec. 1.415(c)-2(g), will be treated as the general
definition of compensation for purposes of identifying specified
employees. However, the final regulations also provide that a service
recipient may use any available definition of compensation under
section 415 and the accompanying regulations, including any available
safe harbor and any available election under the timing rules or
special rules, provided that the definition is applied consistently to
all employees of the service recipient for purposes of identifying
specified employees. A service recipient may elect to use such a
definition of compensation regardless of whether another definition of
compensation is being used for purposes of a qualified plan sponsored
by the service recipient. However, once a list of specified employees
has become effective, the service recipient cannot change the
definition of compensation for purposes of identifying specified
employees for the period with respect to which such list is effective.
For a discussion of the methods for making an election regarding the
definition of compensation, see section VII.C.4.e of this preamble.
Commentators requested clarification of the treatment of the
compensation of certain nonresident alien employees. As discussed in
the preceding paragraph, for purposes of identifying key employees, the
general definition of compensation under Sec. 1.415(c)-2(a) applies. A
service recipient may elect to apply the rule of Sec. 1.415-
2(g)(5)(ii) and not treat as compensation certain compensation
excludible from an employee's gross income on account of the location
of the services or the identity of the employer that is not effectively
connected with the conduct of a trade or business within the United
States. If no such election is made, the provisions of Sec. 1.415(c)-
2(g)(5)(i) would apply, requiring the treatment as compensation of
certain compensation excludible from an employee's gross income due to
the location of the services or the identity of the service recipient.
b. Alternative Methods for Applying the Six-Month Delay Requirement
Commentators expressed concern that an attempt to identify key
employees could result in an underinclusive list. Rather than risk a
violation, commentators suggested that service recipients be permitted
to use an alternative method for determining employees subject to the
six-month delay requirement, even where such an alternative method may
result in an over-inclusive list. A nonqualified deferred compensation
plan may provide that all payments upon separation from service will
commence six months after the separation from service, regardless of
whether the service provider is a specified employee. In addition, the
final regulations provide that a plan may use an alternative method
identifying the service providers whose distributions will be subject
to a six-month delay, provided that the alternative method is
reasonably designed to include all specified employees, the alternative
method is an objectively determinable standard providing no direct or
indirect election to any service provider regarding the application of
the rule, and the alternative method results in no more than 200
service providers being identified in the class as of any date. Use of
such an alternative method to delay a payment in accordance with the
rules governing the delay of payments to a specified employee will not
be treated as a change in the time and form of payment for purposes of
the subsequent deferral rules even if the service provider is not a
specified employee when the payment is delayed. However, if the list
fails to include any individual who is a specified employee and that
individual has a right to a payment of deferred compensation upon a
separation from service without the required six-month delay, the plan
providing such right to such individual will not be in compliance with
section
[[Page 19262]]
409A. For a discussion of the method of initiating an alternative
method designation, see section VII.C.4.e of this preamble.
c. Specified Employee Effective Date Issues
Under the proposed regulations, the employees identified as of an
identification date would become specified employees effective as of
the first day of the fourth month following the identification date.
Commentators stated that service recipients who could compile the list
of specified employees more quickly should be permitted to make the
list effective at an earlier date. The final regulations provide that
the first day of the fourth month will be the specified employee
effective date if the service recipient does not specify another date.
However, the final regulations permit a service recipient to specify a
specified employee effective date following the specified employee
identification date upon which the new list of specified employees will
become effective, provided that the specified employee effective date
may not be later than the first day of the fourth month following the
specified employee identification date. For example, an employer that
designates December 31 as a specified employee identification date for
purposes of identifying key employees for purposes of the six-month
delay rule, may specify any subsequent date on or before the following
April 1 as the first date of the 12-month period during which such list
of key employees will be treated as specified employees. To prevent
manipulation, any change to the specified employee effective date may
not become applicable until 12 months following the change in such
specified employee effective date.
The final regulations also clarify that the six-month delay
requirement applies only where the service provider is a specified
employee as of the date of separation from service, and does not become
applicable if the service provider is not a specified employee as of
the date of separation from service even if the service provider
subsequently would have become a specified employee if the separation
had not occurred.
d. Corporate Transactions
In response to comments, the final regulations significantly alter
the proposed rules governing the identification of specified employees
following a corporate transaction, such as a merger or spin-off.
Commentators requested clarification of the determination of the next
applicable specified employee identification date following the
corporate transaction. In addition, commentators generally objected to
any rule that resulted in the treatment of more than 50 employees as
specified employees due to a corporate transaction (in addition to 1-
percent and 5-percent owners treated as specified employees). The final
regulations generally permit service recipients to avoid this result,
but also permit service recipients to simply combine the pre-
transaction separate lists of specified employees where it is
determined that such treatment would be administratively less
burdensome. Service recipients can determine whether to combine such
lists on a case-by-case basis, if there are multiple transactions
during the same year.
With respect to mergers and acquisitions, the final regulations
address combinations of two public corporations, and combinations of a
public and a closely-held corporation. For purposes of the discussion
of the rules regarding the treatment of the identification of specified
employees following such a transaction, references to specified
employees include specified employees determined under any permissible
method that the entities participating in the transaction used
immediately before the transaction. Where two public corporations merge
and become one public corporation, or a public corporation becomes a
subsidiary of another public corporation, the final regulations provide
that the resulting service recipient's next specified employee
identification date and the first specified employee effective date
following the transaction is the specified employee identification date
and specified employee effective date that the acquiring service
recipient would have been required to use absent the merger. For the
period after the date of the transaction and before the next specified
employee effective date, the specified employee list of the resulting
service recipient consists of the 50 most highly compensated service
providers appearing on the combined lists of the two service
recipients' specified employees in effect as of the date of the
transaction, ranking such specified employees in order of the amount of
compensation used to determine each specified employees' status as a
specified employee, plus any 1-percent and 5-percent owners not
otherwise included who would be treated as specified employees.
Alternatively, however, the resulting service recipient may use any
other reasonable method to determine its specified employees
immediately after the transaction, provided that such method is adopted
not later than 90 days after the merger and applied prospectively from
the date of adoption. For a discussion of the procedures for adopting
such a method, see section VII.C.4.e of this preamble.
Where a public corporation and a private corporation merge and
become a public corporation, or where a private corporation becomes a
subsidiary of a public corporation, the resulting service recipient's
next specified employee identification date and specified employee
effective date following the transaction will be the specified employee
identification date and specified employee effective date that the pre-
transaction public corporation would have been required to use absent
such transaction. For the time period after the transaction and before
the next specified employee effective date, the specified employees of
the pre-transaction public service recipient immediately before the
transaction will continue to be the specified employees of the
resulting service recipient, and service providers of the pre-merger
private service recipient will not become specified employees until the
next specified employee effective date. Consequently, the nonqualified
deferred compensation plans in which service providers of the formerly
private service recipient participate will not be required to contain a
plan term delaying a payment upon separation from service of such
service providers, or to delay such a payment, until the next specified
employee effective date.
The final regulations also address spin-off transactions. Where as
part of a corporate transaction, a public service recipient becomes two
separate public service recipients, the final regulations provide that
the next specified employee identification date and specified employee
effective date of each of the post-transaction service recipients is
the specified employee identification date and specified employee
effective date that the pre-transaction service recipient would have
been required to use absent such transaction. For the period after the
date of the transaction and before the next specified employee
effective date, the specified employees of the pre-transaction service
recipient immediately before the transaction continue to be the
specified employees of the post-transaction service recipients.
The final regulations provide guidance on initial public offerings
and other corporate transactions where all or part of a private service
recipient becomes one or more public service
[[Page 19263]]
recipients. In that case, except as discussed in this paragraph, each
post-transaction public service recipient will have a December 31
specified employee identification date and an April 1 specified
employee date. Alternatively, the new public service recipient may
establish a different specified employee identification date and
specified employee effective date, provided that the specified employee
identification date and specified employee effective date must be
established on or before the date of the initial public offering or
other corporate transaction.
For the period between the date of the initial public offering or
other corporate transaction and the first specified employee effective
date, the list of specified employees of each post-transaction public
service recipient is comprised of the service providers that at the
time of the corporate transaction or public offering would have been
classified as specified employees of the former private service
recipient, had such service recipient adopted the same specified
employee identification date and specified employee effective date as
selected by such post-transaction public service recipient, and had
such former private service recipient been a public service recipient
as of such specified employee identification date.
e. Alternatives for the Identification of Specified Employees
As discussed in this preamble, the final regulations provide
certain default definitions for purposes of identifying specified
employees, where the service recipient has not adopted another
definition. These default rules include the following provisions: the
specified employee identification date is December 31; the specified
employee effective date is April 1; the general definition of
compensation under Sec. 1.415(c)-2(a) will apply (without giving
effect to any use of the special timing rules under Sec. 1.415(c)-2(e)
or of a safe harbor definition of compensation under Sec. 1.415(c)-
2(d)); and certain rules regarding the identification of specified
employees after a merger of public service recipients or an initial
public offering or other transaction involving a formerly nonpublic
service recipient becoming a public service recipient will apply.
Alternatively, the final regulations also provide that the service
recipient may use other permissible rules and definitions, provided
that such alternatives become effective only in accordance with the
rules and deadlines set forth in the final regulations. In addition,
the final regulations permit a service recipient to use an alternative
method for purposes of identifying specified employees, with certain
limitations, and to make an election under Sec. 1.415(c)-2(g)(5)(i)
regarding the treatment as compensation of certain compensation
excludible from an employee's gross income due to the location of the
services or the identity of the employer. For purposes of these rules,
a service recipient may use one of these alternatives when all
necessary corporate action has been taken to make such alternative
binding for purposes of all affected deferred compensation plans in
which service providers of the service recipient participate.
Accordingly, as a practical matter, the service recipient may find it
expedient either to specify the definition of specified employee in all
of its nonqualified deferred compensation plans or to retain the
discretion in all such plans to make such determinations and take any
necessary corporate action in accordance with each such plan.
f. Application of the Six-Month Delay Rule
The final regulations reflect the statutory language that a plan
may provide that a payment will be made, notwithstanding the six-month
delay, upon the service provider's death. A commentator requested
similar treatment for the occurrence of a disability, unforeseeable
emergency, or change in control event during the six months following
the separation from service. The Treasury Department and the IRS do not
believe that the statute permits such flexibility, but rather
categorically prohibits any distribution due to a separation from
service during the six months following the separation from service
except where the service provider dies. Accordingly, where a payment on
account of a separation from service has been delayed because the
service provider is a specified employee, the payment may not be
accelerated due to disability, a change in control event, or an
unforeseeable emergency. However, where a payment is made to a
specified employee on account of disability, a change in control event,
or an unforeseeable emergency (as defined for purposes of section
409A), the payment need not be delayed merely because the specified
employee separates from service after incurring the disability or
unforeseeable emergency, or after the change in control event.
Commentators further requested that various types of periodic
benefit payments be excluded from the six-month delay requirement, even
if such payments constitute a payment of deferred compensation.
Commentators argued that the requirement to delay such payments would
be excessively burdensome and impracticable, given the nature and
amount of benefits generally available under such arrangements. The
Treasury Department and the IRS are not convinced that periodic payment
or reimbursement plans should be excluded from the six-month delay
rule; otherwise, deferred compensation could simply be converted to
such programs to avoid the delay. However, as clarified in the final
regulations, certain plans that provide for reimbursements or in-kind
benefits during the six months following a separation from service will
not be treated as nonqualified deferred compensation plans under the
rules governing separation pay plans. See section III.J.6 of this
preamble.
The final regulations also provide that the required delay of a
payment to a specified employee upon a separation of service is not
violated where the payment is made before the end of the six-month
period due to an acceleration of a payment in compliance with the
provisions of the regulations permitting accelerated distributions due
to a domestic relations order, to satisfy a Federal, state, local, or
foreign ethics law, or to pay certain employment taxes (see section
VIII of this preamble).
5. Different Times and Forms of Payment on Separation From Service
Under Specified Circumstances
The final regulations continue to provide that a time and form of
payment must be specified with respect to each permissible payment
event. Under the proposed regulations, a second time and form of
payment could be established for a payment due to a permissible payment
event where the distinction was based upon the event occurring before
or after a certain date, such as the service provider reaching a
certain age. Commentators requested that different times and forms of
payment be permitted if based upon different types of separations from
service. The final regulations generally provide that the time and form
of payment upon a separation from service may vary depending upon
either or both of the following: (1) Whether the separation from
service occurs during a limited period of time not to exceed two years
following a change in control event as defined for purposes of section
409A; or (2) whether the separation from service occurs before or after
a specified date (for example, the attainment of a specified age), or
before or after a combination of a specified date and a specified
period of service determined under a predetermined objective
[[Page 19264]]
formula or pursuant to the method for crediting service under a
qualified plan sponsored by the service recipient. The addition or
deletion of such a different time and form of payment applicable to an
existing deferral is subject to the subsequent deferral election rules
and the anti-acceleration rules.
D. Disability
The final regulations generally adopt the definition of disability
and other provisions related to the payment of an amount upon a service
provider becoming disabled contained in the proposed regulations,
subject to the modifications described in this preamble. For this
purpose, a participant is disabled if the participant is unable to
engage in any substantial gainful activity by reason of any medically
determinable physical or mental impairment that can be expected to
result in death or can be expected to last for a continuous period of
not less than 12 months, or is, by reason of any medically determinable
physical or mental impairment that can be expected to result in death
or can be expected to last for a continuous period of not less than 12
months, receiving income replacement benefits for a period of not less
than 3 months under an accident and health plan covering employees of
the participant's employer. The determination of whether a service
provider is disabled may be made by any person, including the
administrator of a disability insurance program, and the plan need not
specify who will make the determination. However, the plan will be
treated as complying with section 409A only if the disability required
for a payment complies with the definition of disability under the
regulations, and a payment due to a disability will be deemed to comply
with section 409A if the service provider has actually suffered a
qualifying disability. The final regulations also provide that a plan
may provide that a service provider will be deemed disabled if the
service provider is determined to be totally disabled by the Social
Security Administration or the Railroad Retirement Board.
Commentators raised questions concerning the ability to pay upon
the occurrence of a disability that does not qualify as a disability
under the statute, where as a result of the disability the service
provider has a separation from service. Such a payment would not
constitute a payment due to a disability that complied with section
409A. However, if the plan provided for a payment due to the separation
from service, a payment would constitute a payment due to a separation
from service regardless of whether the separation from service resulted
from such a disability and regardless of whether the service provider's
right to receive such payment was conditioned upon the service provider
being disabled under such disability definition. For a discussion of
the ability to provide for different times and forms of payment due to
different types of separations from service, including separations from
service due to certain disabilities, see section VII.C.4 of this
preamble.
E. Death
Most of the comments with respect to amounts that are payable due
to the death of a service provider related to whether a beneficiary of
the service provider could be given the opportunity to elect a time and
form of payment under a plan without violating section 409A. The final
regulations clarify that elections with respect to the time and form of
payment to a beneficiary are subject to the general rules governing
subsequent deferrals and accelerated payments, including elections by
either the service provider or the beneficiary (with an exception for
amounts payable under a domestic relations order). However, a change in
a beneficiary will not be treated as a change in the time and form of
payment, if the change in the time of payment stems solely from the
different life expectancy of the new beneficiary, such as in the case
of a joint and survivor annuity. Commentators requested that
beneficiaries be permitted a limited period of time in which to change
the time and form of payment without being subject to the subsequent
deferral and anti-acceleration provisions. The Treasury Department and
the IRS do not believe that the statutory language supports this type
of late deferral election or payment acceleration. Accordingly, these
suggestions are not adopted in the final regulations.
F. Change in Ownership or Effective Control of a Corporation
The final regulations generally adopt the provisions contained in
the proposed regulations with respect to the definition of a change in
control event, as well as certain special rules with respect to
payments upon a change in control event, subject to the modifications
described in this preamble.
One commentator requested that the threshold for a change in the
effective control of a corporation be lowered from 35 percent to 20
percent, especially for a public corporation. The legislative history
of section 409A indicates that the definition of a change in control
event is to be based upon, but more restrictive than, the definition
provided in section 280G. H.R. Conf. Rep. No. 108-755, at 730 (2004).
Given that Sec. 1.280G-1, Q&A-28(a)(1) provides for a 20 percent
standard, the adoption of that standard is not appropriate in light of
the legislative history. However, the final regulations lower the
threshold to 30 percent.
One commentator requested guidance with respect to the application
of the change in control provisions to non-stock, non-profit
corporations. The Treasury Department and the IRS are considering
whether such guidance is appropriate, and if so what types of changes
could be treated as analogous to a change in control event involving a
stock corporation. Until further guidance, a non-stock, non-profit
corporation may apply the change in effective control provisions in
Sec. 1.409A-3(i)(5) (relating to a change in the composition of the
board of directors) by analogy to changes in the composition of its
board of directors, trustees, or other governing body.
The final regulations continue to provide that in the case of a
payment on account of certain change in control events (a change in
ownership of a corporation or a change in the ownership of a
substantial portion of a corporation's assets), compensation payable
pursuant to the service recipient's purchase of service recipient stock
or a service recipient stock right held by a service provider, or
payment of amounts of deferred compensation calculated by reference to
the value of service recipient stock, generally may be treated as
complying with the requirements of section 409A if paid under the terms
and conditions that govern the payments to shareholders or the service
recipient in connection with the change in control event. The final
regulations continue to require that such amounts be paid no later than
five years after the change in control event. However, the final
regulations also provide that where such compensation is made subject
to a condition on payment that constitutes a substantial risk of
forfeiture under section 409A (without regard to the prohibition on
additions or extensions of forfeiture conditions), and such
compensation is payable under the same terms and conditions as apply to
payments made to shareholders generally with respect to stock of the
service recipient, or to the service recipient itself, pursuant to the
change in control event, for purposes of determining whether such
compensation is a short-term deferral the requirements of the short-
term
[[Page 19265]]
deferral rule are applied as if the legally binding right to such
compensation arose on the date that it became subject to the
substantial risk of forfeiture. The regulations also provide rules
under which certain pre-existing forfeiture conditions may be extended
or modified in connection with such a change in control event.
G. Unforeseeable Emergency
The final regulations apply the provisions set forth in section
409A(a)(2)(B)(ii) regarding payments upon an unforeseeable emergency.
The final regulations provide that a distribution on account of
unforeseeable emergency may not be made to the extent that such
emergency is or may be relieved through reimbursement or compensation
from insurance or otherwise, by liquidation of the service provider's
assets, to the extent the liquidation of such assets would not cause
severe financial hardship, or by cessation of deferrals under the plan.
The final regulations clarify that for these purposes, the availability
of payments due to the unforeseeable emergency under any other
nonqualified deferred compensation plan as defined for purposes of
section 409A, including plans that would be nonqualified deferred
compensation plans for purposes of section 409A except due to the
effective date of the statute, or under any qualified plan (including
any assets available by obtaining a loan under a qualified plan), need
not be considered in determining whether an emergency is or may be
relieved through other means. Accordingly, a payment due to an
unforeseeable emergency may be made pursuant to a nonqualified deferred
compensation plan that is subject to section 409A even though the
financial need could be satisfied through an available distribution or
loan from a qualified plan, from a grandfathered nonqualified deferred
compensation plan, or from another nonqualified deferred compensation
plan that is subject to section 409A.
Section 826 of the Pension Protection Act of 2006, Public Law 109-
280 (120 Stat. 780) modified the rules governing payments upon an
unforeseeable emergency. Specifically, section 826 requires that the
Treasury Department and the IRS modify the rules for determining
whether a service provider has had an unforeseeable emergency for
purposes of section 409A(a)(2)(B)(ii) to provide that if an event would
constitute a hardship under the plan if it occurred with respect to the
service provider's spouse or dependent, such event will, to the extent
permitted under a plan, constitute a hardship if it occurs with respect
to a person who is a beneficiary under the plan with respect to the
service provider. The final regulations reflect this modification.
H. Multiple Payment Events
The final regulations provide that a plan may provide for a payment
based upon the earlier of, or the later of, a series of events,
provided that each payment event would otherwise satisfy the
requirements of section 409A. The final regulations also provide that
for purposes of the subsequent deferral and acceleration rules, each
payment event will be viewed separately for purposes of analyzing the
effect of a change in the time and form of payment. For a discussion of
the effect of the addition or deletion of a permissible payment event
from such a list, see section IX.C of this preamble.
I. Delay in Payment by the Service Recipient
Commentators requested that a service recipient be permitted to
delay a payment, where the delay is due to bona fide business concerns
such as cash flow considerations. Where a payment is delayed due to the
operation of a pre-specified objective, nondiscretionary formula
related to the business performance of the service recipient, the
payment generally may be delayed (for example, where payments in any
given year are limited to a certain percentage of cash flow) provided
that the time for later payment is governed by the objective,
nondiscretionary formula. See section VII.B.3 of this preamble. In
addition, the final regulations provide that if at the time of a
specified payment date the making of the payment would jeopardize the
ability of the service recipient to continue as a going concern, the
payment will be treated as made upon the specified payment date if the
payment is made during the first taxable year of the service provider
in which the making of the payment would not have such effect. This
provision is not required to be explicitly provided in the plan.
Because this provision permits the service recipient to delay any
payment the making of which would jeopardize the ability of the service
recipient to continue as a going concern, the provision in the proposed
regulations permitting a delay in payment required to avoid a violation
of a loan covenant or similar contractual obligation, where such
violation would cause material harm to the service recipient, has not
been adopted in the final regulations. Rather, where the payment would
result in a violation of a loan covenant or similar contractual
obligation, and the violation would jeopardize the ability of the
service recipient to continue as a going concern, the payment can be
delayed under the general provision.
The final regulations adopt the provision of the proposed
regulations that permits a delay in payment necessary to avoid the
application of the deduction limitation under section 162(m), subject
to the following modifications. First, a plan is not required to
provide explicitly for such a delay. However, the final regulations
require that where any payment in a service recipient's taxable year is
delayed in accordance with this provision, then all payments that could
be delayed in accordance with this provision must be delayed (though
some payments may be delayed until after separation from service and
others until the earliest taxable year in which the deduction
limitation no longer applies). Second, except as provided in the next
sentence, the regulations provide that the payment must be made either
during the service provider's first taxable year in which the service
recipient reasonably anticipates, or reasonably should anticipate, that
if the service recipient makes such payment during such year such
payment will not fail to be deductible because of section 162(m) or, if
later, during the period beginning on the day the service provider
separates from service and ending on the later of the last day of the
service provider's taxable year in which the separation from service
occurs or the 15th day of the third month following the separation from
service. Finally, the final regulations provide that where the payment
has been delayed until the service provider's separation from service,
the six-month delay requirement for specified employees may apply.
Although commentators argued that the six-month delay rule should not
apply because the original payment would not have been subject to the
rule, this same argument could be made with respect to any deferral
election to have current compensation paid instead at a separation from
service, and accordingly is not adopted in the final regulations.
J. Disputed Payments and Refusals to Pay
The final regulations adopt the provisions in the proposed
regulations with respect to disputed payments and refusals to pay,
subject to certain modifications. If a payment is not made due to a
service recipient's refusal to pay an amount, the amount generally will
be treated as paid in a timely
[[Page 19266]]
manner if the service provider makes reasonable, good faith efforts to
collect the payment. This provision is intended to address not only
intentional refusals to pay, but also inadvertent delays (but, in
either case, only if there is no collusion between the service provider
and service recipient). For example, where through oversight a service
recipient fails to make a payment on the required payment date, the
payment will be treated as made on the specified date if the service
provider makes reasonable, good faith efforts to collect the payment,
generally through providing timely notice to the service recipient that
the payment is due and unpaid. For this purpose, efforts to collect the
payment will be presumed not to be reasonable, good faith efforts if
notice is not given to the service recipient within 90 days of the
latest date upon which the payment could have been timely made in
accordance with the terms of the plan and the regulations and, if not
paid, further measures to enforce the payment are not taken within 180
days after such date. For a discussion of payments that are accelerated
due to a settlement of a bona fide dispute as to the service provider's
right to the payment, see section VIII.G of this preamble.
K. Back-to-Back Arrangements
The proposed regulations addressed certain arrangements under which
an entity (the intermediate service recipient) receives services from a
service provider and provides services to a client (the ultimate
service recipient), and the time the intermediate service recipient is
entitled to receive a payment for services rendered to the ultimate
service recipient is controlled by the date on which the intermediate
service recipient is obligated to make a payment of deferred
compensation to the service provider. For example, assume an
intermediate service recipient provides investment management services
for a group of investors. Pursuant to a nonqualified deferred
compensation plan, the intermediate service recipient has agreed to pay
its employee a sum certain when the employee terminates employment.
Under the intermediate service recipient's agreement with the investor
group, the investors will pay the same sum certain to the intermediate
service recipient when the employee terminates employment. The proposed
regulations referred to these types of arrangements as back-to-back
arrangements.
The final regulations adopt the proposed provisions that addressed
back-to-back nonqualified deferred compensation arrangements, subject
to the modifications described in this section. The final regulations
clarify that the rules addressing back-to-back arrangements apply
regardless of whether the arrangement between the service provider and
the intermediate service recipient is actually subject to section 409A,
as long as each arrangement that is part of the overall back-to-back
scheme complies with the requirements of section 409A without regard to
whether such arrangement is actually subject to section 409A.
Accordingly, the accommodations afforded to back-to-back arrangements
are only applicable to the extent that each arrangement satisfies the
requirements of section 409A as if those requirements applied to each
such arrangement (modified in accordance with the back-to-back rules).
Commentators also requested that, with respect to taxpayers
providing management services that are not eligible for the exception
from coverage for independent contractors with multiple unrelated
customers, the exception from the general payment timing rules
permitting certain back-to-back arrangements be expanded to include not
only arrangements where the payment from an ultimate service recipient
to the intermediate service recipient is based upon the timing of a
required payment under a section 409A compliant plan from the
intermediate service recipient to a service provider (a forward back-
to-back arrangement), but also where the payment to the service
provider is based upon a required payment under a section 409A
compliant arrangement from the ultimate service recipient to the
intermediate service recipient (a reverse back-to-back arrangement).
For example, a service recipient that provides investment management
services to an investor group may have an arrangement whereby the
investors are required to pay all amounts due to the investment manager
service recipient if the investor group terminates the client
relationship, and the investment manager service recipient in turn has
an agreement with an employee to pay the employee a certain percentage
of the amount the investor group pays to the investment manager service
recipient, following termination of the client relationship. The final
regulations do not provide an exception from the requirements of
section 409A for reverse back-to-back arrangements, but the Treasury
Department and the IRS will continue to study the matter.
VIII. Prohibition of Accelerated Payments
A. In General
Section 409A(a)(3) provides that a plan may not permit the
acceleration of the time or schedule of any payment under the plan,
except as provided in regulations by the Secretary. The final
regulations retain the provisions in the proposed regulations relating
to accelerated payments, subject to the modifications described in this
preamble.
The final regulations generally provide that a payment of an amount
as a substitute for a payment of deferred compensation will be treated
as a payment of the deferred compensation, including for purposes of
the prohibition on accelerated payments. Where a payment of an amount
results in an actual or potential reduction of, or an actual or
potential current or future offset to, an amount of deferred
compensation, or the service provider receives a loan the repayment of
which is secured by or may be accomplished through an offset of a
nonqualified deferred compensation benefit, then the payment or loan is
a substitute for the deferred compensation and is treated as a payment
of the deferred compensation itself. If a service provider's rights to
deferred compensation are subject to anticipation, alienation, sale,
transfer, assignment, pledge, encumbrance, attachment, or garnishment
by creditors of the service provider or the service provider's
beneficiary, such amounts are treated as having been paid to the
service provider.
The receipt of a payment of compensation, or right to a payment of
compensation, proximate to the purported forfeiture or voluntary
relinquishment of a right to deferred compensation generally is treated
as a substituted payment for the payment of the deferred compensation.
For example, where the right to an amount of deferred compensation is
purportedly relinquished or forfeited, and concurrently or subsequently
the service provider receives a current bonus payment, the bonus
payment will be presumed to be a substitute payment for the amount of
deferred compensation. The presumption is rebuttable by a showing that
the compensation paid would have been paid regardless of the
relinquishment or forfeiture of the right to the deferred compensation.
For a discussion of the application of this provision to amounts
forfeitable upon a separation from service, see section III.J.1 of this
preamble.
A plan may not provide discretion to a service provider regarding
whether a
[[Page 19267]]
payment will be accelerated under one of the rules permitting the
acceleration of payments under specified circumstances (for example, to
comply with a domestic relations order), including through the
provision of an election. However, where a plan provides a service
recipient discretion to accelerate payments under one of the rules
permitting the acceleration of a payment, the failure to accelerate
such a payment will not constitute a subsequent deferral election.
B. Plan Termination and Liquidation
The proposed regulations contained provisions permitting a service
recipient to terminate and liquidate a nonqualified deferred
compensation plan, including when the service recipient has declared
bankruptcy, when the service recipient has participated in certain
change in control events, or at the discretion of the service
recipient, all subject to certain restrictions and limitations.
Commentators expressed concern over the restrictions and limitations.
Some comments reflected confusion as to the meaning of these terms in
the context of section 409A. The termination and liquidation of a
nonqualified deferred compensation plan involves both the amendment of
the plan to cease deferrals under the plan and provide for payment of
all benefits accrued under the plan, and the accelerated payment of
benefits accrued under the plan.
Several comments suggested that the final regulations expand the
circumstances under which a service recipient may terminate and
liquidate a nonqualified deferred compensation plan. Generally these
comments requested discretion in case of a change in business
conditions or circumstances, resulting in the service recipient's
desire to terminate and liquidate the plan. The final regulations
expand the circumstances under which a sale of assets of a corporation
will result in a separation from service. See section VII.C.2.f of this
preamble. In addition, the final regulations continue to allow the
service recipient to terminate and liquidate a plan during a defined
period following a change in control event. Outside of these particular
business events, the comments failed to provide an objective standard
or category of changes in business conditions or circumstances that
would provide a safeguard against the use of plan termination and
liquidation provisions to circumvent the prohibition on accelerations.
Accordingly, the final regulations do not expand the ability of a
service recipient to exercise its discretion to terminate and liquidate
a deferred compensation plan. However, the period of time during which
a service recipient may not commence a new plan after terminating and
liquidating a nonqualified deferred compensation plan has been
shortened from five years to three years. Also, the final regulations
provide that a discretionary plan termination and liquidation will not
qualify for this exception if it is proximate to a downturn in the
financial health of the service recipient.
The final regulations clarify the rules under which a deferred
compensation plan may be terminated and liquidated upon a change in
control event. Under the final regulations, the service recipient must,
within the 30 days preceding or the 12 months following the change in
control event, take all necessary action to terminate and liquidate the
plan and such action must be irrevocable. In addition, for the plan to
be treated as terminated and liquidated, all other arrangements that
would be classified with the plan as a single plan if the same service
provider participated in the plan and all the other arrangements must
be terminated and liquidated, so that all service providers who are
participants in the plan and all such other arrangements required to be
terminated and liquidated must receive all amounts of compensation
deferred under the terminated and liquidated plan and other
arrangements within 12 months of the date the service recipient takes
such irrevocable action to terminate and liquidate the arrangements.
For purposes of the rule, the entities comprising the service recipient
are determined immediately following the change in control event, and
the rule only applies with respect to service providers for whom a
change in control has occurred. For example, where the change in
control event consists of a sale of a subsidiary corporation such that
the subsidiary corporation is no longer treated as a single service
recipient with the (former) parent corporation, the requirement to
terminate and liquidate substantially similar arrangements applies only
to the purchaser service recipient group of corporations that now owns
the subsidiary corporation. In addition, the rule would apply only to
the service providers that had experienced a change in control,
generally consisting only of the service providers of the subsidiary
corporation. Where the change in control event consists of an asset
purchase, the applicable service recipient with discretion to terminate
and liquidate the plan is deemed to be the entity retaining the
deferred compensation liability after the transaction.
Some commentators asked whether the plan termination and
liquidation rules apply if a plan is terminated and liquidated when the
service provider has no vested right to a payment, and all payments are
forfeited. Where the service recipient retained the unfettered
discretion to terminate such a plan without paying benefits, the
service provider may not have obtained a legally binding right to a
payment. In addition, if a service provider forfeits benefits under a
nonqualified deferred compensation plan in exchange for other taxable
benefits, those benefits may be treated as a payment of amounts under
the nonqualified deferred compensation plan.
C. Conflicts of Interest and Ethics Rules
The proposed regulations contained a special accelerated payment
rule to permit accelerated payments required to be made by a
certificate of divestiture. Notice 2006-64, 2006-29 IRB 88, see Sec.
601.601(d)(2), expanded this exception to address situations in which a
letter is received from the Office of Government Ethics that
divestiture of the deferred compensation is required. Several
commentators requested an expansion of these rules.
The final regulations provide that a payment may be accelerated
where necessary for a Federal officer or employee in the executive
branch to comply with an ethics agreement with the Federal government.
The final regulations also provide that a payment may be accelerated
where reasonably necessary to avoid the violation of a Federal, state,
local, or foreign conflict of interest law or ethics law (including
where such payment is reasonably necessary to permit the service
provider to participate in activities in the normal course of his or
her position in which the service provider would otherwise not be able
to participate under an applicable law). For this purpose, a payment
will be reasonably necessary to avoid such a violation if the making of
the payment is a necessary part of a combination of actions resulting
in compliance with the applicable law. A payment may be considered
necessary to avoid such a violation even though actions other than
making the payment could also result in compliance with the applicable
law. For example, as requested by several commentators, this provision
would provide a public accounting firm the ability to accelerate
payments where reasonably necessary to satisfy conflict of interest
rules prescribed by the Securities and Exchange Commission. This
paragraph
[[Page 19268]]
is intended to address payments to service providers, as well as
payments to a spouse or minor children where such payments are
reasonably necessary to comply with the applicable law. For this
purpose, foreign law is considered to be applicable only to foreign
earned income from sources within the foreign country that promulgated
such law.
D. State and Local Taxes, RRTA Tax and Foreign Taxes
Commentators stated that certain state and local jurisdictions tax
nonqualified deferred compensation plans under a different set of rules
than the Federal income tax rules, typically by reference to the rules
applicable to FICA taxes. Commentators also requested that
accelerations be permitted to cover applicable RRTA taxes. Finally,
commentators requested that accelerated payments be permitted to
account for the tax laws of foreign jurisdictions that may not be
consistent with the Federal income tax rules. The final regulations
adopt the suggestions with respect to state and local taxes, RRTA
taxes, and foreign taxes.
E. Minimum Distributions Under Section 280H(d)
One commentator suggested that acceleration be permitted to allow a
personal service corporation to make minimum distributions to avoid
taxation under section 280H(d). The Treasury Department and the IRS
believe that such a provision would give taxpayers excessive control
over the payment of deferred amounts that would be inconsistent with
the purposes of section 409A. Therefore, this suggestion was not
adopted.
F. Top Hat Plan Rules
Some commentators requested that the final regulations permit a
service recipient to accelerate payments or cancel deferral elections
with respect to a service provider who is not part of a select group of
management or highly compensated employees for purposes of the
exclusion from coverage under certain provisions of the Employee
Retirement Income Security Act of 1974 relating to top hat plans. See,
for example, 29 U.S.C. 1051(2). Given the current lack of clarity with
respect to the scope of coverage of the top hat plan rules, and the
actions required when a plan participant no longer satisfies the
requirement to qualify for the top hat plan rules, the Treasury
Department and the IRS are not confident that an exception to the anti-
acceleration provisions based upon these rules is feasible.
Accordingly, the final regulations do not adopt this suggestion.
G. Settlements of Bona Fide Disputes Regarding the Right to a Payment
Commentators requested relief for certain payments made as a
settlement of a dispute as to a service provider's right to a deferred
amount. For example, assume that a plan provides for a payment of
deferred compensation upon a termination of an employee's employment
other than for cause and the employee and employer have a bona fide
dispute as to whether the employee was terminated for cause, and thus
whether the service provider is entitled to any payment under the plan.
The final regulations provide that payments may be accelerated,
including acceleration to payment as a lump sum, where the right to
such payments arises as part of a settlement between the service
provider and the service recipient of a bona fide dispute as to the
service provider's right to the deferred amount. The provision applies
only to a deferred amount, the right to which is the subject of an
arm's length settlement of a bona fide dispute between the service
provider and the service recipient, and only to the portion of the
deferred amount that is the subject of the bona fide dispute. The
provision does not apply to disputes that relate only to when (and not
whether) a payment is due. Whether a payment qualifies for the
exception is based on the particular facts and circumstances. A payment
will be presumed not to meet this exception unless the payment is
subject to a substantial reduction in the value of the payment made in
relation to the amount that would have been payable had there been no
dispute as to the service provider's right to the payment. For this
purpose, a reduction that is less than 25 percent of the present value
of the deferred amount in dispute generally is not a substantial
reduction. In addition, a payment will be presumed not to meet this
exception if the payment is made proximate to a downturn in the
financial health of the service recipient.
H. Cashout Rules
Commentators requested various modifications to the cashout rules
generally expanding the conditions under which a service recipient may
exercise discretion to cash out a service provider's entire amount
deferred under a plan. The final regulations generally provide that a
service recipient may exercise such discretion at any time that a
service provider's amount deferred under the plan is less than the
applicable dollar amount under section 402(g)(1)(B) for that calendar
year. For this purpose, the plan aggregation rules apply, so a service
recipient may not use this rule to cash out an amount under one
arrangement but not another arrangement where the two arrangements
would be treated as one plan. The final regulations, unlike the
proposed regulations, do not require that a service provider have
separated from service for the service recipient to cash out the amount
deferred. In addition, the plan does not need to be amended to provide
this discretion to the service recipient. Finally, the amount has been
changed from $10,000 to the limit on elective deferrals under section
402(g) to permit the amount to be adjusted for changes in the cost of
living.
The final regulations also provide that a plan under which amounts
are to be paid in installments may provide for immediate payment of all
remaining installments if the present value of the deferred amount to
be paid in the remaining installments falls below a predetermined
amount, and such immediate payment will not constitute an accelerated
payment for purposes of Sec. 1.409A-3(j)(1), provided that such
feature (including the predetermined amount) is established no later
than the latest time at which the time and form of payment is otherwise
required to be established, and provided further that any change in
such feature including the predetermined amount must comply with the
requirements for a change in the time and form of payment.
I. Other Acceleration Issues
Commentators requested that a service recipient be permitted to
cancel a service provider's deferral elections in two situations.
First, commentators asked that such a cancellation be allowed when the
service provider is transferred to a position that is not eligible to
participate in the plan. The Treasury Department and the IRS are not
confident that a standard can be established that would clearly
distinguish a bona fide transfer to an ineligible position from a pro
forma transfer designed to avoid the prohibition on accelerated
payments, especially when the underlying plan is specific to the
service provider, as in the case of an individual employment agreement,
and accordingly the final regulations do not adopt this suggestion.
Second, commentators asked that a service provider's deferral election
be cancelled if the service provider becomes disabled. The final
regulations permit the cancellation of the service provider's deferral
election due to a disability, provided that for this purpose a
disability is defined as any medically determinable physical or mental
[[Page 19269]]
impairment resulting in the service provider's inability to perform the
duties of his or her position or any substantially similar position,
where such impairment can be expected to result in death or can be
expected to last for a continuous period of not less than six months.
IX. Subsequent Changes in the Time and Form of Payment
A. In General
The final regulations clarify that the rules governing changes in
the time and form of payment apply both to service providers and
service recipients. Accordingly, a service provider, a service
recipient, or both a service provider and a service recipient may have
and exercise discretion to defer a deferred compensation payment after
the time and form of payment have been specified, provided that such
discretion is limited to changes that comply with the requirements of
these regulations addressing subsequent changes in the time and form of
payment.
B. Annuities
Many commentators requested clarification and expansion of the
rules that allow taxpayers to treat actuarially equivalent life
annuities as one form of payment, thereby allowing elections among such
annuity forms at any time before the initial annuity payment without
regard to the rules on subsequent deferral elections. The final
regulations clarify the circumstances under which two actuarially
equivalent life annuities may be treated as one form of payment.
The final regulations generally provide that certain specified
features are ignored for purposes of determining whether a particular
annuity is treated as a life annuity for purposes of the form of
payment rules (but not for purposes of determining whether a life
annuity with such a feature is actuarially equivalent to a life annuity
without such a feature). The specified features include: (1) Term
certain features (under which annuity payments continue for the longer
of the life of the annuitant or a fixed period of time); (2) pop-up
provisions (under which payments increase upon the death of the
beneficiary or another event that eliminates the right to a survivor
annuity); (3) cash refund features (under which payment is provided
upon the death of the last annuitant in an amount that is not greater
than the excess of the present value of the annuity at the annuity
starting date over the total of payments before the death of the last
annuitant); (4) Social Security or Railroad Retirement leveling
features (including leveling features related to early retirement,
survivor or disability benefits); and (5) features applying a
permissible cost-of-living index. Accordingly, a life annuity with any
of the specified features may be treated as a life annuity without
regard to the fact that the features cause the annuity to fail to
satisfy the general definition for life annuities, for example, because
the periodic payments are not substantially equal. However, the life
annuity with such a feature may only be treated as the same form of
payment as a life annuity without such a feature if the two life
annuities are actuarially equivalent (taking into account the feature)
and have the same initial payment date.
Commentators also raised issues concerning the availability of
subsidized joint and survivor annuities. The final regulations provide
that for purposes of the definition of a time and form of payment, a
subsidized joint and survivor annuity is treated as actuarially
equivalent to a single life annuity provided that, neither the annual
lifetime annuity benefit nor the annual survivor benefit available
under the joint and survivor annuity is greater than the annual
lifetime annuity benefit available under the single life annuity. For
example, a single life annuity providing $100 a month for the lifetime
of the service provider may be treated as actuarially equivalent to a
joint and survivor annuity providing up to $100 a month for the
lifetime of the service provider and up to $100 a month to the
surviving joint annuitant.
Commentators asked whether the actuarial assumptions and methods
used to determine actuarial equivalency must be applied consistently.
The final regulations clarify that in determining whether two life
annuities are actuarially equivalent, the same actuarial assumptions
and methods must be used in valuing each life annuity. This requirement
applies over the entire term of the service provider's participation in
the plan, such that the annuities must be actuarially equivalent at all
times for the annuity options to be treated as one time and form of
payment. However, provided the actuarial methods and assumptions are
reasonable, there is no requirement that consistent actuarial
assumptions and methods be used over the term of the service provider's
participation in the plan. Accordingly, the plan may change the
actuarial assumptions and methods used to determine the life annuity
payments, provided that all of the actuarial assumptions and methods
are reasonable. In addition, there is no requirement that the actuarial
assumptions and methods used under a nonqualified deferred compensation
plan be the same as those used in a qualified plan sponsored by the
service recipient.
C. Application to Multiple Payment Events
The final regulations continue to provide that the subsequent
deferral and anti-acceleration rules generally will apply to the
addition or deletion of a permissible payment event. Commentators asked
for clarification of how these rules apply.
The Treasury Department and the IRS believe that a failure to
provide for a payment event at death, disability or an unforeseeable
emergency generally will result from oversight, and that the addition
of such a provision generally would not be abusive. Accordingly, the
final regulations provide that the addition of death, disability, or an
unforeseeable emergency as a potentially earlier payment event is a
permissible acceleration. This provision does not apply to the addition
of death, disability, or an unforeseeable emergency as a potentially
later payment event, such as through the addition of death as a payment
event to a plan providing for a payment of deferred compensation on a
fixed date, so that after the change the payment would be due on the
later of the fixed date or death. Nor, for example, would it apply to
an amendment of a plan to substitute a service provider's death as a
new payment event, instead of a fixed payment date. In those cases, the
rules governing subsequent deferral elections apply. In addition, the
substitution of death as a payment event for an amount that is deferred
compensation will not cause the plan to be treated as a death benefit
plan not subject to section 409A, but the substitution or addition of a
payment event other than death as a payment event in a death benefit
plan may result in the plan being treated as providing for deferred
compensation.
The anti-acceleration provisions apply to the addition of a
specified date or fixed schedule, a change in control event, or
separation from service as a potentially earlier payment event,
including the substitution of one of these payment events for another
payment event. In addition, the anti-acceleration provisions apply
where a payment event is removed from a plan term requiring payment
upon the latest of two or more payment events. The provisions governing
subsequent deferral elections apply to all changes in the time and form
of payment, whether resulting from the addition, deletion or
substitution of another payment event.
[[Page 19270]]
Commentators requested clarification of how this provision would apply
where the events were not specified dates, such as the substitution of
a change in control payment event for a separation from service event.
In such a situation, to satisfy the rules governing subsequent
deferrals, this substitution would only be permissible if the change
were not effective for one year, and provided that the payment would
only occur upon the later of a change in control event or at least five
years following a separation from service.
D. Application to Domestic Relations Orders
The final regulations provide that the rules governing changes in
the time and form of payment do not apply to changes in the time and
form of payment under the terms of a domestic relations order, to the
extent the change in the time and form of payment applies to a payment
that will be made to the alternate payee and not the service provider.
Accordingly, for example, a domestic relations order generally may
provide for a new time and form of payment to a spouse or former spouse
of the service provider, or provide such spouse or former spouse
discretion to determine the time and form of payment to such spouse or
former spouse.
X. Application to Nonqualified Deferred Compensation Plans Linked to
Qualified Plans and Other Arrangements
A. Plans Linked to Qualified Plans and Certain Broad-Based Foreign
Retirement Plans
The final regulations generally adopt the relief provided in the
proposed regulations with respect to the election-timing and the anti-
acceleration rules for changes in the amount of benefits under a
nonqualified deferred compensation plan that result from an election
(or failure to elect) by a service provider, or an amendment by a
service recipient, in respect of a subsidized or ancillary benefit
under a qualified plan. In response to comments, this relief is
similarly extended to certain broad-based foreign retirement plans. In
addition, this relief is extended for benefit formulas that include a
reduction for amounts credited to the service provider's account under
a tax-qualified plan (which may include matching contributions) or
certain broad-based foreign retirement plans that provide benefits
expressed as an account balance.
In response to comments, the final regulations also clarify that
the linked plan relief provided for elective deferrals (including
designated Roth contributions) and matching type contributions, each up
to the section 402(g) dollar limit on elective deferrals, are separate,
additive limits and are not a single, coordinated limit. In addition,
the final regulations clarify that the section 402(g) dollar limits are
increased by the limit on catch-up contributions under section 414(v)
for any year in which the service provider qualifies for such increase.
Commentators raised issues concerning other types of plans under
which a service provider must participate in a qualified plan to
receive nonqualified deferred compensation. Specifically, commentators
asked whether a plan could comply with section 409A if it provided that
an employee must defer the maximum amount permissible under a qualified
plan in order to defer any amount under a nonqualified deferred
compensation plan. Where the service provider can change the service
provider's election to defer the maximum amount permissible under the
qualified plan during the taxable year, and thereby change or
discontinue deferrals under a nonqualified deferred compensation plan,
the service provider can effectively make a late election to defer (or
not defer) amounts under the nonqualified plan. The final regulations
generally do not provide any additional relief with respect to this
type of plan. However, where the additional amounts deferred under the
nonqualified deferred compensation plan reflect only matching
contributions that would be available under the qualified plan absent
the restrictions in the qualified plan intended to reflect limits on
qualified plan contributions under sections 401(m) and 401(a)(17), the
final regulations provide relief but solely with respect to the
matching amount that could have been contributed to the qualified plan
absent such limits.
Commentators also stated that the rules in the proposed regulations
did not adequately address the impact of after-tax contributions.
Specifically, commentators requested relief for service providers who
change their after-tax contributions (other than designated Roth
contributions) under a qualified plan during a year where such decrease
causes a corresponding change in nonqualified plan elective deferrals.
The final regulations provide some additional relief concerning
matching or other contributions contingent upon the making of an after-
tax contribution. However, other suggestions were not adopted in the
final regulations, because the Treasury Department and the IRS are
concerned that such plans may give the service provider excessive
control over amounts deferred under a nonqualified deferred
compensation plan, contrary to the statutory intent.
B. Plans Linked to Cafeteria Plans
Commentators expressed concern that changes to elections under a
section 125 cafeteria plan could change the amount of eligible
compensation used for purposes of a benefit formula under a
nonqualified deferred compensation plan and thereby create an
impermissible deferral election or acceleration of payment under the
nonqualified deferred compensation plan. The final regulations provide
relief from the deferral election-timing and anti-acceleration rules
for changes to section 125 elections properly made in accordance with
the rules under section 125, to the extent that the change in the
amount deferred under the nonqualified deferred compensation plan
results solely from the application of the change in amount of eligible
compensation resulting from the election change under the cafeteria
plan to a benefit formula based upon the service provider's eligible
compensation, and only to the extent that such change applies in the
same manner as any other increase or decrease in the eligible
compensation would apply to such benefit formula.
C. Offsets
i. In General
Some commentators requested clarification whether an arrangement
under which a specified amount paid by a service recipient to a service
provider reduces or offsets an amount that is payable to the service
provider under a nonqualified deferred compensation plan will be
treated as providing for an acceleration of a payment under the
nonqualified deferred compensation plan. As an example, one commentator
stated that a plan may require that any payout at separation from
service of accrued leave that is determined to be in excess of the
correct amount of such payment will be deducted from the amount due
under a nonqualified deferred compensation plan, rather than repaid
separately by the service provider. One commentator suggested that
offsets be permitted for all service provider debts of a kind and in
amounts customarily incurred in the ordinary course of the business
relationship between the service provider and the service recipient.
The Treasury Department and the IRS believe that the unfettered
discretion to settle debts between a service recipient and a service
provider through offsets from payments of nonqualified deferred
[[Page 19271]]
compensation is not consistent with the intent of the statute, because
it creates opportunities to disguise accelerated payments of deferred
compensation. Accordingly, amounts that currently or in the future may
be offset against nonqualified deferred compensation are treated as
payments of deferred compensation and may violate the anti-acceleration
rules under section 409A. See section VIII.A of this preamble. However,
the Treasury Department and the IRS agree that the ability to offset
small routine debts against amounts payable under a nonqualified
deferred compensation plan is useful so that service recipients can
avoid the administrative burden involved in paying deferred
compensation amounts to a service provider while at the same time
attempting to collect small amounts owed by the same service provider.
Accordingly, the final regulations provide that payments of deferred
compensation may be offset by amounts owed to the service recipient by
the service provider, where such debt is incurred in the ordinary
course of the service relationship, to the extent the entire offset in
any taxable year does not exceed $5,000 and the offset is taken at the
same time and in the same amount as the debt otherwise would have been
due from the service provider.
ii. Social Security Benefits and Disability Benefits
Commentators requested clarification of the treatment of
nonqualified deferred compensation plans that offset benefits with
payments received as Social Security benefits and disability benefits.
A plan provision providing for a direct, dollar-for-dollar reduction of
payments due under a nonqualified deferred compensation plan by the
amount of payments received or receivable as Social Security benefits
will not fail to provide for a fixed schedule of payments. However, the
rule relates solely to direct reductions in deferred compensation
benefits to reflect eligibility for, or payment of, Social Security
benefits, and does not permit other changes in the time and form of
benefit based upon a service provider's eligibility or elections
related to Social Security benefits. A reduction in a nonqualified
deferred compensation plan benefit equal to the amount receivable under
a service recipient sponsored disability plan generally will be treated
similarly, provided that a substantial number of service providers
participate in the disability plan. However, to allow the payment
schedule to qualify as a fixed schedule, the disability plan must be
established before the date the service provider becomes disabled. In
addition, any subsequent amendment to the disability plan or other
change in the benefit payable under the disability plan may result in
an acceleration of a payment or a subsequent deferral under the
nonqualified deferred compensation plan unless the facts and
circumstances establish otherwise (for example, because the amendment
or change results from actions taken by an independent third party,
such as an unrelated insurer that issued a disability insurance policy
for such disability plan, over which the service recipient and service
provider have no control, or an action of the service recipient with
respect to the disability plan that is generally applicable to a
substantial number of other service providers who participate in such
disability plan and has a material effect on the disability benefits of
such other service providers).
XI. Statutory Effective Dates
A. Effective Dates--Earned and Vested Amounts
As provided in section 885(d) of the American Jobs Creation Act of
2004, section 409A generally is effective for amounts deferred after
December 31, 2004. The final regulations adopt the definition set forth
in the proposed regulations of an amount deferred on or before December
31, 2004, for purposes of the effective date, subject to the
modifications described in this preamble. The final regulations clarify
that the grandfathered amount includes any account balance that is
earned and vested, as well as the present value of any earned and
vested right to future account credits, even if such amounts had not
been credited to the account as of December 31, 2004. For example, if a
service provider had a vested right on December 31, 2004, to have a
bonus amount added to the service provider's account balance in a
nonqualified deferred compensation plan, the service provider's
grandfathered amount would include the amount of such bonus even though
such amount was not calculated and credited to the account until some
time in 2005.
B. Effective Dates--Calculation of Grandfathered Amount
One commentator requested that the grandfathered amount in a
nonaccount balance plan be expressed in terms of the form of benefit
under the plan. So, for example, where the normal benefit was expressed
in the form of an annuity payable at a certain age, that is how the
amount of the grandfathered benefit would also be expressed. The final
regulations do not adopt this suggestion, but reach a similar result by
providing that any actuarial assumptions and methods that were
reasonable to use as of December 31, 2004, may continue to be used in
subsequent years for purposes of determining the grandfathered amount.
C. Material Modifications
Section 885(d)(2) of the American Jobs Creation Act of 2004
provides generally that amounts deferred in taxable years beginning
before January 1, 2005, are treated as amounts deferred in a taxable
year beginning on or after such date if the plan under which the
deferral is made is materially modified after October 3, 2004. The
final regulations adopt the definition set forth in the proposed
regulations of a material modification for these purposes, subject to
the changes described in this preamble.
For purposes of the definition of a material modification under the
effective date rules, the final regulations incorporate the exclusions
from the definition of a modification for purposes of the rules
governing stock rights. For example, a change to a discounted
grandfathered stock right that could be covered by section 409A if
materially modified under the effective date rules, will not be treated
as materially modified and subject to section 409A if the change would
not be treated under the rules governing stock rights as a modification
resulting in treatment as a new grant of a stock right or an extension
resulting in treatment of the stock right as having had a deferral
feature from the date of grant.
The final regulations provide that neither the amendment of a plan
to include a provision allowing for a payment to a person other than
the service provider due to the application of a domestic relations
order, nor the making of a payment in compliance with a domestic
relations order where a plan did not address the ability to make such a
payment, is treated as a material modification for purposes of the
grandfathering rules.
Commentators also requested that a grandfathered plan be permitted
to remove a provision requiring a cancellation of deferrals for a
prescribed period of time under all nonqualified deferred compensation
plans to receive a distribution from the grandfathered plan, without
resulting in a material modification. Commentators argued that because
the enforcement of such a provision by cancelling a current deferral
election generally would result in an immediate violation of section
409A, the inability to remove the requirement that the deferral
election be
[[Page 19272]]
cancelled effectively nullifies the grandfathered right. Under the
final regulations, an amendment to a grandfathered plan that changes
such a provision to require a cancellation of deferrals for the
equivalent period of time beginning with the first possible date that
such a cancellation would not result in a prohibited accelerated
payment (generally the beginning of the subsequent calendar year for a
service provider with a calendar year taxable year) will not constitute
a material modification. For example, taxpayers may amend an early
distribution provision that requires the immediate cessation of
deferrals for 12 months to apply only to deferrals over the first 12
month period with respect to which the service provider can make a
timely deferral election, for example, by prohibiting deferrals of
compensation attributable to services performed during the service
provider's next taxable year.
Commentators requested clarification of the effect of a material
modification of a plan. The specific consequences of a material
modification of a plan are being considered as part of the anticipated
guidance related to income inclusion and calculation. However, the
final regulations provide that for amounts deferred in taxable years
beginning before January 1, 2005, under a plan that is materially
modified after October 3, 2004, whether the plan complies with the
requirements of section 409A is determined by reference to the terms of
the plan in effect, and any actions taken under the plan, on and after
the date of the material modification. Accordingly, where the
materially modified plan is compliant with section 409A and these
regulations immediately following the material modification, the
material modification generally will not itself result in a violation.
XII. Effective Date of Final Regulations
A. Existing Transition Relief
Nothing in this preamble or the final regulations is intended to
restrict the otherwise applicable transition relief. For a description
of the applicable transition relief, see Notice 2006-79, 2006-43 IRB
763 (extension of certain transition relief through 2007), Notice 2006-
64, 2006-29 IRB 88 (transition relief applicable to certain accelerated
payments necessary to comply with Federal ethics requirements), Notice
2006-33, 2006-15 IRB 754 (transition rules with respect to section
409A(b)), Notice 2006-4, 2006-3 IRB 307 (transition relief with respect
to the valuation standards applicable to stock rights issued on or
before the effective date of the final regulations for purposes of the
exclusion from coverage under section 409A for certain stock rights),
the preamble to the proposed regulations (extension of certain
transition relief through 2006), and Notice 2005-1, 2005-1 CB 274
(initial transition relief). See Sec. 601.601(d)(2).
B. Application of Final Regulations
The final regulations are generally effective January 1, 2008. For
periods before January 1, 2008, the standards and transition rules set
forth in Notice 2006-79 continue to apply. For further information
regarding the transition relief for periods before the effective date
of the final regulations, see Notice 2006-79 and section XI of the
preamble to the proposed regulations.
Commentators requested clarification of the impact of the final
regulations becoming effective January 1, 2008, on plans that continue
to defer compensation on or after January 1, 2008. Specifically,
commentators asked whether actions taken with respect to nonqualified
deferred compensation plans that would not have resulted in income
inclusion under section 409A before 2008 because such actions were
consistent with applicable guidance, but would not be consistent with
the final regulations, would need to be modified to avoid income
inclusion under section 409A in 2008 and later years. The following
sections discuss the effect of the final regulations with respect to
the requirements necessary to comply with section 409A, including the
various requirements necessary for a plan to be excluded from coverage
under section 409A.
C. Stock Rights
Many of the comments related to stock options and stock
appreciation rights. Some commentators requested that section 409A not
apply to any stock rights issued before the effective date of the final
regulations. Neither the statute nor the legislative history indicates
an intent for such a broad exception. The Treasury Department and the
IRS understand that certain aspects of the guidance on stock rights
have changed. However, the final regulations generally expand the
exclusion from coverage under section 409A for certain stock rights to
eliminate many issues raised by the proposed regulations. In addition,
with respect to certain types of stock rights, such as discounted stock
options, the guidance has explicitly and consistently indicated that
either rights that would be excluded from coverage under section 409A
must be substituted for such rights or such rights must be modified to
comply with section 409A. Accordingly, the final regulations do not
adopt a categorical exclusion from coverage under section 409A of all
stock rights issued before the issuance of the final regulations.
Commentators also asked whether a stock option must be repriced to
avoid coverage under section 409A if the exercise price would be
treated as having been set at fair market value under section 409A
under the applicable guidance, but would not be treated as having been
set at fair market value if the standard of the final regulations had
been applicable. For this purpose, the guidance provided in Notice
2006-4, 2006-3 IRB 307, see Sec. 601.601(d)(2), remains in effect.
Notice 2006-4 provided certain standards applicable to stock rights
issued before January 1, 2005, for determining whether the exercise
price of such stock right would be treated as having been set at fair
market value for purposes of the exclusion from coverage under section
409A for certain stock rights. As provided in Notice 2006-4, for stock
rights issued before January 1, 2005, the standards applicable to
incentive stock options under section 422 are applicable. Generally
this means that where the sole reason the stock right would fail to
qualify for the exclusion from coverage under section 409A is due to
the exercise price not being set at or above fair market value, the
exercise price will be treated as set at or above fair market value if
based upon a good faith attempt by the issuer to set the exercise price
at or above fair market value. As further explained in Notice 2006-4,
for stock rights issued on or after January 1, 2005, but before January
1, 2008, the provisions of Notice 2005-1 will apply, generally
requiring that fair market value for purposes of setting the exercise
price of a stock right must be determined using a reasonable valuation
method. In addition, for stock rights issued on any date before January
1, 2008, taxpayers may rely upon the provisions of the proposed or
final regulations with regard to the determination of the fair market
value of the underlying stock.
Commentators requested that taxpayers not be required to bring
stock rights granted before January 1, 2008, into compliance with
section 409A if such rights were properly treated as not being subject
to section 409A under the applicable guidance, but instead be permitted
to keep such rights outstanding and unmodified.
The final regulations significantly expand the permissible classes
of stock and the permissible issuers of stock under the service
recipient stock rule,
[[Page 19273]]
and taxpayers may rely on the final regulations for periods before the
effective date of the final regulations. In addition, with respect to
stock rights issued before April 10, 2007 on stock that would have
constituted service recipient stock under a reasonable good faith
interpretation of the statute and applicable guidance, but would not
constitute service recipient stock under the final regulations, such
stock will continue to constitute service recipient stock for purposes
of applying section 409A to such stock right until the exercise or
termination of such right, or until the stock right is modified in a
manner that is treated as the grant of a new right. However, for a
stock right issued on or after April 10, 2007, stock subject to such
stock right will not be treated as service recipient stock after
December 31, 2007, unless such stock satisfies the requirements of the
final regulations, and if the stock does not satisfy these
requirements, such stock right will be required to be modified either
to be excluded from coverage under section 409A, or to comply with the
requirements of section 409A and these regulations.
Commentators also expressed concerns about modifications and
extensions of stock rights that occur before January 1, 2008. Different
concerns and arguments arise depending upon whether these modifications
and extensions occurred on or before the enactment of the statute
(October 23, 2004), on or before the issuance of Notice 2005-1
(December 20, 2004), on or before the issuance of the proposed
regulations (September 30, 2005) or on or before the effective date of
the final regulations (January 1, 2008). The final regulations
significantly expand the permissible types of modifications and
extensions that will not result in treatment of the stock right as a
new grant or as having had a deferral feature from the date of grant,
and taxpayers may rely on these regulations for periods before the
effective date of the regulations. In addition, any modifications or
extensions occurring before the enactment of the statute (October 23,
2004) will not be considered in determining whether the right is
excluded from coverage under section 409A. Finally, any extension
granted before April 10, 2007 solely in order to give the holder of a
stock right an additional period of time within which to exercise the
stock right beyond the time originally prescribed is disregarded for
purposes of the rules treating certain extensions as deferral features
from the time of grant. See Sec. 1.409A-1(b)(5)(v)(C).
D. Initial Deferral Elections
Commentators asked whether and to what extent the final regulations
would impact initial deferral elections made before the effective date
of the final regulations. If a deferral election made before January 1,
2008, was consistent with the proposed regulations or the applicable
transition guidance, the initial deferral election will be deemed to
comply with the provisions of section 409A, regardless of whether the
period of deferral extends beyond December 31, 2007.
In addition, commentators asked whether and to what extent the
final regulations would impact programs established before the
effective date of the final regulations, where initial deferral
elections have not been made by January 1, 2008. For example,
commentators asked how section 409A would apply if a service recipient
has interpreted a program as providing for performance-based
compensation and permitted deferral elections to occur in 2008 or later
in accordance with the rules governing deferrals of performance-based
compensation, but such compensation does not qualify as performance-
based compensation under the final regulations. For a program
established before April 10, 2007 that under a reasonable, good faith
interpretation of the statute and applicable guidance would have
permitted an initial deferral election to be made after December 31,
2007, and on or before December 31, 2008, an initial deferral election
will be deemed to comply with the initial deferral election rules if
made by the deadline established in the plan. For a program established
before April 10, 2007 that under a reasonable, good faith
interpretation of the statute and applicable guidance would have
permitted an initial deferral election to be made after December 31,
2008, an initial deferral election will be deemed to comply with the
initial deferral election rules if made by December 31, 2008.
E. Designation of Time and Form of Payment
Notice 2005-1 and the preamble to the proposed regulations
consistently provide that elections as to the time and form of payment
of deferred compensation would need to be compliant with the final
regulations by the time such regulations were effective. Both Notice
2005-1 and the preamble to the proposed regulations provide detailed
transition guidance, generally permitting service providers and service
recipients to change the time and form of payment at any time through
the end of the transition period. Accordingly, a payment scheme that
violates the provisions of the final regulations will need to be
brought into compliance with the final regulations in accordance with
the transition relief.
F. Service Providers in Pay Status
Commentators asked how the final regulations apply to service
providers that are already in pay status, where the payment trigger is
based upon a reasonable, good faith interpretation of the statute and
applicable guidance but is not in compliance with the final
regulations. This may occur where the service provider has already
begun receiving payments before January 1, 2008, or where all events
necessary to receive the payment have occurred before January 1, 2008.
For example, a service provider may have been treated as having
separated from service before January 1, 2008, under a reasonable, good
faith interpretation of the statute, but would not be treated as having
separated from service under the final regulations. Where payments have
commenced before January 1, 2008, the plan may continue to make such
payments consistent with the application of the plan terms at the time
the payments commenced, or may halt such payments on or before December
31, 2007, and amend the time and form of any remaining payments to
comply with the final regulations in accordance with the transition
guidance provided. Where payments have not commenced by January 1,
2008, but all the events necessary to receive the payment have
occurred, the plan may make payments in accordance with the application
of the plan terms on December 31, 2007, or may amend the time and form
of payments to comply with section 409A in accordance with the
transition guidance provided. Similarly, where payments have not
commenced on or before December 31, 2007, because the service provider
was treated as not having separated from service under a reasonable,
good faith interpretation, but under the final regulations the service
provider would be treated as having separated from service on or before
December 31, 2007, the plan must treat the service provider as having
separated from service on a date on or after April 10, 2007 and on or
before December 31, 2007. Nothing in this paragraph is to be construed
to permit the continuation of any payment schedule based upon an
application of section 409A on or before December 31, 2007, that failed
to meet the requirements of the applicable transition guidance. In
addition, nothing
[[Page 19274]]
in this paragraph is intended to waive the application of the
constructive receipt doctrine or section 451 with respect to any
discretion provided to the service provider (or former service
provider) with respect to the application of these provisions.
In addition, commentators asked how the final regulations would
apply in the case of the six-month delay for specified employees of
public corporations. Where a separation from service occurs on or
before December 31, 2007, under circumstances that under a reasonable,
good faith interpretation of the statute and applicable guidance would
not result in application of the six-month delay requirement for a
payment to a specified employee, the beginning or continuation of
payments of deferred compensation on or after January 1, 2008, will not
result in a violation of the six-month delay requirement for a payment
to a specified employee.
XIII. Additional Transition Relief
A. Collectively Bargained Plans
Consistent with Notice 2006-79, Sec. 3.05, the final regulations
provide that a nonqualified deferred compensation plan maintained
pursuant to one or more collective bargaining agreements in effect on
October 3, 2004, is not required to comply with the provisions of
section 409A on or before the earlier of the date on which the last of
such collective bargaining agreements terminates (determined without
regard to any extension of any agreement after October 3, 2004) or
December 31, 2009.
With respect to amounts deferred under a nonqualified deferred
compensation plan maintained pursuant to one or more collective
bargaining agreements in effect on October 3, 2004, the plan may
provide, or be amended to provide, for new payment elections with
respect to both the time and form of payment of such amounts, and the
election or amendment will not be treated as a change in the time or
form of payment under section 409A(a)(4) or an acceleration of a
payment under section 409A(a)(3), provided that the plan is so amended
and elections are made before the date on which section 409A first
applies to such plan. A deferral election may be made with respect to
an amount that is a short-term deferral within the meaning of Sec.
1.409A-1(b)(4), provided that the election is made before the date on
which section 409A would apply to an amount deferred under such plan
and before January 1 of the calendar year in which the amount would
otherwise have been paid.
B. Requirement To Amend Plans on or Before December 31, 2007
Where there have been deferrals of compensation under a plan as of
January 1, 2008 but the deferred compensation has not been paid, the
plan must be made compliant with section 409A on or before December 31,
2007, with respect to such deferred compensation. These amendments are
required only to bring the document into compliance effective January
1, 2008, and are not required to reflect any amendments made or actions
taken under the transition rules to the extent such amendments or
actions do not affect the plan's compliance with section 409A and these
regulations for periods on or after January 1, 2008. For example, if a
plan contains a haircut provision permitting an immediate distribution
contingent on the forfeiture of a certain portion of a deferred amount,
the haircut provision need not be removed retroactively for periods
before January 1, 2008, where the plan has been operated in compliance
with the applicable transition guidance (and thus no payment pursuant
to the haircut provision has been made after December 31, 2004). In
addition, a plan need not be amended to be made compliant with section
409A with respect to amounts deferred under the plan that were paid on
or before December 31, 2007, in compliance with the transition
guidance. However, the taxpayer must be able to demonstrate that the
plan was operated in compliance with the transition guidance, including
demonstrating that amounts were deferred or paid in compliance with the
transition rules. For example, where payments were made in conjunction
with elections of payment dates by either the service recipient or
service provider during the transition period, the taxpayer must be
able to demonstrate that the elections were provided and made in
accordance with the transition rules.
XIV. Calculation and Timing of Income Inclusion Amounts, Reporting and
Withholding
A. In General
These regulations do not address the calculation and timing of
amounts required to be included in income under section 409A(a). Nor do
these regulations address the reporting and withholding requirements
applicable to service recipients providing nonqualified deferred
compensation covered by section 409A. The Treasury Department and the
IRS intend to issue further guidance, including such transition
guidance as may be appropriate with respect to the reporting and
withholding requirements. See Notice 2006-100, 51 IRB 1109, for
transition rules applicable to the reporting and withholding
requirements for 2005 and 2006. See Sec. 601.601(d)(2).
B. Operational Violations During the Transition Period
Commentators on the proposed regulations and Notice 2006-100 asked
whether a service provider whose nonqualified deferred compensation
plan violated section 409A in operation before January 1, 2008, would
be required to include an amount in income under section 409A only in
the taxable year of the service provider in which the operational
failure occurred (assuming this was the only year of an operational
failure), or in such year and all prior years beginning after December
31, 2004. Commentators argued that for years before the operational
violation, the taxpayer could be treated as operating the plan in
reasonable, good faith compliance with the statute and Notice 2005-1,
and therefore should be required to include an amount in income under
section 409A only for the year in which the operational violation
occurred. For example, where a taxpayer exercised a discounted stock
option covered by section 409A in 2006, commentators argued that the
taxpayer should be treated as operating the plan in reasonable, good
faith compliance with section 409A during 2005, so that the taxpayer
would be required to include an amount in income as a result of the
section 409A violation only to 2006.
Where an operational failure occurs in 2006 or 2007, and no
operational failures occurred in any prior year, the taxpayer
(including the service recipient) may report the amounts required to be
included in income under section 409A as taxable income only in the
year of the operational failure. In addition, where the violation
results from a payment, a taxpayer may include the required amount in
income only for the year in which such violation occurs, regardless of
whether the portion of the deferred compensation plan under which such
payment was made is ever amended to comply with the requirements of
section 409A for periods before such payment. For example, where a
taxpayer exercises a discounted stock option subject to section 409A in
2006, and there was no operational violation in 2005, the taxpayer may
include an amount in income under section 409A for 2006, and the
taxpayer will not be required to include an amount in income with
respect to such stock option for 2005,
[[Page 19275]]
even if the taxpayer does not amend the stock option to comply with
section 409A for 2005. However, where all or part of the total amount
deferred in the year of the violation was also an amount deferred in
one or more prior years that was not subject to a substantial risk of
forfeiture in such year, taxpayers are also required to calculate and
pay any applicable tax under section 409A(a)(1)(B)(i)(I) (based on the
amount of interest determined under section 409A(a)(1)(B)(ii)). For
example, if the discounted stock right in the previous example was not
subject to a substantial risk of forfeiture as of December 31, 2005,
the taxpayer would be required to compute and report the additional tax
under section 409A(a)(1)(B)(i)(I) on the taxpayer's 2006 return. For
purposes of this paragraph, the service recipient should treat the
application of section 409A in the same manner for purposes of income
tax withholding and reporting obligations.
C. Application of Plan Aggregation Rules During the Transition Period
Notice 2006-100 provides that where there is a required income
inclusion under section 409A in 2006, the plan aggregation rules apply
in determining the amount includible in income. Commentators asked
whether the plan aggregation rules would apply where the taxpayer
violates section 409A in 2006 with respect to one arrangement (the
first arrangement), but retains the right to modify another arrangement
(the second arrangement) to exclude a right to an amount provided under
the second arrangement from coverage under section 409A, where the
second arrangement would otherwise be aggregated with the first
arrangement. For this purpose, if the legally binding right to the
amount under the second arrangement ultimately is modified (including,
where permitted by applicable guidance, by the substitution of another
right for such right), so that the right to the amount is excluded from
coverage under section 409A, then the right to the amount is treated as
always having been excluded from coverage under section 409A.
Accordingly, the amount payable under the second arrangement would not
be required to be aggregated with the first arrangement for purposes of
determining the amount includible in income under section 409A.
However, if the right to the amount under the second arrangement is not
timely modified to be excluded from coverage under section 409A, the
right to the amount under the second arrangement will remain subject to
the plan aggregation rules regardless of whether the second arrangement
is, or is amended to be, compliant with the requirements of section
409A. In such a case, because the right to the amount under the second
arrangement could have been modified to be excluded from coverage under
section 409A, and would not have been subject to the plan aggregation
rules, the violation with respect to the second arrangement is not
treated as occurring until the first taxable year of the service
provider during which the arrangement could not have been so modified.
For example, assume a taxpayer with a calendar year taxable year
exercised a discounted stock right during 2006 in violation of section
409A and that the taxpayer held another unexercised discounted stock
right described in Notice 2006-79, Sec. 3.07 (relating to certain
stock rights issued to corporate insiders) that could have been
modified by December 31, 2006, to be excluded from coverage (by
exchanging such stock right for another stock right pursuant to the
preamble to the proposed regulations). If the unexercised stock right
was not so modified by December 31, 2006, it would violate section 409A
on January 1, 2007. Alternatively, assume a second taxpayer exercised a
discounted stock right in 2006 in violation of section 409A and that
taxpayer held another unexercised discounted stock right (not described
in Notice 2006-79, Sec. 3.07) that could have been modified by
December 31, 2007, to be excluded from coverage. If the second taxpayer
failed to timely modify such unexercised stock right, the unexercised
stock right would violate section 409A on January 1, 2008.
D. Failures to Amend During the Transition Period to Comply With the
Rules of Section 409A
Commentators asked how section 409A and these regulations would
apply to a plan that was operated in compliance with the transition
guidance through December 31, 2007, but is not amended to become
compliant with section 409A and these regulations by December 31, 2007.
For these purposes, the plan will be treated as failing to comply with
the requirements of section 409A and these regulations as of January 1,
2008, so that no amounts will be required to be included in income
under section 409A with respect to such a violation for any taxable
year ending before January 1, 2008. However, this does not affect the
application of the tax imposed by section 409A(a)(1)(B)(i)(I) to
amounts that were deferred in taxable years ending before January 1,
2008, to the extent that such amounts were not subject to a substantial
risk of forfeiture in one or more of such earlier taxable years.
XV. Offshore Trusts and Arrangements With Financial Triggers
These regulations do not address the application of section
409A(b), generally prohibiting the use of offshore trusts associated
with nonqualified deferred compensation plans, and the use of triggers
whereby amounts held in a trust or other arrangement become restricted
to the use for payment of nonqualified deferred compensation upon an
event related to the financial health of the service recipient. For
transition guidance related to the application of section 409A(b) to
certain outstanding arrangements, see Notice 2006-33, 2006-15 IRB 754.
See Sec. 601.601(d)(2). Taxpayers may continue to rely upon Notice
2006-33 until further guidance is issued.
Applicability Date
These regulations are applicable for taxable years beginning on or
after January 1, 2008. Taxpayers may relay on the provisions of these
final regulations for taxable years beginning before January 1, 2008.
Effect on Other Documents
Notice 2005-1, 2005-1 CB 274, is obsoleted for taxable years
beginning on or after January 1, 2008, except for the following
sections of the guidance which remain effective as modified by any
other applicable guidance: Q&A-6 (application to arrangements covered
by section 457); Q&A-7 (application to arrangements between a
partnership and a partner of the partnership); and Q&A-24 through Q&A-
38 (information reporting and withholding guidance). For a discussion
of the effect of reliance upon Notice 2005-1 or the proposed
regulations for taxable years beginning before January 1, 2008, for
arrangements continuing into taxable years beginning on or after
January 1, 2008, see section XII of this preamble. See Sec.
601.601(d)(2).
Notice 2006-4, 2006-3 IRB 307, addressing certain stock rights
issued before January 1, 2008, is superseded by these final regulations
with respect to stock rights issued in taxable years of the service
provider beginning on or after January 1, 2008. For a discussion of the
effect of reliance upon Notice 2005-1, Notice 2006-4, or the proposed
regulations for taxable years beginning before January 1, 2008, for
stock rights remaining outstanding on or after January 1, 2008, see
section XII of this preamble.
Notice 2006-33, 2006-15 IRB 754, Notice 2006-79, 2006-43 IRB 763,
and Notice 2006-100, 2006-51 IRB 1109, are
[[Page 19276]]
not affected by these final regulations. Notice 2006-64, 2006-29 IRB
88, is superseded by the final regulations effective for taxable years
of a service provider beginning on or after January 1, 2008. See Sec.
601.601(d)(2).
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because the
regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Drafting Information
The principal author of these regulations is Stephen Tackney of the
Office of Division Counsel/Associate Chief Counsel (Tax Exempt and
Government Entities). However, other personnel from the IRS and the
Treasury Department participated in their development.
List of Subjects 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Sections 1.409A-0 through 1.409A-6 are added to read as
follows:
Sec. 1.409A-0 Table of contents.
This section lists captions contained in Sec. Sec. 1.409A-1,
1.409A-2, 1.409A-3, 1.409A-4, 1.409A-5 and 1.409A-6.
Sec. 1.409A-1 Definitions and covered plans.
(a) Nonqualified deferred compensation plan.
(1) In general.
(2) Qualified employer plans.
(3) Certain foreign plans.
(i) Participation addressed by treaty.
(ii) Participation by nonresident aliens, certain resident aliens,
and bona fide residents of possessions.
(iii) Participation by U.S. citizens and lawful permanent residents.
(iv) Plans subject to a totalization agreement and similar plans.
(v) Broad-based foreign retirement plan.
(4) Section 457 plans.
(5) Certain welfare benefits.
(b) Deferral of compensation
(1) In general.
(2) Earnings.
(3) Compensation payable pursuant to the service recipient's
customary payment timing arrangement.
(4) Short-term deferrals.
(i) In general.
(ii) Certain delayed payments.
(iii) Examples.
(5) Stock options, stock appreciation rights, and other equity-based
compensation.
(i) Stock rights.
(A) Nonstatutory stock options not providing for the deferral of
compensation.
(B) Stock appreciation rights not providing for the deferral of
compensation.
(C) Stock rights that may provide for the deferral of compensation.
(D) Feature for the deferral of compensation.
(E) Rights to dividends.
(ii) Statutory stock options.
(iii) Service recipient stock.
(A) In general.
(B) American depositary receipts.
(C) Mutual company units.
(D) Other entities.
(E) Eligible issuer of service recipient stock.
(1) In general.
(2) Investment vehicles.
(3) Corporate structures established or transactions undertaken for
purposes of avoiding coverage under section 409A.
(4) Substitutions and assumptions by reason of a corporate
transaction.
(iv) Determination of the fair market value of service recipient
stock.
(A) Stock readily tradable on an established securities market.
(B) Stock not readily tradable on an established securities market.
(1) In general.
(2) Presumption of reasonableness.
(3) Use of alternative methods.
(v) Modifications, extensions, substitutions, and assumptions of
stock rights.
(A) Treatment of modified and extended stock rights.
(B) Modification in general.
(C) Extensions.
(1) In general.
(2) Certain extensions before April 10, 2007.
(3) Examples.
(D) Substitutions and assumptions of stock rights by reason of a
corporate transaction.
(E) Acceleration of date when exercisable.
(F) Discretionary added benefits.
(G) Change in underlying stock increasing value.
(H) Change in the number of shares purchasable.
(I) Rescission of changes.
(J) Successive modifications and extensions.
(K) Modifications and extensions in effect on October 23, 2004.
(vi) Meaning and use of certain terms.
(A) Option.
(B) Date of grant of option.
(C) Stock.
(D) Exercise price.
(E) Exercise.
(F) Transfer.
(G) Readily tradable.
(H) Application to stock appreciation rights.
(6) Restricted property, section 402(b) trusts, and section 403(c)
annuities.
(i) In general.
(ii) Promises to transfer property.
(7) Arrangements between partnerships and partners. [Reserved]
(8) Certain foreign plans.
(i) Plans with respect to compensation covered by treaty or other
international agreement.
(ii) Plans with respect to certain other compensation.
(iii) Tax equalization agreements.
(iv) Certain limited deferrals of a nonresident alien.
(v) Additional foreign plans.
(vi) Earnings.
(9) Separation pay plans.
(i) In general.
(ii) Collectively bargained separation pay plans.
(iii) Separation pay due to involuntary separation from service or
participation in a window program.
(iv) Foreign separation pay plans.
(v) Reimbursements and certain other separation payments.
(A) In general.
(B) Medical benefits.
(C) In-kind benefits and direct service recipient payments.
(D) Limited payments.
(E) Limited period of time.
(vi) Window programs--definition.
(10) Certain indemnification and liability insurance plans.
(11) Legal settlements.
(12) Certain educational benefits.
(c) Plan.
(1) In general.
(2) Plan aggregation rules.
(i) In general.
(ii) Dual status.
(3) Establishment of plan.
(i) In general.
(ii) Initial deferral election provisions.
(iii) Subsequent deferral election provisions.
(iv) Payment accelerations.
(v) Six-month delay for specified employees.
(vi) Plan amendments.
(vii) Transition rule for written plan requirement.
(viii) Plan aggregation rules.
(d) Substantial risk of forfeiture.
(1) In general.
(2) Stock rights.
(3) Enforcement of forfeiture condition.
(i) In general.
(ii) Examples.
(e) Performance-based compensation.
(1) In general.
(2) Payments based upon subjective performance criteria.
(3) Equity-based compensation.
(f) Service provider.
(1) In general.
(2) Independent contractors.
(i) In general.
(ii) Related person.
(iii) Significant services.
[[Page 19277]]
(iv) Management services.
(v) Services provided to related persons.
(g) Service recipient.
(h) Separation from service.
(1) Employees.
(i) In general.
(ii) Termination of employment.
(2) Independent contractors.
(i) In general.
(ii) Special rule.
(3) Definition of service recipient and employer.
(4) Asset purchase transactions.
(5) Dual status.
(6) Collectively bargained plans covering multiple employers.
(i) Specified employee.
(1) In general.
(2) Definition of compensation.
(3) Specified employee identification date.
(4) Specified employee effective date.
(5) Alternative methods of satisfying the six-month delay rule.
(6) Corporate transactions.
(i) Mergers and acquisitions of public service recipients.
(ii) Mergers and acquisitions of nonpublic service recipients.
(iii) Spinoffs.
(iv) Public offerings and other corporate transactions.
(v) Alternative methods of compliance.
(7) Nonresident alien employees.
(8) Elections affecting the identification of specified employees.
(j) Nonresident alien.
(k) Established securities market.
(l) Stock right.
(m) Separation pay plan.
(n) Involuntary separation from service.
(1) In general.
(2) Separations from service for good reason.
(i) In general.
(ii) Safe harbor.
(3) Special rule for certain collectively bargained plans.
(o) Earnings.
(p) In-kind benefits.
(q) Application of definitions and rules.
Sec. 1.409A-2 Deferral elections.
(a) Initial elections as to the time and form of payment.
(1) In general.
(2) Service recipient elections.
(3) General rule.
(4) Initial deferral election with respect to short-term deferrals.
(5) Initial deferral election with respect to certain forfeitable
rights.
(6) Initial deferral election with respect to fiscal year
compensation.
(7) First year of eligibility.
(i) In general.
(ii) Eligibility to participate.
(iii) Application to excess benefit plans.
(8) Initial deferral election with respect to performance-based
compensation.
(9) Nonqualified deferred compensation plans linked to qualified
employer plans or certain other arrangements.
(10) Changes in elections under a cafeteria plan.
(11) Initial deferral election with respect to certain separation
pay.
(12) Initial deferral election with respect to certain commissions.
(i) Sales commission compensation.
(ii) Investment commission compensation.
(iii) Commission compensation and related persons.
(13) Initial deferral election with respect to compensation paid for
final payroll period.
(i) In general.
(ii) Transition rule.
(14) Elections to annualize recurring part-year compensation.
(15) USERRA rights.
(b) Subsequent changes in time and form of payment.
(1) In general.
(2) Definition of payments for purposes of subsequent changes in the
time and form of payment.
(i) In general.
(ii) Life annuities.
(A) In general.
(B) Certain features disregarded.
(C) Subsidized joint and survivor annuities.
(D) Actuarial assumptions and methods.
(iii) Installment payments.
(iv) Transition rule.
(3) Beneficiaries.
(4) Domestic relations orders.
(5) Coordination with prohibition against acceleration of payments.
(6) Application to multiple payment events.
(7) Delay of payments under certain circumstances.
(i) Payments subject to section 162(m).
(ii) Payments that would violate Federal securities laws or other
applicable law.
(iii) Other events and conditions.
(8) USERRA rights.
(9) Examples.
(c) Special rules for certain resident aliens.
Sec. 1.409A-3 Permissible payments
(a) In general.
(b) Designation of payment upon a permissible payment event.
(c) Designation of alternative specified dates or payment schedules
based upon date of permissible event.
(d) When a payment is treated as made upon the designated payment
date.
(e) Designation of time and form of payment with respect to
earnings.
(f) Substitutions.
(g) Disputed payments and refusals to pay.
(h) Special rule for certain resident aliens.
(i) Definitions and special rules.
(1) Specified time or fixed schedule.
(i) In general.
(ii) Payment schedules with formula and fixed limitations.
(A) Individual limitations.
(B) Limitations on aggregate payments to all participants in
substantially identical plans.
(iii) Payment schedules determined by timing of payments received by
the service recipient.
(iv) Reimbursement or in-kind benefit plans.
(A) General rule.
(B) Medical reimbursement arrangements.
(v) Tax gross-up payments.
(vi) Examples.
(2) Separation from service--required delay in payment to a
specified employee pursuant to a separation from service.
(i) In general.
(ii) Application of payment rules to delayed payments.
(3) Unforeseeable emergency.
(i) Definition.
(ii) Amount of payment permitted upon an unforeseeable emergency.
(iii) Payments due to an unforeseeable emergency.
(4) Disability.
(i) In general.
(ii) Limited plan definition of disability.
(iii) Determination of disability.
(5) Change in the ownership or effective control of a corporation,
or a change in the ownership of a substantial portion of the assets
of a corporation.
(i) In general.
(ii) Identification of relevant corporation.
(A) In general.
(B) Majority shareholder.
(C) Example.
(iii) Attribution of stock ownership.
(iv) Special rules for certain delayed payments pursuant to a change
in control event.
(A) Certain transaction-based compensation.
(B) Certain nonvested compensation.
(v) Change in the ownership of a corporation.
(A) In general.
(B) Persons acting as a group.
(vi) Change in the effective control of a corporation.
(A) In general.
(B) Multiple change in control events.
(C) Acquisition of additional control.
(D) Persons acting as a group.
(vii) Change in the ownership of a substantial portion of a
corporation's assets.
(A) In general.
(B) Transfers to a related person.
(C) Persons acting as a group.
(6) Certain back-to-back arrangements.
(i) In general.
(ii) Example.
(j) Prohibition on acceleration of payments.
(1) In general.
(2) Application to multiple payment events.
(3) Beneficiaries.
(4) Exceptions.
(i) In general.
(ii) Domestic relations order.
(iii) Conflicts of interest.
(A) Compliance with ethics agreements with the Federal government.
(B) Compliance with ethics laws or conflicts of interest laws.
(iv) Section 457 plans.
(v) Limited cashouts.
(vi) Payment of employment taxes.
(vii) Payment upon income inclusion under section 409A.
(viii) Cancellation of deferrals following an unforeseeable
emergency or hardship distribution.
(ix) Plan terminations and liquidations.
(x) Certain distributions to avoid a nonallocation year under
section 409(p).
(xi) Payment of state, local, or foreign taxes.
(xii) Cancellation of deferral elections due to disability.
(xiii) Certain offsets.
(xiv) Bona fide disputes as to a right to a payment.
(5) Nonqualified deferred compensation plans linked to qualified
employer plans or certain other arrangements.
(6) Changes in elections under a cafeteria plan.
[[Page 19278]]
Sec. 1.409A-4 Calculation of income inclusion [Reserved]
Sec. 1.409A-5 Funding [Reserved]
Sec. 1.409A-6 Application of section 409A and effective dates.
(a) Statutory application and effective dates
(1) Application to amounts deferred.
(i) In general.
(ii) Collectively bargained plans.
(2) Identification of date of deferral for statutory effective date
purposes.
(3) Calculation of amount of compensation deferred for statutory
effective date purposes.
(i) Nonaccount balance plans.
(ii) Account balance plans.
(iii) Equity-based compensation plans.
(iv) Earnings.
(v) Definition of plan.
(4) Material modifications.
(i) In general.
(ii) Adoptions of new plans.
(iii) Suspension or termination of a plan.
(iv) Changes to investment measures--account balance plans.
(v) Stock rights.
(vi) Rescission of modifications.
(vii) Definition of plan.
(b) Regulatory applicability date.
Sec. 1.409A-1 Definitions and covered plans.
(a) Nonqualified deferred compensation plan--(1) In general. Except
as otherwise provided in this paragraph (a), the term nonqualified
deferred compensation plan means any plan (within the meaning of
paragraph (c) of this section) that provides for the deferral of
compensation (within the meaning of paragraph (b) of this section).
Whether a plan provides for the deferral of compensation generally is
determined at the time the service provider obtains a legally binding
right to the compensation under the plan, and is not affected by any
retroactive change to the plan to characterize the right as one that
does not provide for the deferral of compensation. For example, amounts
deferred under a nonqualified deferred compensation plan do not become
an excluded death benefit if the plan is amended so that the amounts
are payable only upon the death of the service provider. If a principal
purpose of a plan is to achieve a result with respect to a deferral of
compensation that is inconsistent with the purposes of section 409A,
the Commissioner may treat the plan as a nonqualified deferred
compensation plan for purposes of section 409A and the regulations
thereunder.
(2) Qualified employer plans. The term nonqualified deferred
compensation plan does not include a qualified employer plan. The term
qualified employer plan means any of the following plans:
(i) Any plan described in section 401(a) and a trust exempt from
tax under section 501(a) or that is described in section 402(d).
(ii) Any annuity plan described in section 403(a).
(iii) Any annuity contract described in section 403(b).
(iv) Any simplified employee pension (within the meaning of section
408(k)).
(v) Any simple retirement account (within the meaning of section
408(p)).
(vi) Any plan under which an active participant makes deductible
contributions to a trust described in section 501(c)(18).
(vii) Any eligible deferred compensation plan (within the meaning
of section 457(b)).
(viii) Any plan described in section 415(m).
(ix) Any plan described in Sec. 1022(i)(2) of the Employee
Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat.
829, 942) (Sept. 2, 1974) (ERISA).
(3) Certain foreign plans--(i) Participation addressed by treaty.
With respect to an individual for a taxable year, the term nonqualified
deferred compensation plan does not include any scheme, trust,
arrangement, or plan maintained with respect to such individual, to the
extent contributions made by or on behalf of such individual to such
scheme, trust, arrangement, or plan, or credited allocations, accrued
benefits, earnings, or other amounts constituting income, of such
individual under such scheme, trust, arrangement, or plan, are
excludable by such individual for Federal income tax purposes pursuant
to any bilateral income tax convention to which the United States is a
party.
(ii) Participation by nonresident aliens, certain resident aliens,
and bona fide residents of possessions. With respect to an alien
individual for a taxable year during which such individual is a
nonresident alien, a resident alien classified as a resident alien
solely under section 7701(b)(1)(A)(ii) (and not section
7701(b)(1)(A)(i)), or a bona fide resident of a possession (within the
meaning of section 937(a)), the term nonqualified deferred compensation
plan does not include any broad-based foreign retirement plan (within
the meaning of paragraph (a)(3)(v) of this section).
(iii) Participation by U.S. citizens and lawful permanent
residents. With respect to an individual for a given taxable year
during which such individual is a U.S. citizen or a resident alien
classified as a resident alien under section 7701(b)(1)(A)(i), other
than an individual who is also a bona fide resident of a possession
(within the meaning of section 937(a)), the term nonqualified deferred
compensation plan does not include a broad-based foreign retirement
plan (within the meaning of paragraph (a)(3)(v) of this section), but
only with respect to a plan, or a portion of a plan where such portion
may be distinguished, providing for nonelective deferrals of modified
foreign earned income, and earnings with respect to such nonelective
deferrals, and only to the extent that the amounts deferred under all
such plans of the service recipient, or all portions of such plans, in
which the service provider participates in such taxable year, do not
exceed the applicable limits under section 415(b) (applied to
nonaccount balance plans as defined in paragraph (c)(2)(i)(C) of this
section) and section 415(c) (applied to account balance plans as
defined in paragraph (c)(2)(i)(A) of this section) that would be
applicable if such plans were plans subject to section 415 and the
modified foreign earned income of such individual were treated as
compensation for purposes of applying section 415(b) and (c). For
purposes of this paragraph (a)(3)(iii), the term modified foreign
earned income means foreign earned income as defined in section
911(b)(1) without regard to section 911(b)(1)(B)(iv) and without regard
to the requirement that the income be attributable to services
performed during the period described in section 911(d)(1)(A) or (B).
The provisions of this paragraph (a)(3)(iii) do not apply to any
individual with respect to any taxable year in which the individual is
simultaneously eligible to participate in a broad-based foreign
retirement plan and a qualified employer plan described in paragraph
(a)(2) of this section. For purposes of this paragraph (a)(3)(iii), an
individual is eligible to participate in a qualified employer plan if
under the terms of the plan and without further amendment or action by
the plan sponsor, the individual is eligible to make or receive
contributions or accrue benefits under the plan (regardless of whether
the individual has elected to participate in the plan).
(iv) Plans subject to a totalization agreement and similar plans.
The term nonqualified deferred compensation plan does not include any
social security system of a jurisdiction to the extent that benefits
provided under or contributions made to the system are subject to an
agreement entered into pursuant to section 233 of the Social Security
Act (42 U.S.C. 433) with any foreign jurisdiction. In addition, the
term nonqualified deferred compensation plan does not include a
[[Page 19279]]
social security system of a foreign jurisdiction to the extent that
benefits are provided under or contributions are made to a government-
mandated plan as part of that foreign jurisdiction's social security
system.
(v) Broad-based foreign retirement plan. The term broad-based
foreign retirement plan means a scheme, trust, arrangement, or plan
(regardless of whether sponsored by a U.S. person) that is written and
that, in the case of an employer-maintained plan, satisfies the
following conditions:
(A) The plan is nondiscriminatory insofar as the employees who,
under the terms of the plan (alone or in combination with other
comparable plans) and without further amendment or action by the
employer, are eligible to make or receive contributions or accrue
benefits under the plan other than earnings (regardless of whether the
employee has elected to participate in the plan), are a wide range of
employees, substantially all of whom are nonresident aliens, resident
aliens classified as resident aliens solely under section
7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)), or bona fide
residents of a possession (within the meaning of section 937(a)),
including rank and file employees.
(B) The plan (alone or in combination with other comparable plans)
actually provides significant benefits for a substantial majority of
such covered employees.
(C) The benefits actually provided under the plan to such covered
employees are nondiscriminatory.
(D) The plan contains provisions or is the subject of tax law
provisions or other legal restrictions that generally discourage
employees from using plan benefits for purposes other than retirement
or restrict access to plan benefits before separation from service,
including (but not limited to), restricting in-service distributions
except in events similar to an unforeseeable emergency (as defined in
Sec. 1.409A-3(i)(3)(i)) or hardship (as defined for purposes of
section 401(k)(2)(B)(i)(IV)), or for educational purposes or the
purchase of a primary residence.
(4) Section 457 plans. A nonqualified deferred compensation plan
under section 457(f) may constitute a nonqualified deferred
compensation plan for purposes of this paragraph (a). The rules of
section 409A apply to nonqualified deferred compensation plans
separately and in addition to any requirements applicable to such plans
under section 457(f). In addition, nonelective deferred compensation of
non-employees described in section 457(e)(12) and a grandfathered plan
or arrangement described in Sec. 1.457-2(k)(4) may constitute a
nonqualified deferred compensation plan for purposes of this paragraph
(a). The term nonqualified deferred compensation plan does not include
a length of service award to a bona fide volunteer under section
457(e)(11)(A)(ii). For purposes of the application of section 409A to a
plan to which section 457 applies, a payment under the plan generally
means the provision of cash or property to the service provider,
provided that for purposes of the application of the short-term
deferral rule set forth in paragraph (b)(4) of this section, the
inclusion in income of an amount under section 457(f) is treated as a
payment of the amount.
(5) Certain welfare benefits. The term nonqualified deferred
compensation plan does not include any bona fide vacation leave, sick
leave, compensatory time, disability pay, or death benefit plan. For
these purposes, the term ``disability pay'' has the same meaning as
provided in Sec. 31.3121(v)(2)-1(b)(4)(iv)(C) of this chapter, and the
term death benefit plan refers to a plan providing death benefits as
defined in Sec. 31.3121(v)(2)-1(b)(4)(iv)(C) of this chapter, provided
that for purposes of this paragraph, such disability pay and death
benefits may be provided through insurance and the lifetime benefits
payable under the plan are not treated as including the value of any
taxable term life insurance coverage or taxable disability insurance
coverage provided under the plan. The term nonqualified deferred
compensation plan also does not include any Archer Medical Savings
Account as described in section 220, any Health Savings Account as
described in section 223, or any other medical reimbursement
arrangement, including a health reimbursement arrangement, that
satisfies the requirements of section 105 and section 106 such that the
benefits or reimbursements provided under such arrangement are not
includible in income.
(b) Deferral of compensation--(1) In general. Except as otherwise
provided in paragraphs (b)(3) through (b)(12) of this section, a plan
provides for the deferral of compensation if, under the terms of the
plan and the relevant facts and circumstances, the service provider has
a legally binding right during a taxable year to compensation that,
pursuant to the terms of the plan, is or may be payable to (or on
behalf of) the service provider in a later taxable year. Such
compensation is deferred compensation for purposes of section 409A,
this section and Sec. Sec. 1.409A-2 through 1.409A-6. A legally
binding right to an amount that will be excluded from income when and
if received does not constitute a deferral of compensation, unless the
service provider has received the right in exchange for, or has the
right to exchange the right for, an amount that will be includible in
income (other than due to participation in a cafeteria plan described
in section 125). A service provider does not have a legally binding
right to compensation to the extent that compensation may be reduced
unilaterally or eliminated by the service recipient or other person
after the services creating the right to the compensation have been
performed. However, if the facts and circumstances indicate that the
discretion to reduce or eliminate the compensation is available or
exercisable only upon a condition, or the discretion to reduce or
eliminate the compensation lacks substantive significance, a service
provider will be considered to have a legally binding right to the
compensation. Whether the discretion to reduce or eliminate the
compensation lacks substantive significance depends on all the relevant
facts and circumstances. However, where the service provider to whom
the compensation may be paid has effective control of the person
retaining the discretion to reduce or eliminate the compensation, or
has effective control over any portion of the compensation of the
person retaining the discretion to reduce or eliminate the
compensation, or is a member of the family (as defined in section
267(c)(4) applied as if the family of an individual includes the spouse
of any member of the family) of the person retaining the discretion to
reduce or eliminate the compensation, the discretion to reduce or
eliminate the compensation will not be treated as having substantive
significance. For this purpose, compensation is not considered subject
to unilateral reduction or elimination merely because it may be reduced
or eliminated by operation of the objective terms of the plan, such as
the application of a nondiscretionary, objective provision creating a
substantial risk of forfeiture. Similarly, a service provider does not
fail to have a legally binding right to compensation merely because the
amount of compensation is determined under a formula that provides for
benefits to be offset by benefits provided under another plan
(including a plan that is qualified under section 401(a)), or because
benefits are reduced due to actual or notional investment losses, or,
in a final average pay plan, subsequent decreases in compensation.
[[Page 19280]]
(2) Earnings. References to the deferral of compensation or
deferred compensation include references to earnings. When the right to
earnings is specified under the terms of the plan, the legally binding
right to earnings arises at the time of the deferral of the
compensation to which the earnings relate. A plan may provide that the
time and form of payment of earnings is treated separately from the
time and form of payment of the underlying compensation, so that,
provided that the rules of section 409A are otherwise met, a plan may
provide that earnings will be paid at a separate time or in a separate
form from the payment of the underlying compensation. For the
application of the deferral election rules to current payments of
earnings and dividend equivalents, see Sec. 1.409A-3(e).
(3) Compensation payable pursuant to the service recipient's
customary payment timing arrangement. A deferral of compensation does
not occur solely because compensation is paid after the last day of the
service provider's taxable year pursuant to the timing arrangement
under which the service recipient normally compensates service
providers for services performed during a payroll period described in
section 3401(b), or with respect to a non-employee service provider, a
period not longer than the payroll period described in section 3401(b)
or if no such payroll period exists, a period not longer than the
earlier of the normal timing arrangement under which the service
provider normally compensates non-employee service providers or 30 days
after the end of the service provider's taxable year.
(4) Short-term deferrals--(i) In general. A deferral of
compensation does not occur if the plan under which a payment (as
defined in Sec. 1.409A-2(b)(2)) is made does not provide for a
deferred payment and the service provider actually or constructively
receives such payment on or before the last day of the applicable 2\1/
2\ month period. The following rules apply for purposes of this
paragraph (b)(4)(i):
(A) The applicable 2\1/2\ month period is the period ending on the
later of the 15th day of the third month following the end of the
service provider's first taxable year in which the right to the payment
is no longer subject to a substantial risk of forfeiture or the 15th
day of the third month following the end of the service recipient's
first taxable year in which the right to the payment is no longer
subject to a substantial risk of forfeiture.
(B) A payment is treated as actually or constructively received if
the payment is includible in income, including if the payment is
includible in income under section 83, the economic benefit doctrine,
section 402(b), or section 457(f).
(C) A right to a payment that is never subject to a substantial
risk of forfeiture is considered to be no longer subject to a
substantial risk of forfeiture on the first date the service provider
has a legally binding right to the payment.
(D) A plan provides for a deferred payment if the plan provides
that any payment will be made or completed on or after any date, or
upon or after the occurrence of any event, that will or may occur later
than the end of the applicable 2\1/2\ month period, such as a
separation from service, death, disability, change in control event,
specified time or schedule of payment, or unforeseeable emergency,
regardless of whether an amount is actually paid as a result of the
occurrence of such a payment date or event during the applicable 2\1/2\
month period. If a plan provides that the service provider or service
recipient may make an election under the plan (including an election
under Sec. 1.409A-2(a)(4)) of a different payment date, schedule, or
event, such right is disregarded for this purpose. In such cases,
whether a plan provides for a deferred payment is determined based on
the payment date, schedule, or event that would apply if no such
election were made, except that if the plan would not provide for a
deferred payment absent such an election, and the service provider or
service recipient makes such an election, whether the plan provides for
a deferred payment is determined based upon the payment date, schedule,
or event that the service provider or service recipient in fact
elected.
(E) A stock right provides for a deferred payment if such right
includes any provision pursuant to which the holder of the stock right
will or may have the right to exercise the stock right after the
applicable 2\1/2\ month period.
(F) This paragraph (b)(4)(i) is applied separately to each payment
(as defined in Sec. 1.409A-2(b)(2)) required to be made under a plan.
(G) If a plan provides for a deferred payment with respect to part
of a payment (for example a life annuity or a series of installment
amounts treated as a single payment), the plan provides for a deferred
payment with respect to the entire payment.
(ii) Certain delayed payments. A payment that otherwise qualifies
as a short-term deferral under paragraph (b)(4)(i) of this section but
is made after the applicable 2\1/2\ month period may continue to
qualify as a short-term deferral if the taxpayer establishes that it
was administratively impracticable to make the payment by the end of
the applicable 2\1/2\ month period and, as of the date upon which the
legally binding right to the compensation arose, such impracticability
was unforeseeable, or the taxpayer establishes that making the payment
by the end of the applicable 2\1/2\ month period would have jeopardized
the ability of the service recipient to continue as a going concern,
and provided further that the payment is made as soon as
administratively practicable or as soon as the payment would no longer
have such effect. For purposes of this paragraph (b)(4)(ii), an action
or failure to act of the service provider or a person under the service
provider's control, such as a failure to provide necessary information
or documentation, is not an unforeseeable event. In addition, a payment
that otherwise qualifies as a short-term deferral under paragraph
(b)(4)(i) of this section but is made after the applicable 2\1/2\ month
period may continue to qualify as a short-term deferral if the taxpayer
establishes that the service recipient reasonably anticipated that the
service recipient's deduction with respect to such payment otherwise
would not be permitted by application of section 162(m), and, as of the
date the legally binding right to the payment arose, a reasonable
person would not have anticipated the application of section 162(m) at
the time of the payment, and provided further that the payment is made
as soon as reasonably practicable following the first date on which the
service recipient anticipates or reasonably should anticipate that, if
the payment were made on such date, the service recipient's deduction
with respect to such payment would no longer be restricted due to the
application of section 162(m). For additional rules applicable to
certain transaction-based compensation, see Sec. 1.409A-
3(i)(5)(iv)(A).
(iii) Examples. The following examples illustrate the provisions of
this paragraph (b)(4). In these examples, except as otherwise noted,
each employee and each employer has a calendar year taxable year and
each employee is an individual who is employed by the specified
employer.
Example 1. On November 1, 2008, Employer Z awards a bonus to
Employee A such that Employee A has a legally binding right to the
payment as of November 1, 2008, that is not subject to a substantial
risk of forfeiture. The bonus plan does not provide for a payment
date or a deferred payment. The bonus plan will not be considered to
have provided for a deferral of compensation if the bonus is paid or
made available to Employee A on or before March 15, 2009.
[[Page 19281]]
Example 2. Employer Y has a taxable year ending August 31. On
November 1, 2008, Employer Y awards a bonus to Employee B so that
Employee B has a legally binding right to the payment as of November
1, 2008, that is not subject to a substantial risk of forfeiture.
The bonus plan does not provide for a payment date or a deferred
payment. The bonus plan will not be considered to have provided for
a deferral of compensation if the bonus is paid or made available to
Employee B on or before November 15, 2009.
Example 3. On November 1, 2008, Employer X awards a bonus to
Employee C such that Employee C has a legally binding right to the
payment as of November 1, 2008. Under the bonus plan, Employee C
will forfeit the bonus unless Employee C continues performing
services through December 31, 2010. The right to the payment is
subject to a substantial risk of forfeiture through December 31,
2010. Employee C has the right to make a written election not later
than December 31, 2009, to receive the bonus on or after December
31, 2015, but Employee C does not make such election. The bonus plan
does not provide for a default payment date or a deferred payment in
the absence of an election by Employee C. The bonus plan will not be
considered to have provided for a deferral of compensation if the
bonus is paid or made available to Employee C on or before March 15,
2011 (and generally any payment before June 1, 2011 would constitute
an impermissible acceleration of a payment).
Example 4. On November 1, 2008, Employer W awards a bonus to
Employee D such that Employee D has a legally binding right to the
payment as of November 1, 2008. Under the bonus plan, the bonus will
be determined based on services performed during the period from
January 1, 2009 through December 31, 2010. The bonus is scheduled to
be paid as a lump sum payment on February 15, 2011. Under the bonus
plan, Employee D will forfeit the bonus unless Employee D continues
performing services through the scheduled payment date (February 15,
2011). Provided that at all times before the scheduled payment date
Employee D is required to continue to perform services to retain the
right to the bonus, and the bonus is paid on or before March 15,
2012, the bonus plan will not be considered to have provided for a
deferral of compensation.
Example 5. On November 1, 2008, Employer V awards a bonus to
Employee E such that Employee E has a legally binding right to the
payment as of November 1, 2008. Under the bonus plan, Employee E
will forfeit the bonus unless Employee E continues performing
services through December 31, 2010. Under the bonus plan, the bonus
is scheduled to be paid as a lump sum payment on July 1, 2011. By
specifying a payment date after the applicable 2\1/2\ month period,
the bonus plan provides for a deferred payment. The bonus plan
provides for a deferral of compensation, and will not qualify as a
short-term deferral regardless of whether the bonus is paid or made
available on or before March 15, 2011.
Example 6. On November 1, 2008, Employer U awards a bonus to
Employee F such that Employee F has a legally binding right to the
payment as of November 1, 2008, that is not subject to a substantial
risk of forfeiture. The bonus plan provides for a lump sum payment
upon Employee F's separation from service. Because the separation
from service is an event that may occur after the applicable 2\1/2\
month period, the bonus plan provides for a deferred payment and
therefore provides for a deferral of compensation. Accordingly, the
bonus plan will not qualify as a short-term deferral regardless of
whether Employee F separates from service and the bonus is paid or
made available on or before March 15, 2009.
Example 7. On November 1, 2008, Employer T grants Employee G a
legally binding right to the payment of a life annuity with the
first annuity payment on November 1, 2013, provided that Employee G
continues performing services for Employer T continuously through
November 1, 2013. Because the life annuity is treated as a single
payment, and because all payments of the life annuity may not occur
during the applicable 2\1/2\ month period, the plan provides for a
deferred payment and none of the amounts payable under the annuity
will qualify as a short-term deferral, so that section 409A applies
to all amounts that are payable under the plan.
Example 8. On November 1, 2008, Employer S grants Employee H a
stock right providing for an exercise price less than the fair
market value of the underlying stock on November 1, 2008. The stock
right is subject to a substantial risk of forfeiture requiring
services through November 1, 2010. The stock right becomes
exercisable when the substantial risk of forfeiture lapses and
expires on November 1, 2013. Employee H continues providing services
through November 1, 2010, at which time the substantial risk of
forfeiture lapses. The stock right provides for a deferred payment
and will not qualify as a short-term deferral regardless of whether
Employee H exercises the stock right on or before March 15, 2011.
(5) Stock options, stock appreciation rights, and other equity-
based compensation--(i) Stock rights--(A) Nonstatutory stock options
not providing for the deferral of compensation. An option to purchase
service recipient stock does not provide for a deferral of compensation
if--
(1) The exercise price may never be less than the fair market value
of the underlying stock (disregarding lapse restrictions as defined in
Sec. 1.83-3(i)) on the date the option is granted and the number of
shares subject to the option is fixed on the original date of grant of
the option;
(2) The transfer or exercise of the option is subject to taxation
under section 83 and Sec. 1.83-7; and
(3) The option does not include any feature for the deferral of
compensation other than the deferral of recognition of income until the
later of the following:
(i) The exercise or disposition of the option under Sec. 1.83-7.
(ii) The time the stock acquired pursuant to the exercise of the
option first becomes substantially vested (as defined in Sec. 1.83-
3(b)).
(B) Stock appreciation rights not providing for the deferral of
compensation. A right to compensation based on the appreciation in
value of a specified number of shares of service recipient stock
occurring between the date of grant and the date of exercise of such
right (a stock appreciation right) does not provide for a deferral of
compensation if--
(1) Compensation payable under the stock appreciation right cannot
be greater than the excess of the fair market value of the stock
(disregarding lapse restrictions as defined in Sec. 1.83-3(i)) on the
date the stock appreciation right is exercised over an amount specified
on the date of grant of the stock appreciation right (the stock
appreciation right exercise price), with respect to a number of shares
fixed on or before the date of grant of the right;
(2) The stock appreciation right exercise price may never be less
than the fair market value of the underlying stock (disregarding lapse
restrictions as defined in Sec. 1.83-3(i)) on the date the right is
granted; and
(3) The stock appreciation right does not include any feature for
the deferral of compensation other than the deferral of recognition of
income until the exercise of the stock appreciation right.
(C) Stock rights that may provide for the deferral of compensation.
An option to purchase stock other than service recipient stock, or a
stock appreciation right with respect to stock other than service
recipient stock, generally will provide for the deferral of
compensation within the meaning of this paragraph (b). If under the
terms of an option to purchase service recipient stock (other than an
incentive stock option described in section 422 or a stock option
granted under an employee stock purchase plan described in section
423), the exercise price is or could become less than the fair market
value of the stock (disregarding lapse restrictions as defined in Sec.
1.83-3(i)) on the date of grant, the grant of the option generally will
provide for the deferral of compensation within the meaning of this
paragraph (b). If under the terms of a stock appreciation right with
respect to service recipient stock, the compensation payable under the
stock appreciation right is or could be any amount greater than, with
respect to a predetermined number of shares, the excess of the fair
market value of the stock (disregarding lapse restrictions as defined
in Sec. 1.83-3(i)) on the date the stock appreciation right is
exercised
[[Page 19282]]
over the fair market value of the stock (disregarding lapse
restrictions as defined in Sec. 1.83-3(i)) on the date of grant of the
stock appreciation right, the grant of the stock appreciation right
generally will provide for a deferral of compensation within the
meaning of this paragraph (b).
(D) Feature for the deferral of compensation. To the extent a stock
right provides a right other than the right to receive cash or stock on
the date of exercise and such additional right would otherwise allow
compensation to be deferred beyond the date of exercise, the entire
arrangement (including the underlying stock right) provides for the
deferral of compensation. For purposes of this paragraph (b)(5)(i),
neither the right to receive substantially nonvested stock (as defined
in Sec. 1.83-3(b)) upon the exercise of a stock right, nor the right
to pay the exercise price with previously acquired shares, constitutes
a feature for the deferral of compensation.
(E) Rights to dividends. For purposes of this paragraph (b)(5)(i),
the right, directly or indirectly contingent upon the exercise of a
stock right, to receive an amount equal to all or part of the dividends
or other distributions (other than stock dividends described in
paragraph (b)(5)(v)(H) of this section) declared and paid on the number
of shares underlying the stock right between the date of grant and the
date of exercise of the stock right constitutes an offset to the
exercise price of the stock option or an increase in the amount payable
under the stock appreciation right (generally causing such stock right
to be subject to section 409A). A plan providing a right to dividends
or other distributions declared and paid on the number of shares
underlying a stock right, the payment of which is not contingent upon,
or otherwise payable on, the exercise of the stock right, may provide
for a deferral of compensation, but the existence of the right to
receive such an amount will not be treated as a reduction to the
exercise price of (or an increase to the compensation payable under)
the stock right. Thus, a right to such dividends or distributions that
is not contingent, directly or indirectly, upon the exercise of a stock
right will not cause the related stock right to fail to satisfy the
requirements of the exclusion from the definition of a deferral of
compensation provided in paragraphs (b)(5)(i)(A) and (B) of this
section.
(ii) Statutory stock options. The grant of an incentive stock
option as described in section 422, or the grant of an option under an
employee stock purchase plan described in section 423 (including the
grant of an option with an exercise price discounted in accordance with
section 423(b)(6) and the accompanying regulations), does not
constitute a deferral of compensation. However, the exclusion for
statutory stock options under this paragraph (b)(5)(ii) does not apply
to a modification, extension, or renewal of a statutory option that is
treated as the grant of a new option that is not a statutory option.
See Sec. 1.424-1(e). In such event, the option is treated for purposes
of this paragraph (b) as if it had been a nonstatutory stock option
from the date of the original grant. Accordingly, if such modification,
extension, or renewal of the stock option would have been treated as
the grant of a new option or as causing the option to have had a
deferral feature from the date of grant under paragraph (b)(5)(v) of
this section, the modification, extension, or renewal of the stock
option is treated as the grant of a new option or as causing the option
to have had a deferral feature from the date of grant for purposes of
this paragraph (b)(5).
(iii) Service recipient stock--(A) In general. Except as otherwise
provided in paragraphs (b)(5)(iii)(B), (C), and (D) of this section,
the term service recipient stock means a class of stock that, as of the
date of grant, is common stock for purposes of section 305 and the
regulations thereunder of a corporation that is an eligible issuer of
service recipient stock (as defined in paragraph (b)(5)(iii)(E) of this
section). Notwithstanding the foregoing, the term service recipient
stock does not include a class of stock that has any preference as to
distributions other than distributions of service recipient stock and
distributions in liquidation of the issuer. The term service recipient
stock also does not include any stock that is subject to a mandatory
repurchase obligation (other than a right of first refusal), or a put
or call right that is not a lapse restriction as defined in Sec. 1.83-
3(i), if the stock price under such right or obligation is based on a
measure other than the fair market value (disregarding lapse
restrictions as defined in Sec. 1.83-3(i)) of the equity interest in
the corporation represented by the stock.
(B) American depositary receipts. An American depositary receipt or
American depositary share may constitute service recipient stock, to
the extent that the stock traded on a foreign securities market to
which the American depositary receipt or American depositary share
relates qualifies as service recipient stock.
(C) Mutual company units. Mutual company units may constitute
service recipient stock. For this purpose, the term mutual company unit
means a fixed percentage of the overall value of a non-stock mutual
company or association. For purposes of determining the value of the
mutual company unit, the unit may be valued in accordance with the
rules set forth in paragraph (b)(5)(iv)(B) of this section governing
valuation of service recipient stock the shares of which are not traded
on an established securities market, applied as if the mutual company
were a stock corporation with one class of common stock and the number
of shares of such stock determined according to such fixed percentage.
For example, an appreciation right based on the appreciation of 10
mutual company units, where each unit is defined as one percent of the
overall value of the mutual company, would be valued as if the
appreciation right were based upon 10 shares of a corporation, with 100
shares of common stock (and no other class of stock), the shares of
which are not readily tradable on an established securities market.
(D) Other entities. An interest in an entity other than a
corporation or non-stock mutual company or association may constitute
service recipient stock to the extent designated by the Commissioner in
revenue procedures, notices, or other guidance published in the
Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
(E) Eligible issuer of service recipient stock--(1) In general. The
term eligible issuer of service recipient stock means only the
corporation for which the service provider provides direct services on
the date of grant of the stock right (if the entity receiving such
services is a corporation), and any corporation in a chain of
corporations or other entities in which each corporation or other
entity has a controlling interest in another corporation or other
entity in the chain, ending with the corporation or other entity that
has a controlling interest in the corporation or other entity for which
the service provider provides direct services on the date of grant of
the stock right. For this purpose, the term controlling interest has
the same meaning as provided in Sec. 1.414(c)-2(b)(2)(i), provided
that the language ``at least 50 percent'' is used instead of ``at least
80 percent'' each place it appears in Sec. 1.414(c)-2(b)(2)(i). In
addition, where the use of such stock with respect to the grant of a
stock right to such service provider is based upon legitimate business
criteria, the term controlling interest has the same meaning as
provided in Sec. 1.414(c)-
[[Page 19283]]
2(b)(2)(i), provided that the language ``at least 20 percent'' is used
instead of ``at least 80 percent'' each place it appears in Sec.
1.414(c)-2(b)(2)(i). For purposes of determining ownership of an
interest in an organization, the rules of Sec. Sec. 1.414(c)-3 and
1.414(c)-4 apply. The determination of whether a grant is based on
legitimate business criteria is based on the facts and circumstances,
focusing primarily on whether there is a sufficient nexus between the
service provider and the issuer of the stock right so that the grant
serves a legitimate non-tax business purpose other than simply
providing compensation to the service provider that is excluded from
the requirements of section 409A. For example, stock of a corporation
that owns an interest in a joint venture involving an operating
business, used with respect to stock rights granted to service
providers of the joint venture who are former service providers of such
corporation, generally will constitute use of service recipient stock
based upon legitimate business criteria, and therefore could constitute
service recipient stock with respect to such service providers if the
corporation owns at least 20 percent of the joint venture and the other
requirements of this paragraph (b)(5)(iii) are met. Similarly, the
legitimate business criteria requirement generally would be met if the
corporate venturer issued such a right to an employee of the joint
venture who it reasonably expected would in the future become an
employee of the corporate venturer. However, where a service provider
has no real nexus with a corporate venturer, such as generally happens
when the corporate venturer is a passive investor in the service
recipient joint venture, a stock right issued to that employee on the
investor corporation's stock generally would not be based upon
legitimate business criteria. Similarly, where a corporation holds only
a minority interest in an entity that in turn holds a minority interest
in the entity for which the service provider performs services, such
that the corporation holds only an insubstantial indirect interest in
the entity receiving the services, legitimate business criteria
generally would not exist for issuing a stock right on the
corporation's stock to the service provider.
(2) Investment vehicles. Notwithstanding the provisions of
paragraph (b)(5)(iii)(E)(1) of this section, except as to a service
provider providing services directly to such corporation, for purposes
of this paragraph (b)(5), an eligible issuer of service recipient stock
does not include any corporation whose primary purpose is to serve as
an investment vehicle with respect to the corporation's minority
ownership interests in entities other than the service recipient.
(3) Corporate structures established or transactions undertaken for
purposes of avoiding coverage under section 409A. Notwithstanding the
provisions of paragraph (b)(5)(iii)(E)(1) of this section, an eligible
issuer of service recipient stock does not include any corporation
within a group of entities treated as a single service recipient if a
purpose of the establishment of the structure of the ownership, or a
purpose of a significant transaction between or among two or more
entities comprising a single service recipient, is to provide deferred
compensation not subject to the application of section 409A. If an
entity becomes a member of a group of corporations or other entities
treated as a single service recipient, and the primary source of income
or value of such entity arises from the provision of management
services to other members of the service recipient group, it is
presumed that such structure was established for purposes of avoiding
the application of section 409A if any stock rights are issued with
respect to such entity.
(4) Substitutions and assumptions by reason of a corporate
transaction. If the requirements of paragraph (b)(5)(v)(D) of this
section are met such that the substitution of a new stock right
pursuant to a corporate transaction for an outstanding stock right, or
the assumption of an outstanding stock right pursuant to a corporate
transaction, would not be treated as the grant of a new stock right or
a change in the form of payment for purposes of this section and
Sec. Sec. 1.409A-2 through 1.409A-6, the stock underlying the stock
right that replaced the stock right that is substituted or assumed will
be treated as service recipient stock for purposes of applying this
paragraph (b)(5) to the replacement stock rights if such underlying
stock otherwise satisfies the requirements of paragraph (b)(5)(iii)(A)
of this section. For example, if by reason of a spinoff transaction
(under which the stock of a subsidiary corporation is distributed to
the stockholders of a distributing corporation), a stock option to
purchase distributing corporation stock is replaced with a stock option
to purchase distributing corporation stock and a stock option to
purchase the spun off subsidiary corporation's stock (each otherwise
satisfying the requirements of paragraph (b)(5)(iii)(A) of this
section), and where such substitution is not treated as a modification
of the original stock option pursuant to paragraph (b)(5)(v)(D) of this
section, both the distributing corporation stock and the subsidiary
corporation stock are treated as service recipient stock for purposes
of applying this paragraph (b)(5) to the replacement stock options.
(iv) Determination of the fair market value of service recipient
stock--(A) Stock readily tradable on an established securities market.
For purposes of paragraph (b)(5)(i) of this section, in the case of
service recipient stock that is readily tradable on an established
securities market, the fair market value of the stock may be determined
based upon the last sale before or the first sale after the grant, the
closing price on the trading day before or the trading day of the
grant, the arithmetic mean of the high and low prices on the trading
day before or the trading day of the grant, or any other reasonable
method using actual transactions in such stock as reported by such
market. The determination of fair market value also may be determined
using an average selling price during a specified period that is within
30 days before or 30 days after the applicable valuation date, provided
that the program under which the stock right is granted, including a
program with a single participant, must irrevocably specify the
commitment to grant the stock right with an exercise price set using
such an average selling price before the beginning of the specified
period. For this purpose, the term average selling price refers to the
arithmetic mean of such selling prices on all trading days during the
specified period, or the average of such prices over the specified
period weighted based on the volume of trading of such stock on each
trading day during such specified period. To satisfy this requirement,
the service recipient must designate the recipient of the stock right,
the number and class of shares of stock that are subject to the stock
right, and the method for determining the exercise price including the
period over which the averaging will occur, before the beginning of the
specified averaging period. Notwithstanding the forgoing provisions of
this paragraph (b)(5)(iv)(A), where applicable foreign law requires
that a compensatory stock right be priced based upon a specific price
averaging method and period, a stock right granted in accordance with
such applicable foreign law will be treated as meeting the requirements
of this paragraph (b)(5)(iv)(A), provided that the averaging period
does not exceed 30 days.
(B) Stock not readily tradable on an established securities
market--(1) In general. For purposes of paragraph
[[Page 19284]]
(b)(5)(i) of this section, in the case of service recipient stock that
is not readily tradable on an established securities market, the fair
market value of the stock as of a valuation date means a value
determined by the reasonable application of a reasonable valuation
method. The determination whether a valuation method is reasonable, or
whether an application of a valuation method is reasonable, is made
based on the facts and circumstances as of the valuation date. Factors
to be considered under a reasonable valuation method include, as
applicable, the value of tangible and intangible assets of the
corporation, the present value of anticipated future cash-flows of the
corporation, the market value of stock or equity interests in similar
corporations and other entities engaged in trades or businesses
substantially similar to those engaged in by the corporation the stock
of which is to be valued, the value of which can be readily determined
through nondiscretionary, objective means (such as through trading
prices on an established securities market or an amount paid in an
arm's length private transaction), recent arm's length transactions
involving the sale or transfer of such stock or equity interests, and
other relevant factors such as control premiums or discounts for lack
of marketability and whether the valuation method is used for other
purposes that have a material economic effect on the service recipient,
its stockholders, or its creditors. The use of a valuation method is
not reasonable if such valuation method does not take into
consideration in applying its methodology all available information
material to the value of the corporation. Similarly, the use of a value
previously calculated under a valuation method is not reasonable as of
a later date if such calculation fails to reflect information available
after the date of the calculation that may materially affect the value
of the corporation (for example, the resolution of material litigation
or the issuance of a patent) or the value was calculated with respect
to a date that is more than 12 months earlier than the date for which
the valuation is being used. The service recipient's consistent use of
a valuation method to determine the value of its stock or assets for
other purposes, including for purposes unrelated to compensation of
service providers, is also a factor supporting the reasonableness of
such valuation method.
(2) Presumption of reasonableness. For purposes of this paragraph
(b)(5)(iv)(B), the use of any of the following methods of valuation is
presumed to result in a reasonable valuation, provided that the
Commissioner may rebut such a presumption upon a showing that either
the valuation method or the application of such method was grossly
unreasonable:
(i) A valuation of a class of stock determined by an independent
appraisal that meets the requirements of section 401(a)(28)(C) and the
regulations as of a date that is no more than 12 months before the
relevant transaction to which the valuation is applied (for example,
the date of grant of a stock option).
(ii) A valuation based upon a formula that, if used as part of a
nonlapse restriction (as defined in Sec. 1.83-3(h)) with respect to
the stock, would be considered to be the fair market value of the stock
pursuant to Sec. 1.83-5, provided that such stock is valued in the
same manner for purposes of any nonlapse restriction applicable to the
transfer of any shares of such class of stock (or any substantially
similar class of stock) to the issuer or any person that owns stock
possessing more than 10 percent of the total combined voting power of
all classes of stock of the issuer (applying the stock attribution
rules of Sec. 1.424-1(d)), other than an arm's length transaction
involving the sale of all or substantially all of the outstanding stock
of the issuer, and such valuation method is used consistently for all
such purposes, and provided further that this paragraph
(b)(5)(iv)(B)(2)(ii) does not apply with respect to stock subject to a
stock right payable in stock, where the stock acquired pursuant to the
exercise of the stock right is transferable other than through the
operation of a nonlapse restriction.
(iii) A valuation, made reasonably and in good faith and evidenced
by a written report that takes into account the relevant factors
described in paragraph (b)(5)(iv)(B)(1) of this section, of illiquid
stock of a start-up corporation. For this purpose, illiquid stock of a
start-up corporation means service recipient stock of a corporation
that has no material trade or business that it or any predecessor to it
has conducted for a period of 10 years or more and has no class of
equity securities that are traded on an established securities market
(as defined in paragraph (k) of this section), where such stock is not
subject to any put, call, or other right or obligation of the service
recipient or other person to purchase such stock (other than a right of
first refusal upon an offer to purchase by a third party that is
unrelated to the service recipient or service provider and other than a
right or obligation that constitutes a lapse restriction as defined in
Sec. 1.83-3(i)), and provided that this paragraph
(b)(5)(iv)(B)(2)(iii) does not apply to the valuation of any stock if
the service recipient or service provider may reasonably anticipate, as
of the time the valuation is applied, that the service recipient will
undergo a change in control event as described in Sec. 1.409A-
3(i)(5)(v) or Sec. 1.409A-3(i)(5)(vii) within the 90 days following
the action to which the valuation is applied, or make a public offering
of securities within the 180 days following the action to which the
valuation is applied. For purposes of this paragraph
(b)(5)(iv)(B)(2)(iii), a valuation will not be treated as made
reasonably and in good faith unless the valuation is performed by a
person or persons that the corporation reasonably determines is
qualified to perform such a valuation based on the person's or
persons'' significant knowledge, experience, education, or training.
Generally, a person will be qualified to perform such a valuation if a
reasonable individual, upon being apprised of such knowledge,
experience, education, and training, would reasonably rely on the
advice of such person with respect to valuation in deciding whether to
accept an offer to purchase or sell the stock being valued. For this
purpose, significant experience generally means at least five years of
relevant experience in business valuation or appraisal, financial
accounting, investment banking, private equity, secured lending, or
other comparable experience in the line of business or industry in
which the service recipient operates.
(3) Use of alternative methods. For purposes of this paragraph
(b)(5), a different valuation method may be used for each separate
action for which a valuation is relevant, provided that a single
valuation method is used for each separate action and, once used, may
not retroactively be altered. For example, one valuation method may be
used to establish the exercise price of a stock option, and a different
valuation method may be used to determine the value at the date of the
repurchase of stock pursuant to a put or call right. However, once an
exercise price or amount to be paid has been established, the exercise
price or amount to be paid may not be changed through the retroactive
use of another valuation method. In addition, notwithstanding the
foregoing, where after the date of grant, but before the date of
exercise or transfer, of the stock right, the service recipient stock
to which the stock right relates becomes readily tradable on an
established securities market, the service recipient must use the
valuation method set forth in paragraph (b)(5)(iv)(A) of this section
[[Page 19285]]
for purposes of determining the payment at the date of exercise or the
purchase of the stock, as applicable.
(v) Modifications, extensions, substitutions, and assumptions of
stock rights--(A) Treatment of modified and extended stock rights. A
modification of the terms of a stock right within the meaning of
paragraph (b)(5)(v)(B) of this section is considered to be the grant of
a new stock right. The new stock right may or may not constitute a
deferral of compensation under paragraph (b)(5)(i) of this section,
determined at the date of grant of the new stock right. If there is an
extension of a stock right (within the meaning of paragraph
(b)(5)(v)(C) of this section), the stock right is treated as having had
an additional deferral feature from the original date of grant of the
stock right, and therefore will be treated as a plan providing for the
deferral of compensation from the original grant date for purposes of
this paragraph (b).
(B) Modification in general. Except as otherwise provided in
paragraph (b)(5)(v) of this section, the term modification means any
change in the terms of the stock right (or change in the terms of the
plan pursuant to which the stock right was granted or in the terms of
any other agreement governing the stock right) that may provide the
holder of the stock right with a direct or indirect reduction in the
exercise price of the stock right regardless of whether the holder in
fact benefits from the change in terms. A change in the terms of the
stock right shortening the period during which the stock right is
exercisable is not a modification. It is not a modification to add a
feature providing the ability to tender previously acquired stock for
the stock purchasable under the stock right, or to withhold or have
withheld shares of stock to facilitate the payment of the exercise
price or the employment taxes or required withholding taxes resulting
from the exercise of the stock right. In addition, it is not a
modification for the grantor to exercise discretion specifically
reserved under a stock right with respect to the transferability of the
stock right.
(C) Extensions--(1) In general. An extension of a stock right
refers to the provision to the holder of an additional period of time
within which to exercise the stock right beyond the time originally
prescribed under the terms of the stock right, the conversion or
exchange of a stock right for a legally binding right to compensation
in a future taxable year, or the addition of any feature for the
deferral of compensation not permitted in paragraph (b)(5)(i)(A)(3) of
this section (in the case of a stock option) or not permitted in
paragraph (b)(5)(i)(B)(3) of this section (in the case of a stock
appreciation right) to the terms of the stock right, other than at a
time when the exercise price of the stock right equals or exceeds the
fair market value of the service recipient stock that could be
purchased (in the case of an option) or the fair market value of the
service recipient stock used to determine the payment to the service
provider (in the case of a stock appreciation right), and includes a
renewal of such right that has such effect. It is not an extension if
the exercise period of a stock right is extended to a date no later
than the earlier of the latest date upon which the stock right could
have expired by its original terms under any circumstances or the 10th
anniversary of the original date of grant of the stock right. If the
exercise period of a stock right is extended at a time when the
exercise price of the stock right equals or exceeds the fair market
value of the service recipient stock that could be purchased (in the
case of an option) or the fair market value of the service recipient
stock used to determine the payment to the service provider (in the
case of a stock appreciation right), it is not an extension of the
original stock right. Instead, in such a case, the original stock right
is treated as modified rather than extended and a new stock right is
treated as having been granted for purposes of this section. In
addition, it is not an extension of a stock right if the expiration of
the stock right is tolled while the holder cannot exercise the stock
right because such an exercise would violate an applicable Federal,
state, local, or foreign law, or would jeopardize the ability of the
service recipient to continue as a going concern, provided that the
period during which the stock right may be exercised is not extended
more than 30 days after the exercise of the stock right first would no
longer violate an applicable Federal, state, local, and foreign laws or
would first no longer jeopardize the ability of the service recipient
to continue as a going concern. For this purpose, a provision of
foreign law shall be considered applicable only to foreign earned
income (as defined under section 911(b)(1) without regard to section
911(b)(1)(B)(iv) and without regard to the requirement that the income
be attributable to services performed during the period described in
section 911(d)(1)(A) or (B)) from sources within the foreign country
that promulgated such law.
(2) Certain extensions before April 10, 2007. An extension of a
stock right before April 10, 2007 solely in order to provide the holder
of such stock right an additional period of time beyond the time
originally prescribed under the terms of such stock right within which
to exercise the stock right is disregarded for purposes of applying the
rules contained in paragraph (b)(5)(v)(C)(1) of this section. For
purposes of applying the rules contained in paragraph (b)(5)(v)(C)(1)
of this section on and after April 10, 2007, such a stock right is
treated as having specified at the date of grant the time within which
to exercise such stock right that was prescribed under the terms of
such stock right in effect on April 10, 2007. Nothing in this paragraph
(b)(5)(v)(C)(2) affects any other action treated as the extension of a
stock right, including the addition of a deferral feature.
(3) Examples. The following examples illustrate the provisions of
this paragraph (b)(5)(v)(C). In the examples, each employee is an
individual employed by the specified employer, and each employee and
each employer has a calendar year taxable year.
Example 1. On July 1, 2009, Employer Z grants Employee A a
nonstatutory stock option that does not provide for the deferral of
compensation in accordance with paragraph (b)(5)(i)(A) of this
section. The terms of the nonstatutory stock option provide that the
exercise period of the stock option expires on the earlier of July
1, 2019, or 3 months after Employee A's separation from service. On
July 1, 2011, Employee A separates from service. On the same day,
Employee A and Employer Z change the exercise period of the option
so that it expires on July 1, 2013. Because the exercise period of
the stock right is not extended beyond July 1, 2019, the change is
not an extension for purposes of this paragraph (b)(5)(v)(C).
Example 2. The facts are the same as in Example 1 except that
Employee A separates from service on July 1, 2018, and on the same
day, Employee A and Employer Z change the exercise period of the
option so that it expires on July 1, 2020. As of July 1, 2018, the
fair market value of the underlying stock exceeds the exercise
price. Because the exercise period of the stock right is extended
beyond July 1, 2019, the change is an extension for purposes of this
paragraph (b)(5)(v)(C).
Example 3. The facts are the same as in Example 2 except that as
of July 1, 2018, the fair market value of the underlying stock is
less than the exercise price of the option. Because the exercise
period of the stock right is extended at a time when the fair market
value of the underlying stock is less than the exercise price, the
change is not an extension for purposes of this paragraph
(b)(5)(v)(C) and the change is treated as a modification of the
option, resulting in the extension of the exercise period being
treated as the grant of a new option on July 1, 2018.
Example 4. On July 1, 2009, Employer Y grants to Employee B a
stock appreciation
[[Page 19286]]
right with respect to 200 shares of Employer Y common stock that
does not provide for the deferral of compensation in accordance with
paragraph (b)(5)(i)(B) of this section. Upon exercise of the stock
appreciation right, Employee B is entitled to receive the excess of
the fair market value of a share of Employer Y common stock on the
date of exercise over $100 (the fair market value of a share of
Employer Y common stock on July 1, 2009), multiplied by the number
of shares with respect to which Employee B is exercising the right.
The exercise period of the right expires on the earlier of July 1,
2019, or 3 months after Employee B separates from service. Employee
B cannot exercise the stock appreciation right with respect to more
than 100 shares unless Employee B continues to be employed by
Employer Y through June 30, 2014. On July 1, 2011, when the fair
market value of a share of Employer Y common stock is $200, Employee
B and Employer Y amend the stock appreciation right to provide that
the right will be exercisable only during calendar year 2018, except
that before January 1, 2017, Employee B may elect to designate
calendar year 2023 or any subsequent calendar year before 2033 as
the year in which the right will be exercisable. The amendment
constitutes an extension of the stock appreciation right under
paragraph (b)(5)(v)(C)(1) of this section. Under paragraph
(b)(5)(v)(A) of this section, the stock appreciation right is
treated as having had an additional deferral feature from the
original date of grant (July 1, 2009) of the right, and therefore is
treated as a plan providing for the deferral of compensation from
that date. During the period from July 1, 2009, through June 30,
2011, the provisions of the stock appreciation right relating to the
time and form of payment did not satisfy the requirements of Sec.
1.409A-3(a). Therefore, the stock appreciation right provides for a
deferral of compensation that does not comply with section 409A.
(D) Substitutions and assumptions of stock rights by reason of a
corporate transaction. If the requirements of Sec. 1.424-1 (without
regard to the requirement described in Sec. 1.424-1(a)(2) that an
eligible corporation be the employer of the optionee) would be met if
the stock right were a statutory option, the substitution of a new
stock right pursuant to a corporate transaction (as defined in Sec.
1.424-1(a)(3)) for an outstanding stock right or the assumption of an
outstanding stock right pursuant to a corporate transaction will not be
treated as the grant of a new stock right or a change in the form of
payment for purposes of this section and Sec. Sec. 1.409A-2 through
1.409A-6. For purposes of the preceding sentence, the requirement of
Sec. 1.424-1(a)(5)(iii) will be deemed to be satisfied if the ratio of
the exercise price to the fair market value of the shares subject to
the stock right immediately after the substitution or assumption is not
greater than the ratio of the exercise price to the fair market value
of the shares subject to the stock right immediately before the
substitution or assumption. In the case of a transaction described in
section 355 in which the stock of the distributing corporation and the
stock distributed in the transaction are both readily tradable on an
established securities market immediately after the transaction, for
purposes of this paragraph (b)(5)(v), the requirements of Sec. 1.424-
1(a)(5) related to the fair market value of the stock may be satisfied
by--
(1) Using the last sale before or the first sale after the
specified date as of which such valuation is being made, the closing
price on the last trading day before or the trading day of a specified
date, the arithmetic mean of the high and low prices on the last
trading day before or the trading day of such specified date, or any
other reasonable method using actual transactions in such stock as
reported by such market on a specified date, for the stock of the
distributing corporation and the stock distributed in the transaction,
provided the specified date is designated before such specified date,
and such specified date is not more than 60 days after the transaction;
(2) Using the arithmetic mean of such market prices on trading days
during a specified period designated before the beginning of such
specified period, where such specified period is not longer than 30
days and ends no later than 60 days after the transaction; or
(3) Using an average of such prices during such prespecified period
weighted based on the volume of trading of such stock on each trading
day during such prespecified period.
(E) Acceleration of date when exercisable. Although with respect to
a stock right not immediately exercisable in full, a change in the
terms of the right solely to accelerate or delay, within the original
term of the stock right, the time at which the stock right (or any
portion of such stock right) may be exercised is not a modification for
purposes of this section, with respect to a stock right subject to
section 409A, such an acceleration may constitute an impermissible
acceleration of a payment date under Sec. 1.409A-3(j) or a subsequent
deferral under Sec. 1.409A-2(b).
(F) Discretionary added benefits. If a change to a stock right
provides, either by its terms or in substance, that the holder may
receive an additional benefit under the stock right at the future
discretion of the grantor, and the addition of such benefit would
constitute a modification or extension, then the addition of such
discretion is a modification or extension at the time that the stock
right is changed to provide such discretion.
(G) Change in underlying stock increasing value. A change in the
terms of the stock subject to a stock right that increases the value of
the stock is a modification of such stock right, except to the extent
that a new stock right is substituted for such stock right by reason of
the change in the terms of the stock in accordance with paragraph
(b)(5)(v)(D) of this section.
(H) Change in the number of shares purchasable. If a stock right is
amended solely to increase the number of shares subject to the stock
right, the increase is not considered a modification of the stock right
but is treated as the grant of a new additional stock right to which
the additional shares are subject. Notwithstanding the previous
sentence, if the exercise price and number of shares subject to a stock
right are proportionally adjusted to reflect a stock split (including a
reverse stock split) or stock dividend, and the only effect of the
stock split or stock dividend is to increase (or decrease) on a pro
rata basis the number of shares owned by each shareholder of the class
of stock subject to the stock right, then there is no modification of
the stock right if it is proportionally adjusted to reflect the stock
split or stock dividend and the aggregate exercise price of the stock
right is not less than the aggregate exercise price before the stock
split or stock dividend.
(I) Rescission of changes. A change to the terms of a stock right
(or change in the terms of the plan pursuant to which the stock right
was granted or in the terms of any other agreement governing the right)
is not considered a modification or extension of the stock right to the
extent the change in the terms of the stock right is rescinded by the
earlier of the date the stock right is exercised or the last day of the
service provider's taxable year during which such change occurred.
Thus, for example, if the terms of a stock right granted to an
individual employee with a calendar year taxable year are changed on
March 1 in a manner that would result in an extension of the stock
right, and the change is rescinded on November 1 of the same year, and
the stock right is not exercised before the change is rescinded, the
stock right is not considered extended under this paragraph (b)(5)(v).
(J) Successive modifications and extensions. The rules of this
paragraph (b)(5)(v) apply as well to successive modifications and
extensions.
(K) Modifications and extensions in effect on October 23, 2004. For
purposes of the application of section 409A and
[[Page 19287]]
these regulations to a stock right, if a legally binding right to a
modification or extension of such stock right existed on October 23,
2004, such modification or extension is disregarded, and the stock
right is treated as if granted with the terms and conditions in effect
on October 23, 2004.
(vi) Meaning and use of certain terms--(A) Option. The term option
means the right or privilege of an individual to purchase stock from a
corporation by virtue of an offer of the corporation continuing for a
stated period of time, whether or not irrevocable, to sell such stock
at a price determined under paragraph (b)(5)(vi)(D) of this section,
such individual being under no obligation to purchase. While no
particular form of words is necessary, the option must express an offer
to sell at the option price, the maximum number of shares purchasable
under the option, and the period of time during which the offer remains
open. The term option includes a warrant that meets the requirements of
this paragraph (b)(5)(vi)(A). An option may be granted as part of or in
conjunction with an employee stock purchase plan or subscription
contract. An option must be in writing (in paper or electronic form)
provided that such writing is adequate to establish an option right or
privilege that is enforceable under applicable law.
(B) Date of grant of option. (1) The language the date of grant of
the option, and similar phrases, refer to the date when the granting
corporation completes the corporate action necessary to create the
legally binding right constituting the option. A corporate action
creating the legally binding right constituting the option is not
considered complete until the date on which the maximum number of
shares that can be purchased under the option and the minimum exercise
price are fixed or determinable, and the class of underlying stock and
the identity of the service provider is designated. Ordinarily, if the
corporate action provides for an immediate offer of stock for sale to a
service provider, or provides for a particular date on which such offer
is to be made, the date of the granting of the option is the date of
such corporate action if the offer is to be made immediately, or the
date provided as the date of the offer, as the case may be. However, an
unreasonable delay in the giving of notice of such offer to the service
provider will be taken into account as indicating that the corporation
provided that the offer was to be made at the subsequent date on which
such notice is given.
(2) If the corporation imposes a condition on the granting of an
option (as distinguished from a condition governing the exercise of the
option), such condition generally will be given effect in accordance
with the intent of the corporation. However, if the grant of an option
is subject to approval by stockholders, the date of grant of the option
will be determined as if the option had not been subject to such
approval. A condition that does not require corporate action, such as
the approval of, or registration with, some regulatory or government
agency, for example, a stock exchange or the Securities and Exchange
Commission, is ordinarily considered a condition upon the exercise of
the option unless the corporate action clearly indicates that the
option is not to be granted until such condition has been satisfied.
(3) In general, a condition imposed upon the exercise of an option
will not operate to make ineffective the granting of the option. For
example, on June 1, 2008, Corporation A grants to X, an employee, an
option to purchase 5,000 shares of the corporation's common stock,
exercisable by X on or after June 1, 2009, provided X is employed by
the corporation on June 1, 2009, and provided that A's profits during
the fiscal year preceding the year of exercise exceed $200,000. Such an
option is granted to X on June 1, 2008, and will be treated as
outstanding as of such date.
(C) Stock. The term stock means capital stock of any class,
including voting or nonvoting common or preferred stock. Except as
otherwise provided, the term stock includes both treasury stock and
stock of original issue. Special classes of stock authorized to be
issued to and held by employees are within the scope of the term stock
for this purpose, provided such stock otherwise possesses the rights
and characteristics of capital stock.
(D) Exercise price. The term exercise price means the consideration
in cash or property that, pursuant to the terms of the option, is the
price at which the stock subject to the option is purchased. The term
exercise price does not include any amounts paid as interest under a
deferred payment plan or treated as interest.
(E) Exercise. The term exercise, when used in reference to an
option, means the act of acceptance by the holder of the option of the
offer to sell contained in the option. In general, the time of exercise
is the time when there is a sale or a contract to sell between the
corporation and the individual. A promise to pay the exercise price
does not constitute an exercise of the option unless the holder of the
option is subject to personal liability on such promise. An agreement
or undertaking by the service provider to make payments under a stock
purchase plan does not constitute the exercise of an option to the
extent the payments made remain subject to withdrawal by or refund to
the service provider.
(F) Transfer. The term transfer, when used in reference to the
transfer to an individual of a share of stock pursuant to the exercise
of an option, means the transfer of ownership of such share, or the
transfer of substantially all the rights of ownership. Such transfer
must, within a reasonable time, be evidenced on the books of the
corporation. A transfer may occur even if a share of stock is subject
to a substantial risk of forfeiture or is not otherwise transferable
immediately after the date of exercise. A transfer does not fail to
occur merely because, under the terms of the arrangement, the
individual may not dispose of the share for a specified period of time,
or the share is subject to a right of first refusal or a right to
acquire the share at the share's fair market value at the time of the
sale.
(G) Readily tradable. For purposes of this section and Sec. Sec.
1.409A-2 through 1.409A-6, stock is treated as readily tradable if it
is regularly quoted by brokers or dealers making a market in such
stock.
(H) Application to stock appreciation rights. For purposes of this
section and Sec. Sec. 1.409A-2 through 1.409A-6, the definitions
provided in paragraphs (b)(5)(vi)(A) through (G) of this section may be
applied by analogy to the issuance of, exercise of, or payment upon the
exercise of, a stock appreciation right.
(6) Restricted property, section 402(b) trusts, and section 403(c)
annuities--(i) In general. If a service provider receives property
from, or pursuant to, a plan maintained by a service recipient, there
is no deferral of compensation merely because the value of the property
is not includible in income by reason of the property being
substantially nonvested (as defined in Sec. 1.83-3(b)), or is
includible in income solely due to a valid election under section
83(b). For purposes of this paragraph (b)(6)(i), a transfer of property
includes the transfer of a beneficial interest in a trust or annuity
plan, or a transfer to or from a trust or under an annuity plan, to the
extent such a transfer is subject to section 83, section 402(b) or
section 403(c). In addition, for purposes of this paragraph (b), a
right to compensation income that will be required to be included in
income under section
[[Page 19288]]
402(b)(4)(A) is not a deferral of compensation.
(ii) Promises to transfer property. A plan under which a service
provider obtains a legally binding right to receive property in a
future taxable year where the property will be substantially vested (as
defined in Sec. 1.83-3(b)) at the time of transfer of the property may
provide for the deferral of compensation and, accordingly, may
constitute a nonqualified deferred compensation plan. A legally binding
right to receive property in a future taxable year where the property
will be substantially nonvested (as defined in Sec. 1.83-3(b)) at the
time of transfer of the property will not provide for the deferral of
compensation and, accordingly, will not constitute a nonqualified
deferred compensation plan unless offered in conjunction with another
legally binding right that constitutes a deferral of compensation.
(7) Arrangements between partnerships and partners. [Reserved.]
(8) Certain foreign plans--(i) Plans with respect to compensation
covered by treaty or other international agreement. A plan in which a
service provider participates does not provide for a deferral of
compensation for purposes of this paragraph (b) to the extent that the
compensation under the plan would have been excluded from gross income
for Federal income tax purposes under the provisions of any bilateral
income tax convention or other bilateral or multilateral agreement to
which the United States is a party if the compensation had been paid to
the service provider at the time that the legally binding right to the
compensation first arose or, if later, the time that the legally
binding right was no longer subject to a substantial risk of
forfeiture.
(ii) Plans with respect to certain other compensation. A plan in
which a service provider participates does not provide for a deferral
of compensation for purposes of this paragraph (b) to the extent that
compensation under the plan would not have been includible in gross
income for Federal tax purposes if it had been paid to the service
provider at the time that the legally binding right to the compensation
first arose or, if later, the time that the legally binding right was
no longer subject to a substantial risk of forfeiture, due to one of
the following:
(A) The service provider was a nonresident alien at such time and
the compensation would not have been includible in gross income under
section 872.
(B) The service provider was a qualified individual (as defined in
section 911(d)(1)) at such time, the compensation would have been
foreign earned income within the meaning of section 911(b)(1) (without
regard to section 911(b)(1)(B)(iv)) if paid at such time, and the
amount of such compensation was equal to or less than the excess (if
any) of the maximum exclusion amount under section 911(b)(2)(D) for
such taxable year over the amount of foreign earned income actually
excluded from gross income by such qualified individual for such
taxable year under section 911(a)(1).
(C) The compensation would have been excludible from gross income
under section 893.
(D) The compensation would have been excludible from gross income
under section 931 or section 933.
(iii) Tax equalization agreements. Compensation paid under a tax
equalization agreement does not provide for a deferral of compensation
if payments made under such tax equalization agreement are made no
later than the end of the second taxable year of the service provider
beginning after the taxable year of the service provider in which the
service provider's U.S. Federal income tax return is required to be
filed (including any extensions) for the year to which the compensation
subject to the tax equalization payment relates, or, if later, the
second taxable year of the service provider beginning after the latest
such taxable year in which the service provider's foreign tax return or
payment is required to be filed or made for the year to which the
compensation subject to the tax equalization payment relates. Where
such payments arise due to an audit, litigation or similar proceeding,
the right to the payments will not be treated as resulting in a
deferral of compensation if the payments are scheduled and made in
accordance with the provisions of Sec. 1.409A-3(i)(1)(v) (timing of
tax gross-up payments). For purposes of this paragraph (b)(8)(iii), the
term tax equalization agreement refers to an agreement, method,
program, or other arrangement that provides payments intended to
compensate the service provider for some or all of the excess of the
taxes actually imposed by a foreign jurisdiction on the compensation
paid by the service recipient to the service provider over the taxes
that would be imposed if the compensation were subject solely to United
States Federal, state, and local income tax, or some or all of the
excess of the United States Federal, state, and local income tax
actually imposed on the compensation paid by the service to the service
provider over the taxes that would be imposed if the compensation were
subject solely to taxes in the foreign jurisdiction, provided that the
payment made under such agreement, method, program, or other
arrangement may not exceed such excess and the amount necessary to
compensate for the additional taxes on the amount paid under the
agreement, method, program, or other arrangement.
(iv) Certain limited deferrals of a nonresident alien. With respect
to a nonresident alien, a foreign plan does not provide for a deferral
of compensation if the amounts deferred under the foreign plan based
upon services performed by the nonresident alien in the United States
(including amounts deferred based upon service credits or compensation
received due to services performed in the United States) do not exceed
the applicable dollar amount under section 402(g)(1)(B) for the taxable
year. If the amounts deferred under the foreign plan based upon the
services performed by the nonresident alien in the United States exceed
the applicable dollar amount, an amount of such deferrals equal to such
amount is treated as not deferred under a nonqualified deferred
compensation plan. For purposes of this paragraph (b)(8)(iv), the term
foreign plan means a plan that, together with all substantially similar
plans, is maintained by a service recipient for a substantial number of
participants, substantially all of whom are nonresident aliens or
resident aliens classified as resident aliens solely under section
7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)).
(v) Additional foreign plans. A plan in which a service provider
participates does not provide for a deferral of compensation for
purposes of this paragraph (b) to the extent designated by the
Commissioner in revenue procedures, notices, or other guidance
published in the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of
this chapter).
(vi) Earnings. Earnings on compensation excluded from the
definition of deferral of compensation pursuant to this paragraph
(b)(8) are also not treated as a deferral of compensation.
(9) Separation pay plans--(i) In general. A plan that otherwise
provides for a deferral of compensation under this paragraph (b) does
not fail to provide a deferral of compensation merely because the right
to payment of the compensation is conditioned upon a separation from
service. However, paragraphs (b)(9)(ii), (iii), (iv), and (v) of this
section provide rules concerning the extent to which certain separation
pay plans do not provide for the deferral of compensation. The
exceptions contained in paragraphs (b)(9)(ii), (iii),
[[Page 19289]]
(iv), and (v) of this section may be used in combination, such that
compensation under a plan that would be excepted under one of those
paragraphs may be treated as excepted under another of those
paragraphs, so that other compensation under a plan may be treated as
excepted under the first of such paragraphs. Notwithstanding any other
provision of this paragraph (b)(9), any payment or benefit, or
entitlement to a payment or benefit, that acts as a substitute for, or
replacement of, amounts deferred by the service recipient under a
separate nonqualified deferred compensation plan constitutes a payment
or a deferral of compensation under the separate nonqualified deferred
compensation plan, and does not constitute a payment or deferral of
compensation under a separation pay plan. If a service provider
receives a payment at separation from service and also has a legally
binding right to an amount of deferred compensation that would be
forfeited upon the separation from service, whether the payment acts as
an acceleration of vesting and substitute payment for the amount of
deferred compensation forfeited, or whether the deferred compensation
is treated as forfeited and the amount paid is treated as a separate
payment of current compensation, is determined based on the facts and
circumstances, provided that, where the separation from service is
voluntary, it is presumed that the payment results from an acceleration
of vesting followed by a payment of the deferred compensation that is
subject to section 409A. Accordingly, any change in the payment
schedule to accelerate or defer the payments would be subject to the
rules of section 409A. The presumption that a right to a payment is not
a new right, but is instead a right substituted for a pre-existing
forfeited right, may be rebutted by demonstrating that the service
provider would have obtained the right to the payment regardless of the
forfeiture of the nonvested right. A factor indicating that the service
provider would have obtained a right to a payment regardless of the
forfeiture of the nonvested right is that the amount to which the
service provider obtains a right is materially less than an amount
equal to the present value of the forfeited amount multiplied by a
fraction, the numerator of which is the period of service the service
provider actually completed, and the denominator of which is the full
period of service the service provider would have been required to
complete to receive the full amount of the payment. For example, where
a service provider is entitled to a future payment only if the service
provider completes three years of service and at the time of
termination the service provider has completed one year of service, the
presumption could be rebutted if the payment to the service provider is
materially less than the present value of one-third of the nonvested
amount. Another such factor is that the payment to the service provider
is of a type customarily made to service providers who separate from
service with the service recipient and do not forfeit nonvested rights
to deferred compensation (for example, a payment of accrued but unused
leave or a payment for a release of actual or potential claims).
(ii) Collectively bargained separation pay plans. A separation pay
plan does not provide for a deferral of compensation to the extent the
plan is a collectively bargained separation pay plan that provides for
separation pay only upon an involuntary separation from service or
pursuant to a window program. Only the portion of the separation pay
plan attributable to employees covered by a bona fide collective
bargaining agreement is considered to be provided under a collectively
bargained separation pay plan. A collectively bargained separation pay
plan is a separation pay plan that meets the following conditions:
(A) The separation pay plan is contained within an agreement that
the Secretary of Labor determines to be a collective bargaining
agreement.
(B) The separation pay provided by the collective bargaining
agreement was the subject of arm's length negotiations between employee
representatives and one or more employers, and the agreement between
employee representatives and one or more employers satisfies section
7701(a)(46).
(C) The circumstances surrounding the agreement evidence good faith
bargaining between adverse parties over the separation pay to be
provided under the agreement.
(iii) Separation pay due to involuntary separation from service or
participation in a window program. A separation pay plan that is not
described in paragraph (b)(9)(ii) of this section and that provides for
separation pay only upon an involuntary separation from service (as
defined in paragraph (n) of this section) or pursuant to a window
program does not provide for a deferral of compensation to the extent
that the separation pay, or portion of the separation pay, provided
under the plan meets the following requirements:
(A) The separation pay (other than amounts described in paragraphs
(b)(9)(iv) and (v) of this section) does not exceed two times the
lesser of--
(1) The sum of the service provider's annualized compensation based
upon the annual rate of pay for services provided to the service
recipient for the taxable year of the service provider preceding the
taxable year of the service provider in which the service provider has
a separation from service with such service recipient (adjusted for any
increase during that year that was expected to continue indefinitely if
the service provider had not separated from service); or
(2) The maximum amount that may be taken into account under a
qualified plan pursuant to section 401(a)(17) for the year in which the
service provider has a separation from service.
(B) The plan provides that the separation pay described in
paragraph (b)(9)(iii)(A) of this section must be paid no later than the
last day of the second taxable year of the service provider following
the taxable year of the service provider in which occurs the separation
from service.
(iv) Foreign separation pay plans. A separation pay plan (including
a plan providing payments upon a voluntary separation from service)
does not provide for deferred compensation to the extent the plan
provides for amounts of separation pay required to be provided under
the applicable law of a foreign jurisdiction. For this purpose, a
provision of foreign law shall be considered applicable only to foreign
earned income (as defined under section 911(b)(1) without regard to
section 911(b)(1)(B)(iv) and without regard to the requirement that the
income be attributable to services performed during the period
described in section 911(d)(1)(A) or (B)) from sources within the
foreign country that promulgated such law.
(v) Reimbursements and certain other separation payments--(A) In
general. To the extent a separation pay plan (including a plan
providing payments upon a voluntary separation from service) entitles a
service provider to payment by the service recipient of reimbursements
that are not otherwise excludible from gross income, for expenses that
the service provider could otherwise deduct under section 162 or
section 167 as business expenses incurred in connection with the
performance of services (ignoring any applicable limitation based on
adjusted gross income), or of reasonable outplacement expenses and
reasonable moving expenses actually incurred by the service provider
and directly related
[[Page 19290]]
to the termination of services for the service recipient, such plan
does not provide for a deferral of compensation to the extent such
rights apply during a limited period of time (regardless of whether
such rights extend beyond the limited period of time). For purposes of
this paragraph (b)(9)(v)(A), the reimbursement of reasonable moving
expenses includes the reimbursement of all or part of any loss the
service provider actually incurs due to the sale of a primary residence
in connection with a separation from service.
(B) Medical benefits. To the extent a separation pay plan
(including a plan providing payments due to a voluntary separation from
service) entitles a service provider to reimbursement by the service
recipient of payments of medical expenses incurred and paid by the
service provider but not reimbursed by a person other than the service
recipient and allowable as a deduction under section 213 (disregarding
the requirement of section 213(a) that the deduction is available only
to the extent that such expenses exceed 7.5 percent of adjusted gross
income), such plan does not provide for a deferral of compensation to
the extent such rights apply during the period of time during which the
service provider would be entitled (or would, but for such plan, be
entitled) to continuation coverage under a group health plan of the
service recipient under section 4980B (COBRA) if the service provider
elected such coverage and paid the applicable premiums.
(C) In-kind benefits and direct service recipient payments. A
service provider's entitlement to in-kind benefits from the service
recipient, or a payment by the service recipient directly to the person
providing the goods or services to the service provider, is treated as
not providing for a deferral of compensation for purposes of this
paragraph (b), if a right to reimbursement by the service recipient for
a payment for such benefits, goods, or services by the service provider
would not be treated as providing for a deferral of compensation under
this paragraph (b)(9)(v).
(D) Limited payments. If not otherwise excluded, a taxpayer may
treat a right or rights under a separation pay plan to a payment or
payments as not providing for a deferral of compensation to the extent
such payments in the aggregate do not exceed the applicable dollar
amount under section 402(g)(1)(B) for the year of the separation from
service.
(E) Limited period of time. For purposes of paragraphs (b)(9)(v)(A)
and (C) of this section, a limited period of time in which expenses may
be incurred, or in which in-kind benefits may be provided by the
service recipient or a third party that the service recipient will pay,
does not include periods beyond the last day of the second taxable year
of the service provider following the taxable year of the service
provider in which the separation from service occurred, provided that
the period during which the reimbursements for such expenses must be
paid may not extend beyond the third taxable year of the service
provider following the taxable year of the service provider in which
the separation from service occurred.
(vi) Window programs--definition. The term window program refers to
a program established by a service recipient in connection with an
impending separation from service to provide separation pay, where such
program is made available by the service recipient for a limited period
of time (no longer than 12 months) to service providers who separate
from service during that period or to service providers who separate
from service during that period under specified circumstances. A
program will not be considered a window program if a service recipient
establishes a pattern of repeatedly providing for similar separation
pay in similar situations for substantially consecutive, limited
periods of time. Whether the recurrence of these programs constitutes a
pattern is determined based on the facts and circumstances. Although no
one factor is determinative, relevant factors include whether the
benefits are on account of a specific business event or condition, the
degree to which the separation pay relates to the event or condition,
and whether the event or condition is temporary or discrete or is a
permanent aspect of the employer's business.
(10) Certain indemnification and liability insurance plans. A plan
in which a service provider participates does not provide for a
deferral of compensation for purposes of this paragraph (b) to the
extent that the plan provides (to the extent permissible under
applicable law), for the indemnification of, or the purchase of an
insurance policy providing for payments of, all or part of the expenses
incurred or damages paid or payable by a service provider with respect
to a bona fide claim against the service provider or service recipient,
including amounts paid or payable by the service provider upon the
settlement of a bona fide claim against the service provider or service
recipient, where such claim is based on actions or failures to act by
the service provider in his or her capacity as a service provider of
the service recipient.
(11) Legal settlements. An agreement to which a service provider is
a party does not provide for a deferral of compensation for purposes of
this paragraph (b) to the extent that the agreement provides for
amounts paid as settlements or awards resolving bona fide legal claims
based on wrongful termination, employment discrimination, the Fair
Labor Standards Act, or worker's compensation statutes, including
claims under applicable Federal, state, local, or foreign laws, or for
reimbursements or payments of reasonable attorneys fees or other
reasonable expenses incurred by the service provider related to such
bona fide legal claims, regardless of whether such settlements, awards,
or reimbursement or payment of expenses pursuant to such claims are
treated as compensation or wages for Federal tax purposes. Whether the
execution of a waiver of any or all of such types of claims indicates
that the amounts are paid as an award or settlement of an actual bona
fide claim for damages under applicable law is determined based on the
facts and circumstances. This paragraph (b)(11) does not apply to any
deferred amounts that did not arise as a result of an actual bona fide
claim for damages under applicable law, such as amounts that would have
been deferred or paid regardless of the existence of such claim, even
if such amounts are paid or modified as part of a settlement or award
resolving an actual bona fide claim. For this purpose, a provision of
foreign law shall be considered applicable only to foreign earned
income (as defined under section 911(b)(1) without regard to section
911(b)(1)(B)(iv) and without regard to the requirement that the income
be attributable to services performed during the period described in
section 911(d)(1)(A) or (B)) from sources within the foreign country
that promulgated such law.
(12) Certain educational benefits. A plan in which a service
provider participates does not provide for a deferral of compensation
to the extent the plan provides for taxable educational benefits. For
purposes of this paragraph (b)(12), the term educational benefits
refers solely to benefits provided to a service provider, consisting
solely of educational assistance for the education of the service
provider, as defined in section 127(c) and the accompanying
regulations, and does not refer to any benefits provided for the
education of any other person, including any spouse,
[[Page 19291]]
child, or other family member of the service provider.
(c) Plan--(1) In general. The term plan includes any agreement,
method, program, or other arrangement, including an agreement, method,
program, or other arrangement that applies to one person or individual.
A plan may be adopted unilaterally by the service recipient or may be
negotiated or agreed to by the service recipient and one or more
service providers or service provider representatives. An agreement,
method, program, or other arrangement may constitute a plan regardless
of whether it is an employee benefit plan under section 3(3) of ERISA,
as amended (29 U.S.C. 1002(3)). The requirements of section 409A are
applied as if a separate plan or plans is maintained for each service
provider. For purposes of determining the terms of a plan, general
provisions of the plan that purport to nullify noncompliant plan terms,
or to supply any specific plan terms required by this section, Sec.
1.409A-2 or Sec. 1.409A-3, are disregarded.
(2) Plan aggregation rules--(i) In general. Except as otherwise
provided, the following rules apply with respect to the application of
this section and Sec. Sec. 1.409A-2 through 1.409A-6 to deferrals of
compensation with respect to a service provider:
(A) All deferrals of compensation at the election of that service
provider under all plans of the service recipient that are account
balance plans, except to the extent that the plan is described in
paragraph (c)(2)(i)(D), (E), (F), (G), or (H) of this section, are
treated as deferred under a single plan. For purposes of this
paragraph, the term account balance plan means--
(1) An agreement, method, program, or other arrangement that is an
account balance plan as defined in Sec. 31.3121(v)(2)-1(c)(1)(ii)(A)
of this chapter, including mandatorily bifurcating the agreement,
method, program, or other arrangement in accordance with the rules
provided in Sec. 31.3121(v)-1(c)(1)(iii)(B) of this chapter; or
(2) An agreement, method, program, or other arrangement that would
be described in paragraph (c)(2)(i)(A)(1) of this section if the
service provider were an employee.
(B) All deferrals of compensation other than at the election of
that service provider, including deferrals reflecting matching by the
service recipient with respect to amounts a service provider elects to
defer, under all plans of the service recipient that are account
balance plans, except to the extent the plan is described in paragraph
(c)(2)(i)(D), (E), (F), (G), or (H) of this section, are treated as
deferred under a single plan. For purposes of this paragraph
(c)(2)(i)(B), the term ``account balance plan'' has the same meaning as
provided in paragraph (c)(2)(i)(A) of this section.
(C) All deferrals of compensation with respect to that service
provider under all plans of the service recipient that are nonaccount
balance plans, except to the extent such plan is described in paragraph
(c)(2)(i)(D), (E), (F), (G), or (H) of this section, are treated as
deferred under a single plan. For purposes of this paragraph
(c)(2)(i)(C), the term nonaccount balance plan means--
(1) An agreement, method, program, or other arrangement that is a
nonaccount balance plan as defined in Sec. 31.3121(v)(2)-1(c)(2)(i) of
this chapter, including mandatorily bifurcating the agreement, method,
program, or other arrangement in accordance with the rules provided in
Sec. 31.3121(v)-1(c)(1)(iii)(B) of this chapter; or
(2) An agreement, method, program, or other arrangement that would
be described in paragraph (c)(2)(i)(C)(1) of this section if the
service provider were an employee.
(D) All deferrals of compensation with respect to that service
provider under all separation pay plans (as defined in paragraph (m) of
this section) of the service recipient to the extent an amount deferred
under the plans is not described in paragraph (c)(2)(i)(E) of this
section and is payable solely upon an involuntary separation from
service within the meaning of paragraph (n) of this section or as a
result of participation in a window program, are treated as deferred
under a single plan.
(E) All deferrals of compensation with respect to that service
provider under all plans of the service recipient to the extent such
amounts deferred consist of rights to in-kind benefits or
reimbursements of expenses, such as membership fees, or expenses
related to aircraft or vehicle usage, to the extent that the right to
the in-kind benefit or reimbursement, separately or in the aggregate,
does not constitute a substantial portion of either the overall
compensation earned by the service provider for performing services for
the service recipient or the overall compensation received due to a
separation from service, are treated as deferred under a single plan.
(F) All deferrals of compensation with respect to that service
provider under all plans of the service recipient to the extent that
the taxation of such compensation is governed by Sec. 1.61-22 or Sec.
1.7872-15 (split-dollar life insurance arrangements), or the taxation
of such compensation would be governed by Sec. 1.61-22 or Sec.
1.7872-15 but for the operation of Sec. 1.61-22(j) (effective date
provisions), are treated as deferred under a single plan.
(G) All deferrals of compensation with respect to that service
provider under all agreements, methods, programs, or other arrangements
of the service recipient to the extent the deferrals under the
agreements, methods, programs, or other arrangements are deferrals of
amounts that would be treated as modified foreign earned income
(meaning foreign earned income as defined under section 911(b)(1)
without regard to section 911(b)(1)(B)(iv) and without regard to the
requirement that the income be attributable to services performed
during the period described in section 911(d)(1)(A) or (B)) if paid to
the service provider at the time the amount is first deferred, and
provided further that substantially all the participants in such
agreements, methods, programs, or other arrangements and any
substantially similar agreements, methods, programs, or other
arrangements are nonresident aliens and that the service provider does
not participate in a substantially identical agreement, method,
program, or other arrangement that does not meet the requirements of
this paragraph (c)(2)(i)(G) (a domestic arrangement), are treated as
deferred under a single plan.
(H) All deferrals of compensation with respect to that service
provider under all plans of the service provider to the extent such
plans are stock rights (as defined in paragraph (c)(2)(l) of this
section) subject to section 409A, are treated as deferred under a
single plan.
(I) All deferrals of compensation with respect to that service
provider under all plans of the service recipient to the extent such
plans are not described in paragraph (c)(2)(i)(A), (B), (C), (D), (E),
(F), (G), or (H) of this section are treated as deferred under a single
plan.
(ii) Dual status. Agreements, methods, programs, and other
arrangements in which a service provider participates are not
aggregated with other agreements, methods, programs, and other
arrangements to the extent the service provider participates in one set
of agreements, methods, programs, and other arrangements due to status
as an employee of the service recipient (employee arrangements) and
another set of agreements, methods, programs, and other arrangements
due to status as an independent contractor of the service recipient
(independent contractor arrangements). For example, where a service
provider deferred amounts under an independent contractor arrangement
while providing services as an independent contractor, and then
[[Page 19292]]
becomes eligible for and defers amounts under a separate employee
arrangement after being hired as an employee, the two arrangements will
not be aggregated for purposes of this paragraph (c)(2). Where an
employee also is a member of the board of directors of the service
recipient (or a similar position with respect to a non-corporate
service recipient), the arrangements under which the employee
participates as a director (director arrangements) are not aggregated
with employee arrangements, provided that the director arrangements are
substantially similar to arrangements provided to service providers
providing services only as directors (or similar positions with respect
to non-corporate service recipients). For example, an employee director
who participates in an employee arrangement and a director arrangement
generally may treat the two arrangements as separate plans, provided
that the director arrangement is substantially similar to arrangements
providing benefits to non-employee directors. To the extent a plan in
which an employee director participates is not substantially similar to
arrangements in which non-employee directors participate, such plan is
treated as an employee plan for purposes of this paragraph (c)(2).
Director plans and independent contractor plans are aggregated for
purposes of this paragraph (c)(2).
(3) Establishment of plan--(i) In general. A plan does not satisfy
the requirements of section 409A and this section and Sec. Sec.
1.409A-2 through 1.409A-3 and Sec. Sec. 1.409A-5 through 1.409A-6,
unless the plan is established and maintained by a service recipient in
accordance with the requirements of this section, Sec. Sec. 1.409A-2
through 1.409A-3 and Sec. Sec. 1.409A-5 through 1.409A-6. For purposes
of this paragraph (c)(3), a plan is established on the latest of the
date on which it is adopted, the date on which it is effective, and the
date on which the material terms of the plan are set forth in writing.
The material terms of the plan may be set forth in writing in one or
more documents. For purposes of this paragraph (c)(3)(i), a plan will
be deemed to be set forth in writing if it is set forth in any other
form that is approved by the Commissioner. The material terms of the
plan include the amount (or the method or formula for determining the
amount) of deferred compensation to be provided under the plan and the
time and form of payment. Notwithstanding the foregoing, a plan will be
deemed to be established as of the date the participant obtains a
legally binding right to a deferral of compensation, provided that the
plan is otherwise established under the rules of this paragraph
(c)(3)(i) by the end of the taxable year of the service provider in
which the legally binding right arises, or with respect to an amount
not payable in the year immediately following the taxable year of the
service provider in which the legally binding right arises (the
subsequent year), the 15th day of the third month of the subsequent
year.
(ii) Initial deferral election provisions. If a plan provides a
service provider or a service recipient with an initial deferral
election, the plan satisfies the requirements of this paragraph (c)(3)
if the plan sets forth in writing, on or before the date the applicable
election is required to be irrevocable to satisfy the requirements of
Sec. 1.409A-2(a), the conditions under which such election may be
made.
(iii) Subsequent deferral election provisions. If a plan permits a
subsequent deferral election described in Sec. 1.409A-2(b), the plan
satisfies the requirements of this paragraph (c)(3) if the plan sets
forth in writing, on or before the date the election is required to be
irrevocable to meet the requirements of Sec. 1.409A-2(b), the
conditions under which such election may be made.
(iv) Payment accelerations. Except as explicitly provided in Sec.
1.409A-3, a plan is not required to set forth in writing the conditions
under which a payment may be accelerated if such acceleration is
permitted under Sec. 1.409A-3(j)(4).
(v) Six-month delay for specified employees. A plan must provide
that distributions to a specified employee may not be made before the
date that is six months after the date of separation from service or,
if earlier, the date of death (the six-month delay rule). The six-month
delay rule, required for payments due to the separation from service of
a specified employee, must be written in the plan. A plan does not fail
to be established and maintained merely because it does not contain the
six-month delay rule when the service provider who has a right to
compensation deferred under such plan is not a specified employee.
However, such provision must be set forth in writing on or before the
date such service provider first becomes a specified employee. In
general, this means the provision must be set forth in writing on or
before the specified employee effective date (as defined in paragraph
(i)(3) of this section) for the first list of specified employees that
includes such service provider.
(vi) Plan amendments. In the case of an amendment that increases
the amount deferred under a nonqualified deferred compensation plan,
the plan is not considered established with respect to the additional
amount deferred until the plan, as amended, is established in
accordance with paragraph (c)(3)(i) of this section.
(vii) Transition rule for written plan requirement. For purposes of
this paragraph (c)(3), a legally enforceable unwritten plan that was
adopted and effective before December 31, 2007, is treated as
established under this section as of the later of the date on which it
was adopted or became effective, provided that the material terms of
the plan are set forth in writing on or before December 31, 2007.
(viii) Plan aggregation rules. The plan aggregation rules of
paragraph (c)(2)(i) of this section do not apply to the requirements of
this paragraph (c)(3). Accordingly, deferrals of compensation under an
agreement, method, program, or other arrangement that fails to meet the
requirements of section 409A solely due to a failure to meet the
requirements of this paragraph (c)(3) are not aggregated with deferrals
of compensation under other agreements, methods, programs, or other
arrangements that meet such requirements.
(d) Substantial risk of forfeiture--(1) In general. Compensation is
subject to a substantial risk of forfeiture if entitlement to the
amount is conditioned on the performance of substantial future services
by any person or the occurrence of a condition related to a purpose of
the compensation, and the possibility of forfeiture is substantial. For
purposes of this paragraph (d), a condition related to a purpose of the
compensation must relate to the service provider's performance for the
service recipient or the service recipient's business activities or
organizational goals (for example, the attainment of a prescribed level
of earnings or equity value or completion of an initial public
offering). For purposes of this paragraph (d), if a service provider's
entitlement to the amount is conditioned on the occurrence of the
service provider's involuntary separation from service without cause,
the right is subject to a substantial risk of forfeiture if the
possibility of forfeiture is substantial. An amount is not subject to a
substantial risk of forfeiture merely because the right to the amount
is conditioned, directly or indirectly, upon the refraining from the
performance of services. Except as provided with respect to certain
transaction-based compensation under Sec. 1.409A-3(i)(5)(iv), the
addition of any risk of
[[Page 19293]]
forfeiture after the legally binding right to the compensation arises,
or any extension of a period during which compensation is subject to a
risk of forfeiture, is disregarded for purposes of determining whether
such compensation is subject to a substantial risk of forfeiture. An
amount will not be considered subject to a substantial risk of
forfeiture beyond the date or time at which the recipient otherwise
could have elected to receive the amount of compensation, unless the
present value of the amount subject to a substantial risk of forfeiture
(disregarding, in determining the present value, the risk of
forfeiture) is materially greater than the present value of the amount
the recipient otherwise could have elected to receive absent such risk
of forfeiture. For this purpose, compensation that the service provider
would receive for continuing to perform services regardless of whether
the service provider elected to receive the amount that is subject to a
substantial risk of forfeiture is not taken into account in determining
whether the present value of the right to the amount subject to a
substantial risk of forfeiture is materially greater than the amount
the recipient otherwise could have elected to receive absent such risk
of forfeiture. For example, a salary deferral generally may not be made
subject to a substantial risk of forfeiture. But, for example, where a
bonus plan provides an election between a cash payment or restricted
stock units with a present value that is materially greater
(disregarding the risk of forfeiture) than the present value of such
cash payment and that will be forfeited absent continued services for a
period of years, the right to the restricted stock units generally will
be treated as subject to a substantial risk of forfeiture.
(2) Stock rights. A stock right is not subject to a substantial
risk of forfeiture at the earlier of the first date the holder may
exercise the stock right and receive cash or property that is
substantially vested (as defined in Sec. 1.83-3(b)) or the first date
that the stock right is not subject to a forfeiture condition that
would constitute a substantial risk of forfeiture. Accordingly, a stock
option that the service provider may exercise immediately and receive
substantially vested stock is not subject to a substantial risk of
forfeiture, even if the stock option automatically terminates upon the
service provider's separation from service.
(3) Enforcement of forfeiture condition--(i) In general. In
determining whether the possibility of forfeiture is substantial in the
case of rights to compensation granted by a service recipient to a
service provider that owns a significant amount of the total combined
voting power or value of all classes of equity of the service recipient
(where the service provider's ownership is determined with application
of the attribution rules under section 318 if the service recipient is
a corporation, or if the service recipient is an entity that is not a
corporation, with application by analogy of the attribution rules under
section 318), all relevant facts and circumstances will be taken into
account in determining whether the probability of the service recipient
enforcing such condition is substantial, including--
(A) The service provider's relationship to other equity holders and
the extent of their control, potential control and possible loss of
control of the service recipient;
(B) The position of the service provider in the service recipient
and the extent to which the service provider is subordinate to other
service providers;
(C) The service provider's relationship to the officers and
directors of the service recipient (or similar positions with respect
to a noncorporate service recipient);
(D) The person or persons who must approve the service provider's
discharge; and
(E) Past actions of the service recipient in enforcing the
restrictions.
(ii) Examples. The following examples illustrate the rules of
paragraph (d)(3)(i) of this section:
Example 1. A service provider would be considered as having
deferred compensation subject to a substantial risk of forfeiture,
but for the fact that the service provider owns 20 percent of the
single class of stock in the transferor corporation. If the
remaining 80 percent of the class of stock is owned by an unrelated
individual (or members of such an individual's family) so that the
possibility of the corporation enforcing a restriction on such
rights is substantial, then such rights are subject to a substantial
risk of forfeiture.
Example 2. A service provider would be considered as having
deferred compensation subject to a substantial risk of forfeiture,
but for the fact that the service provider, who is president of the
corporation, also owns 4 percent of the voting power of all the
stock of a corporation. If the remaining stock is so diversely held
by the public that the president, in effect, controls the
corporation, then the possibility of the corporation enforcing a
restriction on the right to deferred compensation of the president
is not substantial, and such rights are not subject to a substantial
risk of forfeiture.
(e) Performance-based compensation--(1) In general. The term
performance-based compensation means compensation the amount of which,
or the entitlement to which, is contingent on the satisfaction of
preestablished organizational or individual performance criteria
relating to a performance period of at least 12 consecutive months.
Organizational or individual performance criteria are considered
preestablished if established in writing by not later than 90 days
after the commencement of the period of service to which the criteria
relates, provided that the outcome is substantially uncertain at the
time the criteria are established. Performance-based compensation may
include payments based on performance criteria that are not approved by
a compensation committee of the board of directors (or similar entity
in the case of a non-corporate service recipient) or by the
stockholders or members of the service recipient. Performance-based
compensation does not include any amount or portion of any amount that
will be paid either regardless of performance, or based upon a level of
performance that is substantially certain to be met at the time the
criteria is established. In addition, except as provided in paragraph
(e)(3) of this section, compensation is not performance-based
compensation merely because the amount of such compensation is
determined by reference to the value of the service recipient or the
stock of the service recipient. Where a portion of an amount of
compensation would qualify as performance-based compensation if the
portion were the sole amount available under the plan, that portion of
the award will not fail to qualify as performance-based compensation if
that portion is designated separately or otherwise separately
identifiable under the terms of the plan, and the amount of each
portion is determined independently of the other. Compensation may be
performance-based compensation where the amount will be paid regardless
of satisfaction of the performance criteria due to the service
provider's death, disability, or a change in control event (as defined
in Sec. 1.409A-3(i)(5)(i)), provided that a payment made under such
circumstances without regard to the satisfaction of the performance
criteria will not constitute performance-based compensation. For
purposes of this paragraph (e)(1), a disability refers to any medically
determinable physical or mental impairment resulting in the service
provider's inability to perform the duties of his or her position or
any substantially similar position, where such impairment can be
expected to result in death or can be expected to last
[[Page 19294]]
for a continuous period of not less than six months.
(2) Payments based upon subjective performance criteria. The term
performance-based compensation includes payments based upon subjective
performance criteria, provided that--
(i) The subjective performance criteria are bona fide and relate to
the performance of the participant service provider, a group of service
providers that includes the participant service provider, or a business
unit for which the participant service provider provides services
(which may include the entire organization); and
(ii) The determination that any subjective performance criteria
have been met is not made by the participant service provider or a
family member of the participant service provider (as defined in
section 267(c)(4) applied as if the family of an individual includes
the spouse of any member of the family), or a person under the
effective control of the participant service provider or such a family
member, and no amount of the compensation of the person making such
determination is effectively controlled in whole or in part by the
service provider or such a family member.
(3) Equity-based compensation. Compensation is performance-based
compensation if it is based solely on an increase in the value of the
service recipient, or a share of stock in the service recipient, after
the date of a grant or award. However, compensation payable for a
service period that is equal to the value of a predetermined number of
shares of stock, and is variable only to the extent that the value of
such shares appreciates or depreciates, generally will not be
performance-based compensation. Notwithstanding the foregoing, the
attainment of a prescribed value for the service recipient (or a
portion thereof), or a share of stock in the service recipient, may be
used as a preestablished organizational criterion for purposes of
providing performance-based compensation, provided that the other
requirements of paragraph (e)(1) of this section are satisfied. In
addition, an award of equity-based compensation may constitute
performance-based compensation if entitlement to the compensation is
subject to a condition that would cause the award to otherwise qualify
as performance-based compensation, such as a performance-based vesting
condition. A provision that allows a service provider to defer
compensation that would be realized upon the exercise of a stock right
generally constitutes an additional deferral feature for purposes of
the definition of a deferral of compensation under paragraph (b)(5) of
this section.
(f) Service provider--(1) In general. The term service provider
includes an individual, corporation, subchapter S corporation,
partnership, personal service corporation (as defined in section
269A(b)(1)), noncorporate entity that would be a personal service
corporation if it were a corporation, qualified personal service
corporation (as defined in section 448(d)(2)), and noncorporate entity
that would be a qualified personal service corporation if it were a
corporation, for any taxable year in which such individual,
corporation, subchapter S corporation, partnership, or other entity
accounts for gross income from the performance of services under the
cash receipts and disbursements method of accounting. The term service
provider generally includes a person who has separated from service (a
former service provider).
(2) Independent contractors--(i) In general. Except as otherwise
provided in paragraph (f)(2)(iv) of this section, section 409A does not
apply to an amount deferred under a plan between a service provider and
service recipient with respect to a particular trade or business in
which the service provider participates, including earnings credited to
such deferred amount, if during the service provider's taxable year in
which the service provider obtains a legally binding right to the
payment of the amount deferred each of the following applies:
(A) The service provider is actively engaged in the trade or
business of providing services, other than as an employee or as a
member of the board of directors of a corporation (or similar position
with respect to an entity that is not a corporation).
(B) The service provider provides significant services to two or
more service recipients to which the service provider is not related
and that are not related to one another (as defined in paragraph
(f)(2)(ii) of this section).
(C) The service provider is not related to the service recipient,
applying the definition of related person contained in paragraph
(f)(2)(ii) of this section subject to the modification that the
language ``20 percent'' is not used instead of ``50 percent'' each
place ``50 percent'' appears in sections 267(b) and 707(b)(1).
(ii) Related person. For purposes of this paragraph (f)(2), a
person is related to another person if the persons bear a relationship
to each other that is specified in section 267(b) or 707(b)(1), subject
to the modifications that the language ``20 percent'' is used instead
of ``50 percent'' each place it appears in sections 267(b) and
707(b)(1), and section 267(c)(4) is applied as if the family of an
individual includes the spouse of any member of the family; or the
persons are engaged in trades or businesses under common control
(within the meaning of section 52(a) and (b)). In addition, an
individual is related to an entity if the individual is an officer of
an entity that is a corporation, or holds a position substantially
similar to an officer of a corporation with an entity that is not a
corporation.
(iii) Significant services. Whether a service provider is providing
significant services depends on the facts and circumstances of each
case. However, for purposes of paragraph (f)(2)(i) of this section, a
service provider who provides services to two or more service
recipients to which the service provider is not related and that are
not related to one another is deemed to be providing significant
services to two or more of such service recipients for a given taxable
year, if the revenues generated from the services provided to any
service recipient or group of related service recipients during such
taxable year do not exceed 70 percent of the total revenue generated by
the service provider from the trade or business of providing such
services. In addition, in the case of a service provider who has been
providing services in a trade or business for a period of not less than
three consecutive years, for purposes of paragraph (f)(2)(i) of this
section, a service provider who provides services to two or more
service recipients to which the service provider is not related and
that are not related to one another is deemed to be providing
significant services to two or more of such service recipients for a
given taxable year if in each of the prior three taxable years the
revenues generated from the services provided to any service recipient
or group of related service recipients during such prior taxable years
did not exceed 70 percent of the total revenue generated by the service
provider from the trade or business of providing such services and, at
the time an amount is deferred, the service provider does not know or
have reason to anticipate that the revenues generated from the services
provided to any service recipient or group of related service
recipients during the current year will exceed 70 percent of the total
revenue generated by the service provider from the trade or business of
providing such services.
(iv) Management services. This paragraph (f)(2) does not apply to a
service provider to the extent the service provider provides management
services to a service recipient. For purposes of this paragraph
(f)(2)(iv), the term management services means services
[[Page 19295]]
that involve the actual or de facto direction or control of the
financial or operational aspects of a trade or business of the service
recipient, or investment management or advisory services provided to a
service recipient whose primary trade or business includes the
investment of financial assets (including investments in real estate),
such as a hedge fund or a real estate investment trust.
(v) Services provided to related persons. Section 409A does not
apply to an amount deferred under a plan that is a bona fide agreement,
method, program, or other arrangement between a service provider and a
related service recipient arising in the ordinary course of a
particular trade or business in which the service provider is engaged
to the extent that--
(A) The service provider provides services to the service recipient
as an independent contractor;
(B) During the service provider's taxable year in which the amount
is deferred, the service provider qualifies for the safe harbor
provided in paragraph (f)(2)(iii) of this section with respect to such
trade or business; and
(C) Such agreement, method, program, or other arrangement and the
practices thereunder (including billing and collection practices), are
substantially similar to the agreements, methods, programs, or other
arrangements and practices applicable to one or more unrelated service
recipients to whom the service provider provides substantial services
and that produce a majority of the total revenue that the service
provider earns from the trade or business of providing such services
during the taxable year.
(g) Service recipient. Except as otherwise specifically provided in
these regulations, the term service recipient means the person for whom
the services are performed and with respect to whom the legally binding
right to compensation arises, and all persons with whom such person
would be considered a single employer under section 414(b) (employees
of controlled group of corporations), and all persons with whom such
person would be considered a single employer under section 414(c)
(employees of partnerships, proprietorships, etc., under common
control). For example, if the service provider is an employee, the
service recipient generally is the employer (including all persons
treated as a single employer under section 414(b) or (c)).
Notwithstanding the foregoing, section 409A applies to a plan that
provides for the deferral of compensation, even if the payment of the
compensation is not made by the person for whom services are performed.
(h) Separation from service--(1) Employees--(i) In general. An
employee separates from service with the employer if the employee dies,
retires, or otherwise has a termination of employment with the
employer. However, for purposes of this paragraph (h)(1), the
employment relationship is treated as continuing intact while the
individual is on military leave, sick leave, or other bona fide leave
of absence if the period of such leave does not exceed six months, or
if longer, so long as the individual retains a right to reemployment
with the service recipient under an applicable statute or by contract.
For purposes of this paragraph (h)(1), a leave of absence constitutes a
bona fide leave of absence only if there is a reasonable expectation
that the employee will return to perform services for the employer. If
the period of leave exceeds six months and the individual does not
retain a right to reemployment under an applicable statute or by
contract, the employment relationship is deemed to terminate on the
first date immediately following such six-month period. Notwithstanding
the foregoing, where a leave of absence is due to any medically
determinable physical or mental impairment that can be expected to
result in death or can be expected to last for a continuous period of
not less than six months, where such impairment causes the employee to
be unable to perform the duties of his or her position of employment or
any substantially similar position of employment, a 29-month period of
absence may be substituted for such six-month period.
(ii) Termination of employment. Whether a termination of employment
has occurred is determined based on whether the facts and circumstances
indicate that the employer and employee reasonably anticipated that no
further services would be performed after a certain date or that the
level of bona fide services the employee would perform after such date
(whether as an employee or as an independent contractor) would
permanently decrease to no more than 20 percent of the average level of
bona fide services performed (whether as an employee or an independent
contractor) over the immediately preceding 36-month period (or the full
period of services to the employer if the employee has been providing
services to the employer less than 36 months). Facts and circumstances
to be considered in making this determination include, but are not
limited to, whether the employee continues to be treated as an employee
for other purposes (such as continuation of salary and participation in
employee benefit programs), whether similarly situated service
providers have been treated consistently, and whether the employee is
permitted, and realistically available, to perform services for other
service recipients in the same line of business. An employee is
presumed to have separated from service where the level of bona fide
services performed decreases to a level equal to 20 percent or less of
the average level of services performed by the employee during the
immediately preceding 36-month period. An employee will be presumed not
to have separated from service where the level of bona fide services
performed continues at a level that is 50 percent or more of the
average level of service performed by the employee during the
immediately preceding 36-month period. No presumption applies to a
decrease in the level of bona fide services performed to a level that
is more than 20 percent and less than 50 percent of the average level
of bona fide services performed during the immediately preceding 36-
month period. The presumption is rebuttable by demonstrating that the
employer and the employee reasonably anticipated that as of a certain
date the level of bona fide services would be reduced permanently to a
level less than or equal to 20 percent of the average level of bona
fide services provided during the immediately preceding 36-month period
or full period of services provided to the employer if the employee has
been providing services to the service recipient for a period of less
than 36 months (or that the level of bona fide services would not be so
reduced). For example, an employee may demonstrate that the employer
and employee reasonably anticipated that the employee would cease
providing services, but that, after the original cessation of services,
business circumstances such as termination of the employee's
replacement caused the employee to return to employment. Although the
employee's return to employment may cause the employee to be presumed
to have continued in employment because the employee is providing
services at a rate equal to the rate at which the employee was
providing services before the termination of employment, the facts and
circumstances in this case would demonstrate that at the time the
employee originally ceased to provide services, the employee and the
service recipient reasonably anticipated that the employee would not
provide services in
[[Page 19296]]
the future. Notwithstanding the foregoing provisions of this paragraph
(h)(1)(ii), a plan may treat another level of reasonably anticipated
permanent reduction in the level of bona fide services as a separation
from service, provided that the level of reduction required must be
designated in writing as a specific percentage, and the reasonably
anticipated reduced level of bona fide services must be greater than 20
percent but less than 50 percent of the average level of bona fide
services provided in the immediately preceding 12 months. The plan must
specify the definition of separation from service on or before the date
on which a separation from service is designated as a time of payment
of the applicable amount deferred, and once designated, any change to
the definition of separation from service with respect to such amount
deferred will be subject to the rules regarding subsequent deferrals
and the acceleration of payments. For purposes of this paragraph
(h)(1)(ii), for periods during which an employee is on a paid bona fide
leave of absence (as defined in paragraph (h)(1)(i) of this section)
and has not otherwise terminated employment pursuant to paragraph
(h)(1)(i) of this section, the employee is treated as providing bona
fide services at a level equal to the level of services that the
employee would have been required to perform to receive the
compensation paid with respect to such leave of absence. Periods during
which an employee is on an unpaid bona fide leave of absence (as
defined in paragraph (h)(1)(i) of this section) and has not otherwise
terminated employment pursuant to paragraph (h)(1)(i) of this section,
are disregarded for purposes of this paragraph (h)(1)(ii) (including
for purposes of determining the applicable 36-month (or shorter)
period).
(2) Independent contractors--(i) In general. An independent
contractor is considered to have a separation from service with the
service recipient upon the expiration of the contract (or in the case
of more than one contract, all contracts) under which services are
performed for the service recipient if the expiration constitutes a
good-faith and complete termination of the contractual relationship. An
expiration does not constitute a good faith and complete termination of
the contractual relationship if the service recipient anticipates a
renewal of a contractual relationship or the independent contractor
becoming an employee. For this purpose, a service recipient is
considered to anticipate the renewal of the contractual relationship
with an independent contractor if it intends to contract again for the
services provided under the expired contract, and neither the service
recipient nor the independent contractor has eliminated the independent
contractor as a possible provider of services under any such new
contract. Further, a service recipient is considered to intend to
contract again for the services provided under an expired contract if
the service recipient's doing so is conditioned only upon incurring a
need for the services, the availability of funds, or both.
(ii) Special rule. Notwithstanding paragraph (h)(2)(i) of this
section, a plan is considered to satisfy the requirement described in
Sec. 1.409A-3(a)(1) with respect to an amount payable upon a
separation from service if, with respect to amounts payable to a
service provider who is an independent contractor, the plan provides
that--
(A) No amount will be paid to the service provider before a date at
least 12 months after the day on which the contract expires under which
the service provider performs services for the service recipient (or,
in the case of more than one contract, all such contracts expire); and
(B) No amount payable to the service provider on that date will be
paid to the service provider if, after the expiration of the contract
(or contracts) and before that date, the service provider performs
services for the service recipient as an independent contractor or an
employee.
(3) Definition of service recipient and employer. For purposes of
this paragraph (h), the term service recipient or employer means the
service recipient as defined in paragraph (g) of this section, provided
that in applying section 1563(a)(1), (2), and (3) for purposes of
determining a controlled group of corporations under section 414(b),
the language ``at least 50 percent'' is used instead of ``at least 80
percent'' each place it appears in section 1563(a)(1), (2), and (3),
and in applying Sec. 1.414(c)-2 for purposes of determining trades or
businesses (whether or not incorporated) that are under common control
for purposes of section 414(c), ``at least 50 percent'' is used instead
of ``at least 80 percent'' each place it appears in Sec. 1.414(c)-2. A
plan may provide with respect to a deferral of compensation under the
plan that in applying sections 1563(a)(1), (2), and (3) for purposes of
determining a controlled group of corporations under section 414(b),
another defined percentage greater than 50 percent, but not greater
than 80 percent, is used instead of ``at least 80 percent'' at each
place it appears in sections 1563(a)(1), (2), and (3), and in applying
Sec. 1.414(c)-2 for purposes of determining trades or businesses
(whether or not incorporated) that are under common control for
purposes of section 414(c), another defined percentage greater than 50
percent, but not greater than 80 percent, is used instead of ``at least
80 percent'' at each place it appears in Sec. 1.414(c)-2. In addition,
where the use of such definition of service recipient for purposes of
determining a separation from service is based upon legitimate business
criteria, the plan may provide that for purposes of a deferral of
compensation under the plan that in applying sections 1563(a)(1), (2),
and (3) for purposes of determining a controlled group of corporations
under section 414(b), the language ``at least 20 percent'' or another
defined percentage not less than 20 percent but not greater than 50
percent is used instead of ``at least 80 percent'' at each place it
appears in sections 1563(a)(1), (2), and (3), and in applying Sec.
1.414(c)-2 for purposes of determining trades or businesses (whether or
not incorporated) that are under common control for purposes of section
414(c), the language ``at least 20 percent'' or another defined
percentage not less than 20 percent but not greater than 50 percent is
used instead of ``at least 80 percent'' at each place it appears in
Sec. 1.414(c)-2. Where a definition of service recipient or employer
other than the definition provided in the first sentence of this
paragraph (h)(3) (the 50 percent standard) is used, the plan must
designate in writing the alternate definition no later than the last
date at which the time and form of payment of the applicable amount
deferred must be elected in accordance with Sec. 1.409A-2(a), and any
change in the definition for such amounts deferred will constitute a
change in the time and form of payment subject to the rules governing
subsequent deferral elections under Sec. 1.409A-2(b) and the
acceleration of payments under Sec. 1.409A-3(j).
(4) Asset purchase transactions. Where as part of a sale or other
disposition of assets by one service recipient (seller) to an unrelated
service recipient (buyer), a service provider of the seller would
otherwise experience a separation from service with the seller, the
seller and the buyer may retain the discretion to specify, and may
specify, whether a service provider providing services to the seller
immediately before the asset purchase transaction and providing
services to the buyer after and in connection with the asset purchase
transaction has experienced a separation from service for purposes of
this
[[Page 19297]]
paragraph (h), provided that the asset purchase transaction results
from bona fide, arm's length negotiations, all service providers
providing services to the seller immediately before the asset purchase
transaction and providing services to the buyer after and in connection
with the asset purchase transaction are treated consistently
(regardless of position at the seller) for purposes of applying the
provisions of any nonqualified deferred compensation plan, and such
treatment is specified in writing no later than the closing date of the
asset purchase transaction. For purposes of this paragraph (h)(4),
references to a sale or other disposition of assets, or an asset
purchase transaction, refer only to a transfer of substantial assets,
such as a plant or division or substantially all the assets of a trade
or business. For purposes of this paragraph (h)(4), whether a service
recipient is related to another service recipient is determined under
the rules provided in paragraph (f)(2)(ii) of this section.
(5) Dual status. If a service provider provides services both as an
employee of a service recipient and as an independent contractor of a
service recipient, the service provider must separate from service both
as an employee and as an independent contractor to be treated as having
separated from service. If a service provider ceases providing services
as an independent contractor and begins providing services as an
employee, or ceases providing services as an employee and begins
providing services as an independent contractor, the service provider
will not be considered to have a separation from service until the
service provider has ceased providing services in both capacities.
Notwithstanding the foregoing, if a service provider provides services
both as an employee of a service recipient and a member of the board of
directors of a corporate service recipient (or an analogous position
with respect to a non-corporate service recipient), the services
provided as a director are not taken into account in determining
whether the service provider has a separation from service as an
employee for purposes of a nonqualified deferred compensation plan in
which the service provider participates as an employee that is not
aggregated with any plan in which the service provider participates as
a director under paragraph (c)(2)(ii) of this section. In addition, if
a service provider provides services both as an employee of a service
recipient and a member of the board of directors of a corporate service
recipient (or an analogous position with respect to a non-corporate
service recipient), the services provided as an employee are not taken
into account in determining whether the service provider has a
separation from service as a director for purposes of a nonqualified
deferred compensation plan in which the service provider participates
as a director that is not aggregated with any plan in which the service
provider participates as an employee under paragraph (c)(2)(ii) of this
section.
(6) Collectively bargained plans covering multiple employers.
Notwithstanding the foregoing provisions of this paragraph (h), to the
extent a plan is established pursuant to a bona fide collective
bargaining agreement covering services performed by employees for
multiple employers, such plan may define a separation from service in a
reasonable manner that treats the employee as not having separated from
service during periods in which the employee is not providing services
but is available to perform services covered by the collective
bargaining agreement for one or more employers, provided that the
definition also provides that the employee must be deemed to have
separated from service at a specified date not later than the end of
any period of at least 12 consecutive months during which the employee
has not provided any services covered by the collective bargaining
agreement to any participating employer. This paragraph (h)(6) applies
only if the definition of separation from service provided by the
collective bargaining agreement was the subject of arm's length
negotiations between employee representatives and two or more
employers, the agreement between employee representatives and such
employers satisfies section 7701(a)(46), and the circumstances
surrounding the agreement evidence good faith bargaining between
adverse parties over such definition.
(i) Specified employee--(1) In general. The term specified employee
means a service provider who, as of the date of the service provider's
separation from service, is a key employee of a service recipient any
stock of which is publicly traded on an established securities market
or otherwise. For purposes of this paragraph (i)(1), a service provider
is a key employee if the service provider meets the requirements of
section 416(i)(1)(A)(i), (ii), or (iii) (applied in accordance with the
regulations thereunder and disregarding section 416(i)(5)) at any time
during the 12-month period ending on a specified employee
identification date. If a service provider is a key employee as of a
specified employee identification date, the service provider is treated
as a key employee for purposes of this paragraph (i) for the entire 12-
month period beginning on the specified employee effective date.
(2) Definition of compensation. For purposes of identifying a
specified employee by applying the requirements of section
416(i)(1)(A)(i), (ii), and (iii), the definition of compensation under
Sec. 1.415(c)-2(a) is used, applied as if the service recipient were
not using any safe harbor provided in Sec. 1.415(c)-2(d), were not
using any of the special timing rules provided in Sec. 1.415(c)-2(e),
and were not using any of the special rules provided in Sec. 1.415(c)-
2(g). Notwithstanding the foregoing, a service recipient may elect to
use any available definition of compensation under section 415 and the
regulations thereunder in accordance with the election requirements set
forth in paragraph (i)(8) of this section, including any available safe
harbor and any available election under the timing rules or special
rules, provided that the definition is applied consistently to all
employees of the service recipient for purposes of identifying
specified employees. A service recipient may elect to use such an
alternative definition regardless of whether another definition of
compensation is being used for purposes of a qualified plan sponsored
by the service recipient. However, once a list of specified employees
has become effective, the service recipient cannot change the
definition of compensation for purposes of identifying specified
employees for the period with respect to which such list is effective.
(3) Specified employee identification date. Unless another date is
designated in accordance with the requirements of this paragraph (i)(3)
and paragraph (i)(8) of this section, the specified employee
identification date is December 31. A service recipient may designate
in accordance with the requirements of paragraph (i)(8) of this section
any other date as the specified employee identification date, provided
that a service recipient must use the same specified employee
identification date with respect to all nonqualified deferred
compensation plans, and any change to the specified employee
identification date may not be effective for a period of at least 12
months. The service recipient may designate a specified employee
identification date in each plan or in a separate document applicable
to all plans, provided that the service recipient will not be treated
as having designated a specified employee identification date before
the
[[Page 19298]]
designation is legally binding on the service recipient and all
affected service providers. Any designation of a specified employee
identification date made on or before December 31, 2007, may be applied
to any separation from service occurring on or after January 1, 2005,
unless and until subsequently changed pursuant to this paragraph
(i)(3).
(4) Specified employee effective date. Unless another date is
designated in accordance with the requirements of this paragraph (i)(4)
and paragraph (i)(8) of this section, the specified employee effective
date is the first day of the fourth month following the specified
employee identification date. A service recipient may designate in
accordance with the requirements of paragraph (i)(8) of this section
any date following the specified employee identification date as the
specified employee effective date, provided that such date may not be
later than the first day of the fourth month following the specified
employee identification date, and provided further that a service
recipient must use the same specified employee effective date with
respect to all nonqualified deferred compensation plans, and any change
to the specified employee effective date may not be effective for a
period of at least 12 months. The service recipient may designate a
specified employee effective date through inclusion in each plan
document or through a separate document applicable to all plans,
provided that the service recipient will not be treated as having
designated a specified employee effective date on any date before the
designation is legally binding on the service recipient and all
affected service providers. Any designation of a specified employee
effective date made on or before December 31, 2007, may be applied to
any separation from service occurring on or after January 1, 2005,
unless and until subsequently changed pursuant to this paragraph
(i)(4).
(5) Alternative methods of satisfying the six-month delay rule. A
plan may provide, in accordance with the requirements of paragraph
(i)(8) of this section, for an alternative method to identify service
providers who will be subject to the six-month delay rule provided in
section 409A(a)(2)(B)(i), provided that the alternative method is
reasonably designed to include all specified employees (determined
without respect to any available service recipient elections), the
alternative method is an objectively determinable standard providing no
direct or indirect election to any service provider regarding its
application, and the alternative method results in either all service
providers or no more than 200 service providers being identified in the
class as of any date. Use of such an alternative method will not be
treated as a change in the time and form of payment for purposes of
Sec. 1.409A-2(b) (the subsequent deferral rules), even if the service
provider is not a specified employee when the payment is delayed.
(6) Corporate transactions--(i) Mergers and acquisitions of public
service recipients. If as a result of a corporate transaction, two or
more separate service recipients, more than one of which has stock
outstanding that is publicly traded on an established securities market
or otherwise immediately before the transaction, become one service
recipient, any stock of which is publicly traded on an established
securities market or otherwise immediately after the transaction
(resulting public service recipient), the resulting public service
recipient's next specified employee identification date and specified
employee effective date following the corporate transaction are the
specified employee identification date and specified employee effective
date that the acquiring service recipient would have been required to
use absent such transaction. For this purpose, in the case of a
corporate merger, the acquiring service recipient is the service
recipient that included the surviving corporation in such merger, in
the case of an acquisition by a corporation of the stock of another
corporation, the acquiring service recipient is the service recipient
that included the corporation that acquired such stock, and in all
other cases, the surviving service recipient is determined on the basis
of all of the facts and circumstances. For the period between the
transaction and the next specified employee effective date, the list of
specified employees of the resulting public service recipient is
determined by combining the lists of specified employees of all service
recipients participating in the transaction that were in effect at the
date of the corporate transaction, ranking such specified employees in
order of the amount of compensation used to determine each specified
employee's status as a specified employee, and treating the top 50 of
such specified employees, plus any employees described in section
416(i)(1)(ii) or section 416(i)(1)(iii) and the regulations thereunder
(relating to 1-percent and 5-percent owners) who are not included in
such top 50 specified employees, as specified employees for the period
between the corporate transaction and the next specified employee
effective date. Alternatively, the resulting service recipient may
elect in accordance with the requirements of paragraph (i)(8) of this
section to use any reasonable method to determine the specified
employees of the resulting service recipient, including the use of an
alternative method of compliance described in paragraph (i)(5) of this
section, provided that such method is adopted no later than 90 days
after the corporate transaction and applied prospectively from the date
the method is adopted.
(ii) Mergers and acquisitions of nonpublic service recipients. If
as part of a corporate transaction a service recipient that does not
have outstanding stock that is publicly traded on an established
securities market or otherwise immediately before the transaction
(initial private service recipient), and a service recipient with stock
outstanding that is publicly traded on an established securities market
or otherwise immediately before the transaction (initial public service
recipient), become a single service recipient having stock that is
publicly traded on an established securities market or otherwise
immediately after the transaction (resulting public service recipient),
the resulting public service recipient's next specified employee
identification date and specified employee effective date following the
corporate transaction are the specified employee identification date
and specified employee effective date that the initial public service
recipient would have been required to use absent such transaction. For
the period after the date of the corporate transaction and before the
next specified employee effective date, the specified employees of the
initial public service recipient immediately before the transaction
continue to be the specified employees of the resulting public service
recipient, and no service providers of the initial private service
recipient are required to be treated as specified employees.
(iii) Spinoffs. If as part of a corporate transaction, a service
recipient with stock outstanding that is publicly traded on an
established securities market or otherwise immediately before the
transaction (initial public service recipient), becomes two or more
separate service recipients, each with stock outstanding that is
publicly traded on an established securities market or otherwise
immediately after the transaction (post-transaction public service
recipients), the next specified employee identification date of each of
the post-transaction public service recipients is the specified
employee identification date that the initial public
[[Page 19299]]
service recipient would have been required to use absent such
transaction. For the period after the date of the corporate transaction
and before the next specified employee effective date, the specified
employees of the initial public service recipient immediately before
the transaction continue to be the specified employees of the post-
transaction public service recipients.
(iv) Public offerings and other corporate transactions. If as part
of an initial public offering or corporate transaction not described in
paragraph (i)(6)(ii) or (iii) of this section, a service recipient with
no outstanding stock that is publicly traded on an established
securities market or otherwise immediately before such offering or
other transaction (initial private service recipient), becomes one or
more service recipients with stock outstanding that is publicly traded
on an established securities market or otherwise immediately after such
offering or other transaction (post-transaction public service
recipient), each post-transaction public service recipient has a
specified employee identification date of December 31 and a specified
employee effective date of April 1, effective retroactively to the
December 31 and April 1 next preceding the offering or other
transaction for purposes of identifying the specified employees between
the corporation transaction and the next December 31. Alternatively, a
post-transaction public service recipient may elect in accordance with
the requirements of paragraph (i)(8) of this section, a specified
employee identification date and specified employee effective date on
or before the date of the offering or other transaction. If a public
service recipient makes such an election, for the period after the
offering or other transaction and before the next specified employee
effective date, the specified employees of the post-transaction public
service recipient consist of the service providers that at the time of
the offering or other transaction would have been classified as
specified employees of the initial private service recipient, had the
initial private service recipient elected the same specified employee
identification date and specified employee effective date as selected
by the post-transaction public service recipient, and had such initial
private service recipient had stock publicly traded on an established
securities market or otherwise as of the specified employee
identification date preceding the transaction.
(v) Alternative methods of compliance. For purposes of this
paragraph (i)(6), references to specified employees as of a corporate
transaction or offering include any specified employees identified
through the use of an alternative method described in paragraph (i)(5)
of this section, where the use of such alternative method was
established and effective at the time of the corporate transaction or
offering.
(7) Nonresident alien employees. For purposes of determining
whether an employee meets the requirements of section 416(i)(1)(A)(i),
(ii), or (iii) (applied in accordance with the regulations thereunder
and disregarding section 416(i)(5)), and therefore is a key employee,
the incorporation of the rules of Sec. 1.415(c)-2(g)(5) regarding the
definition of compensation applies. Accordingly, the rule of Sec.
1.415(c)-2(g)(5)(i), generally requiring the treatment as compensation
of certain compensation excludible from an employee's gross income due
to the location of the services or the identity of the employer,
applies. In addition, a service recipient may elect in accordance with
paragraph (i)(8) of this section to apply the rule of Sec. 1.415(c)-
2(g)(5)(ii) to not treat as compensation certain compensation
excludible from an employee's gross income on account of the location
of the services or the identity of the employer that is not effectively
connected with the conduct of a trade or business within the United
States. A service recipient may elect to apply the rule of Sec. 1.415-
2(g)(5)(ii) regardless of whether the service recipient has elected to
apply the rule to a qualified plan sponsored by the service recipient;
however, once a list of specified employees has become effective, any
election of the rule for that period may not be changed.
Notwithstanding the foregoing, any election of the rule made before
January 1, 2008, may be effective with respect to any specified
employee identification date on or before December 31, 2007.
(8) Elections affecting the identification of specified employees.
The elections described in paragraphs (i)(2) through (7) of this
section are effective only as of the date that all necessary corporate
action has been taken to make such elections binding for purposes of
all affected nonqualified deferred compensation plans in which the
service providers of the service recipient that would become a
specified employee due to the application of such election participate.
Where a taxpayer attempts to make an election under paragraph (i)(2),
(3), (4), (5), (6), or (7) of this section but such election is not
binding on all the affected nonqualified deferred compensation plans
and applied consistently to all such service providers, the election is
not effective and the rule under paragraph (i)(2), (3), (4), (5), (6),
or (7) of this section, as applicable, that would apply absent an
election is applicable for identifying specified employees.
(j) Nonresident alien. (1) Except as provided in paragraph (j)(2)
of this section, the term nonresident alien means an individual who
is--
(i) A nonresident alien within the meaning of section
7701(b)(1)(B); or
(ii) A dual resident taxpayer within the meaning of Sec.
301.7701(b)-7(a)(1) of this chapter with respect to any taxable year in
which such individual is treated as a nonresident alien for purposes of
computing the individual's U.S. income tax liability.
(2) The term nonresident alien does not include--
(i) A nonresident alien with respect to whom an election is in
effect for the taxable year under section 6013(g) to be treated as a
resident of the United States;
(ii) A former citizen or long-term resident (within the meaning of
section 877(e)(2)) who expatriated after June 3, 2004, and has not
complied with the requirements of section 7701(n); or
(iii) An individual who is treated as a citizen or resident of the
United States for the taxable year under section 877(g).
(k) Established securities market. The term established securities
market means an established securities market within the meaning of
Sec. 1.897-1(m).
(l) Stock right. The term stock right means a stock option (other
than an incentive stock option described in section 422 or an option
granted pursuant to an employee stock purchase plan described in
section 423) or a stock appreciation right.
(m) Separation pay plan. The term separation pay plan means any
plan that provides separation pay or, where a plan provides both
amounts that are separation pay and that are not separation pay, that
portion of the plan that provides separation pay. The term separation
pay means any deferral of compensation (before the application of the
exclusions from the definition of a deferral of compensation set forth
in paragraph (b)(9) of this section) that will not be paid under any
circumstances unless the service provider has had a separation from
service, whether voluntary or involuntary, including payments in the
form of reimbursements of expenses incurred, and the provision of in-
kind benefits. A deferral of compensation that the service provider may
receive without a separation from service does not become separation
pay merely because the service provider elects to receive or receives
the payment after or upon a separation from service.
[[Page 19300]]
A deferral of compensation does not fail to be separation pay merely
because the payment is conditioned upon the execution of a release of
claims, noncompetition or nondisclosure provisions, or other similar
requirements. Notwithstanding the foregoing, any amount, or entitlement
to any amount, that acts as a substitute for, or replacement of,
amounts deferred by the service recipient under a nonqualified deferred
compensation plan constitutes a payment of compensation or deferral of
compensation under such nonqualified deferred compensation plan.
(n) Involuntary separation from service--(1) In general. An
involuntary separation from service means a separation from service due
to the independent exercise of the unilateral authority of the service
recipient to terminate the service provider's services, other than due
to the service provider's implicit or explicit request, where the
service provider was willing and able to continue performing services.
An involuntary separation from service may include the service
recipient's failure to renew a contract at the time such contract
expires, provided that the service provider was willing and able to
execute a new contract providing terms and conditions substantially
similar to those in the expiring contract and to continue providing
such services. The determination of whether a separation from service
is involuntary is based on all the facts and circumstances. Any
characterization of the separation from service as voluntary or
involuntary by the service provider and the service recipient in the
documentation of the separation from service is presumed to properly
characterize the nature of the separation from service. However, the
presumption may be rebutted where the facts and circumstances indicate
otherwise. For example, if a separation from service is designated as a
voluntary separation from service or resignation, but the facts and
circumstances indicate that absent such voluntary separation from
service the service recipient would have terminated the service
provider's services, and that the service provider had knowledge that
the service provider would be so terminated, the separation from
service is involuntary.
(2) Separations from service for good reason--(i) In general.
Notwithstanding paragraph (n)(1) of this section, a service provider's
voluntary separation from service will be treated for purposes of this
section and Sec. Sec. 1.409A-2 through 1.409A-6 as an involuntary
separation from service if the separation from service occurs under
certain limited bona fide conditions, where the avoidance of the
requirements of section 409A is not a purpose of the inclusion of these
conditions in the plan or of the actions by the service recipient in
connection with the satisfaction of these conditions, and a voluntary
separation from service under such conditions effectively constitutes
an involuntary separation from service. Generally such conditions will
be prespecified under an agreement to provide compensation upon a
separation from service for good reason. Such a good reason (or a
similar condition) must be defined to require actions taken by the
service recipient resulting in a material negative change to the
service provider in the service relationship, such as the duties to be
performed, the conditions under which such duties are to be performed,
or the compensation to be received for performing such services. Other
factors taken into account in determining whether a separation from
service for good reason effectively constitutes an involuntary
separation from service include the extent to which the payments upon a
separation from service for good reason are in the same amount and are
to be made at the same time and in the same form as payments available
upon an actual involuntary separation from service, and whether the
service provider is required to give the service recipient notice of
the existence of the condition that would result in treatment as a
separation from service for good reason and a reasonable opportunity to
remedy the condition.
(ii) Safe harbor. For purposes of this section and Sec. Sec.
1.409A-2 through 1.409A-6, if a plan provides that a voluntary
separation from service will be treated as an involuntary separation
from service if the separation from service occurs under certain
express conditions, a separation from service satisfying the conditions
set forth in the plan will be treated as an involuntary separation from
the service if the necessary conditions (or set of conditions) require
the following:
(A) The separation from service must occur during a pre-determined
limited period of time not to exceed two years following the initial
existence of one or more of the following conditions arising without
the consent of the service provider:
(1) A material diminution in the service provider's base
compensation.
(2) A material diminution in the service provider's authority,
duties, or responsibilities.
(3) A material diminution in the authority, duties, or
responsibilities of the supervisor to whom the service provider is
required to report, including a requirement that a service provider
report to a corporate officer or employee instead of reporting directly
to the board of directors of a corporation (or similar governing body
with respect to an entity other than a corporation).
(4) A material diminution in the budget over which the service
provider retains authority.
(5) A material change in the geographic location at which the
service provider must perform the services.
(6) Any other action or inaction that constitutes a material breach
by the service recipient of the agreement under which the service
provider provides services.
(B) The amount, time, and form of payment upon the separation from
service must be substantially identical to the amount, time and form of
payment payable due to an actual involuntary separation from service,
to the extent such a right exists.
(C) The service provider must be required to provide notice to the
service recipient of the existence of the condition described in
paragraph (n)(2)(ii)(A) of this section within a period not to exceed
90 days of the initial existence of the condition, upon the notice of
which the service recipient must be provided a period of at least 30
days during which it may remedy the condition and not be required to
pay the amount.
(3) Special rule for certain collectively bargained plans.
Notwithstanding the foregoing, for purposes of this paragraph (n), to
the extent a plan is subject to a bona fide collective bargaining
agreement covering services performed for multiple employers under
which an employee must separate from service with all such employers in
order to receive a payment, such plan may use any reasonable definition
of involuntary separation from service, provided that such definition
is consistent with any definition of a separation from service adopted
under paragraph (h)(6) of this section, and provided further that the
definition of an involuntary separation from service provided by the
collective bargaining agreement was the subject of arm's length
negotiations between employee representatives and two or more
employers, the agreement between employee representatives and such
employers satisfies section 7701(a)(46), and the circumstances
surrounding the agreement evidence good faith bargaining between
adverse parties over such definition.
(o) Earnings. Whether a deferred amount constitutes earnings on an
amount deferred, or actual or notional income attributable to an amount
deferred, is determined under the
[[Page 19301]]
principles defining income attributable to the amount taken into
account under Sec. 31.3121(v)(2)-1(d)(2) of this chapter. Accordingly,
with respect to an account balance plan, earnings on an amount deferred
generally include an amount credited on behalf of a service provider
under the terms of the plan that reflects a rate of return that does
not exceed either the rate of return on a predetermined actual
investment or, if the income does not reflect the rate of return on a
predetermined actual investment, a reasonable rate of interest. With
respect to nonaccount balance plans, earnings on an amount deferred
generally include an increase, due solely to the passage of time, in
the present value of the future payments to which the service provider
has obtained a legally binding right, the present value of which
constituted the amount deferred (determined as of the date such amount
was deferred), but only if the amount deferred was determined using
reasonable actuarial assumptions and methods. A right to earnings on an
amount deferred generally is treated as a right to a deferral of
compensation for purposes of this section and Sec. Sec. 1.409A-2
through 1.409A-6. However, for purposes of any provision of this
section and Sec. Sec. 1.409A-2 through 1.409A-6 referring to earnings
on deferred compensation (or similar terms), the use of an unreasonable
rate of return, or unreasonable actuarial assumptions and methods,
generally will result in the treatment of some or all of such a right
to deferred compensation as a right only to deferred compensation, and
not a right to earnings on deferred compensation, so that the provision
will not be applicable. With respect to plans that are neither account
balance plans nor nonaccount balance plans, these rules apply by
analogy.
(p) In-kind benefits. The term in-kind benefits refers to services
provided to or on behalf of a service provider, such as financial
planning services, or tangible personal or real property made available
for use by or on behalf of the service provider, such as the use of an
aircraft or vehicle, and does not refer to a transfer of property
within the meaning of section 83 and the regulations thereunder, or a
promise to transfer, or an option to purchase or receive, property in
the future.
(q) Application of definitions and rules. The definitions and rules
set forth in paragraphs (a) through (p) of this section apply for
purposes of section 409A, this section, and Sec. Sec. 1.409A-2 through
1.409A-6.
Sec. 1.409A-2 Deferral elections.
(a) Initial elections as to the time and form of payment--(1) In
general. A plan that is, or constitutes part of, a nonqualified
deferred compensation plan meets the requirements of section
409A(a)(4)(B) only if under the terms of the plan, compensation for
services performed during a service provider's taxable year (the
service year) may be deferred at the service provider's election only
if the election to defer such compensation is made and becomes
irrevocable not later than the latest date permitted in this paragraph
(a). An election will not be considered to be revocable merely because
the service provider or service recipient may make an election to
change the time and form of payment pursuant to paragraph (b) of this
section, or the service recipient may accelerate the time of payment
pursuant to Sec. 1.409A-3(j)(4) (exceptions to prohibition on
accelerated payments). Whether a plan provides a service provider an
opportunity to elect the time or form of payment of compensation is
determined based upon all the facts and circumstances surrounding the
determination of the time and form of payment of the compensation. For
purposes of this section, an election to defer includes an election as
to the time of the payment, an election as to the form of the payment
or an election as to both the time and the form of the payment, but
does not include an election as to the medium of payment (for example,
an election between a payment of cash or a payment of property). Except
as otherwise expressly provided in this section, an election will not
be considered made until such election becomes irrevocable under the
terms of the applicable plan. Accordingly, a plan may provide that an
election to defer may be changed at any time before the last
permissible date for making such an election. Where a plan provides the
service provider a right to make an initial deferral election, and
further provides that the election remains in effect until terminated
or modified by the service provider, the election will be treated as
made as of the date such election becomes irrevocable as to
compensation for services performed during the relevant service year.
For example, where a plan provides that a service provider's election
to defer a set percentage will remain in effect until changed or
revoked, but that as of each December 31 the election becomes
irrevocable with respect to salary payable in connection with services
performed in the immediately following year, the initial deferral
election with respect to salary payable with respect to services
performed in the immediately following year will be deemed to have been
made as of the December 31 upon which the election became irrevocable.
For purposes of this paragraph (a), the reference to a service period
or a performance period refers to the period of service for which the
right to the compensation arises, and may include periods before the
grant of a legally binding right to the compensation. For example,
where a service recipient grants a bonus based upon services performed
in the calendar year 2010, but retains the discretion to rescind the
bonus until 2011 such that the promise of the bonus is not a legally
binding right, the period of service or performance period to which the
compensation relates is the calendar year 2010.
(2) Service recipient elections. A plan that provides for a
deferral of compensation for services performed during a service
provider's taxable year that does not provide the service provider with
an opportunity to elect the time or form of payment of such
compensation must designate the time and form of payment by no later
than the later of the time the service provider first has a legally
binding right to the compensation or, if later, the time the service
provider would be required under this section to make such an election
if the service provider were provided such an election. Such
designation is treated as an initial deferral election for purposes of
this section. Where a plan permits a service recipient to exercise
discretion to disregard a service provider election as to the time or
form of a payment, any service provider election that is subject to
such discretion will be treated as revocable so long as such discretion
may be exercised.
(3) General rule. A plan that is, or constitutes part of, a
nonqualified deferred compensation plan meets the requirements of
section 409A(a)(4)(B) if under the terms of the plan, compensation for
services performed during a service provider's taxable year (the
service year) may be deferred at the service provider's election only
if the election to defer such compensation is made not later than the
close of the service provider's taxable year next preceding the service
year.
(4) Initial deferral election with respect to short-term deferrals.
If a service provider has a legally binding right to a payment of
compensation in a subsequent taxable year that, absent a deferral
election, would be treated as a short-term deferral within the meaning
[[Page 19302]]
of Sec. 1.409A-1(b)(4), an election to defer such compensation may be
made in accordance with the requirements of paragraph (b) of this
section, applied as if the amount were a deferral of compensation and
the scheduled payment date for the amount were the date the substantial
risk of forfeiture lapses. Notwithstanding the requirements of
paragraph (b) of this section, such a deferral election may provide
that the deferred amounts will be payable upon a change in control
event (as defined in Sec. 1.409A-3(i)(5)) without regard to the five-
year additional deferral requirement in paragraph (b) of this section.
(5) Initial deferral election with respect to certain forfeitable
rights. If a service provider has a legally binding right to a payment
in a subsequent year that is subject to a condition requiring the
service provider to continue to provide services for a period of at
least 12 months from the date the service provider obtains the legally
binding right to avoid forfeiture of the payment, an election to defer
such compensation may be made on or before the 30th day after the
service provider obtains the legally binding right to the compensation,
provided that the election is made at least 12 months in advance of the
earliest date at which the forfeiture condition could lapse. For
purposes of this paragraph (a)(5), a condition will not be treated as
failing to require the service provider to continue to provide services
for a period of at least 12 months from the date the service provider
obtains the legally binding right merely because the condition
immediately lapses upon the death or disability (as defined in Sec.
1.409A-3(i)(4)) of the service provider, or upon a change in control
event (as defined in Sec. 1.409A-3(i)(5)), provided that if death,
disability, or a change in control event occurs and the condition
lapses before the end of such 12-month period, a deferral election may
be given effect only if the deferral election is permitted under this
section without regard to this paragraph (a)(5).
(6) Initial deferral election with respect to fiscal year
compensation. In the case of a service recipient with a taxable year
that is not the same as the taxable year of the service provider, a
plan may provide that fiscal year compensation may be deferred at the
service provider's election only if the election to defer such
compensation is made not later than the close of the service
recipient's taxable year immediately preceding the first taxable year
of the service recipient in which any services are performed for which
such compensation is payable. For purposes of this paragraph (a)(6),
the term fiscal year compensation means compensation relating to a
period of service coextensive with one or more consecutive taxable
years of the service recipient, of which no amount is paid or payable
during the service recipient's taxable year or years constituting the
period of service. For example, fiscal year compensation generally
would include a bonus to an individual employee with a calendar year
taxable year that is based on a service period consisting of the
service recipient's two consecutive taxable years ending September 30,
2011, where the amount will be paid after the end of the second of such
taxable years, but would not include either a bonus based on a service
period consisting of one or more calendar years or salary that would
otherwise be paid during such taxable years of the service recipient.
(7) First year of eligibility--(i) In general. In the case of the
first year in which a service provider becomes eligible to participate
in a plan, the service provider may make an initial deferral election
within 30 days after the date the service provider becomes eligible to
participate in such plan, with respect to compensation paid for
services to be performed after the election. In the case of a plan that
does not provide for service provider elections with respect to the
time or form of a payment, the time and form of the payment must be
specified on or before the date that is 30 days after the date the
service provider first becomes eligible to participate in such plan.
For compensation that is earned based upon a specified performance
period (for example, an annual bonus), where a deferral election is
made in the first year of eligibility but after the beginning of the
performance period, the election must apply only to the compensation
paid for services performed after the election. For this purpose, an
election will be deemed to apply to compensation paid for services
performed after the election if the election applies to no more than an
amount equal to the total amount of the compensation for the
performance period multiplied by the ratio of the number of days
remaining in the performance period after the election over the total
number of days in the performance period.
(ii) Eligibility to participate. For purposes of this paragraph
(a)(7), a service provider is eligible to participate in a plan at any
time during which, under the plan's terms and without further amendment
or action by the service recipient, the service provider is eligible to
accrue an amount of deferred compensation under the plan other than
earnings on amounts previously deferred, even if the service provider
has elected not to accrue (or has not elected to accrue) an amount of
deferred compensation. Where a service provider has been paid all
amounts deferred under a plan, and on and before the date of the last
payment was not eligible to continue (or to elect to continue) to
participate in the plan for periods after the last payment (other than
through an election of a different time and form of payment with
respect to the amounts paid), the service provider may be treated as
initially eligible to participate in a plan as of the first date
following such payment that the service provider becomes eligible to
accrue an additional amount of deferred compensation. Where a service
provider has ceased being eligible to participate in a plan (other than
the accrual of earnings), regardless of whether all amounts deferred
under the plan have been paid, and subsequently becomes eligible to
participate in the plan again, the service provider may be treated as
being initially eligible to participate in the plan if the service
provider had not been eligible to participate in the plan (other than
the accrual of earnings) at any time during the 24-month period ending
on the date the service provider again becomes eligible to participate
in the plan.
(iii) Application to excess benefit plans. For purposes of this
paragraph (a)(7), a service provider is treated as initially eligible
to participate in an excess benefit plan as of the first day of the
service provider's taxable year immediately following the first year
the service provider accrues a benefit under the excess benefit plan;
and any election made within 30 days following such date is treated as
applying to benefits accrued under such plan for services performed
before the election. For purposes of this paragraph (a)(7), the term
excess benefit plan means all nonqualified deferred compensation plans
in which a service provider participates, to the extent such plans do
not provide for an election between current compensation (including a
short-term deferral) and deferred compensation and solely provide
deferred compensation equal to the excess of the benefits the service
provider would have accrued under a qualified employer plan (as defined
in Sec. 1.409A-1(a)(2)) in which the service provider also
participates, in the absence of one or more of the limits incorporated
into the plan to reflect one or more of the limits on contributions or
benefits applicable to the qualified
[[Page 19303]]
employer plan under the Internal Revenue Code, over the benefits the
service provider actually accrues under the qualified employer plan.
For purposes of this paragraph (a)(7), once a service provider has
accrued a benefit or deferred compensation under a plan in any year,
the service provider will not become eligible for an initial deferral
election based upon an accrual or deferral under an excess benefit plan
in a subsequent year, even if the benefit or deferred compensation
accrued in a previous year is forfeited or eliminated.
(8) Initial deferral election with respect to performance-based
compensation. In the case of any performance-based compensation (as
defined in Sec. 1.409A-1(e)), an initial deferral election may be made
with respect to such performance-based compensation on or before the
date that is six months before the end of the performance period,
provided that the service provider performs services continuously from
the later of the beginning of the performance period or the date the
performance criteria are established through the date an election is
made under this paragraph (a)(8), and provided further that in no event
may an election to defer performance-based compensation be made after
such compensation has become readily ascertainable. For purposes of
this paragraph (a)(8), if the performance-based compensation is a
specified or calculable amount, the compensation is readily
ascertainable if and when the amount is first substantially certain to
be paid. If the performance-based compensation is not a specified or
calculable amount because, for example, the amount may vary based upon
the level of performance, the compensation, or any portion of the
compensation, is readily ascertainable when the amount is first both
calculable and substantially certain to be paid. For this purpose, the
performance-based compensation is bifurcated between the portion that
is readily ascertainable and the amount that is not readily
ascertainable. Accordingly, in general any minimum amount that is both
calculable and substantially certain to be paid will be treated as
readily ascertainable.
(9) Nonqualified deferred compensation plans linked to qualified
employer plans or certain other arrangements. If a nonqualified
deferred compensation plan provides that the amount deferred under the
plan is determined under the formula for determining benefits under a
qualified employer plan (as defined in Sec. 1.409A-1(a)(2)) or a
broad-based foreign retirement plan (as defined in Sec. 1.409A-
1(a)(3)(v)) maintained by the service recipient but applied without
regard to one or more limitations applicable to the qualified employer
plan under the Internal Revenue Code or to the broad-based foreign
retirement plan under other applicable law, or that the amount deferred
under the nonqualified deferred compensation plan is determined as an
amount offset by some or all of the benefits provided under the
qualified employer plan or the broad-based foreign retirement plan, an
increase in amounts deferred under the nonqualified deferred
compensation plan that results directly from changes in benefit
limitations applicable to the qualified employer plan or the broad-
based foreign retirement plan under the Internal Revenue Code or other
applicable law does not constitute a deferral election under the
nonqualified deferred compensation plan, provided that such operation
does not otherwise result in a change in the time or form of a payment
under the nonqualified deferred compensation plan, and provided further
that such change in the amounts deferred under the nonqualified
deferred compensation plan does not exceed that change in the amounts
deferred under the qualified employer plan or the broad-based foreign
retirement plan, as applicable. In addition, with respect to such a
nonqualified deferred compensation plan, the following actions or
failures to act will not constitute a deferral election under the
nonqualified deferred compensation plan even if in accordance with the
terms of the nonqualified deferred compensation plan, the actions or
inactions result in an increase in the amounts deferred under the plan,
provided that such actions or inactions do not otherwise affect the
time or form of payment under the nonqualified deferred compensation
plan and provided further that with respect to actions or inactions
described in paragraphs (a)(9)(i) or (ii), the change in the amount
deferred under the nonqualified deferred compensation plan does not
exceed the change in the amounts deferred under the qualified employer
plan or the broad-based foreign retirement plan, as applicable:
(i) A service provider's action or inaction under the qualified
employer plan or broad-based foreign retirement plan with respect to
whether to elect to receive a subsidized benefit or an ancillary
benefit under the qualified employer plan or broad-based foreign
retirement plan.
(ii) The amendment of a qualified employer plan or broad-based
foreign retirement plan to add or remove a subsidized benefit or an
ancillary benefit, or to freeze or limit future accruals of benefits
under the qualified plan or freeze or limit future accruals of benefits
or reduce existing benefits under the broad-based foreign retirement
plan.
(iii) A service provider's action or inaction under a qualified
employer plan with respect to elective deferrals and other employee
pre-tax contributions subject to the contribution restrictions under
section 401(a)(30) or section 402(g), including an adjustment to a
deferral election under such qualified employer plan, provided that for
any given taxable year, the service provider's action or inaction does
not result in an increase in the amounts deferred under all
nonqualified deferred compensation plans in which the service provider
participates (other than amounts described in paragraph (a)(9)(iv) of
this section) in excess of the limit with respect to elective deferrals
under section 402(g)(1)(A), (B), and (C) in effect for the taxable year
in which such action or inaction occurs.
(iv) A service provider's action or inaction under a qualified
employer plan with respect to elective deferrals and other employee
pre-tax contributions subject to the contribution restrictions under
section 401(a)(30) or section 402(g), and after-tax contributions by
the service provider to a qualified employer plan that provides for
such contributions, that affects the amounts that are credited under
one or more nonqualified deferred compensation plans as matching
amounts or other similar amounts contingent on such elective deferrals,
employee pre-tax contributions, or after-tax contributions, provided
that the total of such matching or contingent amounts, as applicable,
never exceeds 100 percent of the matching or contingent amounts that
would be provided under the qualified employer plan absent any plan-
based restrictions that reflect limits on qualified plan contributions
under the Internal Revenue Code.
(10) Changes in elections under a cafeteria plan. A change in an
election under a cafeteria plan does not constitute a deferral election
with respect to an amount deferred under a nonqualified deferred
compensation plan to the extent that the change in the amount deferred
under the nonqualified deferred compensation plan results solely from
the application of the change in amount eligible to be treated as
compensation under the terms of the nonqualified deferred compensation
plan resulting from the election change under the cafeteria plan, to a
benefit formula under the nonqualified deferred compensation plan based
upon the
[[Page 19304]]
service provider's eligible compensation, and only to the extent that
such change applies in the same manner as any other increase or
decrease in compensation would apply to such benefit formula.
(11) Initial deferral election with respect to certain separation
pay. In the case of separation pay (as defined in Sec. 1.409A-1(m)),
where such separation pay is the subject of bona fide, arm's length
negotiations at the time of the separation from service, an initial
deferral election may be made at any time up to the time the service
provider obtains a legally binding right to the payment. This paragraph
(a)(11) does not apply to any separation pay to which the service
provider obtained a legally binding right before the negotiations at
the time of the separation from service, including a right to a payment
subject to a condition such as that the service provider separate from
service other than for cause. In the case of separation pay due to
participation in a window program (as defined in Sec. 1.409A-
1(b)(9)(vi)), an initial deferral election may be made at any time
before the time the election to participate in the window program
becomes irrevocable.
(12) Initial deferral election with respect to certain
commissions--(i) Sales commission compensation. For purposes of this
paragraph (a), a service provider earning sales commission compensation
is treated as providing the services to which such compensation relates
only in the service provider's taxable year in which the customer
remits payment to the service recipient or, if applied consistently to
all similarly situated service providers, the service provider's
taxable year in which the sale occurs. For purposes of this paragraph
(a)(12), the term sales commission compensation means compensation or
portions of compensation earned by a service provider if a substantial
portion of the services provided by such service provider to a service
recipient consist of the direct sale of a product or service to an
unrelated customer, the compensation paid by the service recipient to
the service provider consists of either a portion of the purchase price
for the product or service or an amount substantially all of which is
calculated by reference to the volume of sales, and payment of the
compensation is either contingent upon the service recipient receiving
payment from an unrelated customer for the product or services or, if
applied consistently to all similarly situated service providers, is
contingent upon the closing of the sales transaction and such other
requirements as may be specified by the service recipient before the
closing of the sales transaction. For this purpose, a customer is
treated as an unrelated customer only if the customer is not related to
either the service provider or the service recipient. A person is
treated as related to another person if the person would be treated as
related to the other person under Sec. 1.409A-1(f)(2)(ii) or the
person would be treated as providing management services to the other
person under Sec. 1.409A-1(f)(2)(iv).
(ii) Investment commission compensation. For purposes of this
paragraph (a), a service provider earning investment commission
compensation is treated as providing the services to which such
compensation relates over the 12 months preceding the date as of which
the overall value of the assets or asset accounts is determined for
purposes of the calculation of the investment commission compensation.
For purposes of this paragraph (a)(12), the term investment commission
compensation means the compensation or the portion of compensation
earned by a service provider if a substantial portion of the services
provided by such service provider to a service recipient to which such
compensation relates consists of sales of financial products or other
direct customer services to an unrelated customer with respect to
customer assets or customer asset accounts, the customer retains the
right to terminate the customer relationship and may move or liquidate
the assets or asset accounts without undue delay (which may be subject
to a reasonable notice period), such compensation consists of a portion
of the value of the overall assets or asset account balance, an amount
substantially all of which is calculated by reference to the increase
in the value of the overall assets or account balance during a
specified period, or both, and the value of the overall assets or
account balance and investment commission compensation is determined at
least annually. For this purpose, a customer is treated as an unrelated
customer only if the customer is not related to either the service
provider or the service recipient. A person is treated as related to
another person if the person would be treated as related to the other
person under Sec. 1.409A-1(f)(2)(ii) or the person would be treated as
providing management services to the other person under Sec. 1.409A-
1(f)(2)(iv).
(iii) Commission compensation and related persons. The rules of
paragraphs (a)(12)(i) and (ii) of this section apply to sales
commission compensation and investment commission compensation
involving a related customer, provided that substantial sales from
which commission compensation arises are made, or substantial services
from which commission compensation arises are provided, to unrelated
customers by the service recipient, the sales and service arrangement
and the commission arrangement with respect to the related customer are
bona fide, arise from the service recipient's ordinary course of
business, and are substantially the same, both in terms and in
practice, as the terms and practices applicable to unrelated customers
(as defined in such paragraphs) to which individually or in the
aggregate substantial sales are made or substantial services provided
by the service recipient.
(13) Initial deferral election with respect to compensation paid
for final payroll period--(i) In general. Unless a plan provides
otherwise, compensation payable after the last day of the service
provider's taxable year solely for services performed during the final
payroll period described in section 3401(b) containing the last day of
the service provider's taxable year or, with respect to a non-employee
service provider, a period not longer than the payroll period described
in section 3401(b), where such amount is payable pursuant to the timing
arrangement under which the service recipient normally compensates
service providers for services performed during a payroll period
described in section 3401(b), or with respect to a non-employee service
provider, a period not longer than the payroll period described in
section 3401(b), is treated as compensation for services performed in
the subsequent taxable year in which the payment is made. The preceding
sentence does not apply to any compensation paid during such period for
services performed during any period other than such final payroll
period, such as a payment of an annual bonus. Any amendment of a plan
after December 31, 2007, to add a provision providing for a differing
treatment of such compensation may not be effective for 12 months from
the date the amendment is executed and enacted.
(ii) Transition rule. For purposes of this paragraph (a)(13), a
plan that was adopted and effective before December 31, 2007, whether
written or unwritten, will be treated as designating such compensation
for services performed in the taxable year in which the payroll period
ends, unless otherwise set forth in writing before December 31, 2007.
(14) Elections to annualize recurring part-year compensation. In
the case of a service provider receiving recurring part-year
compensation, an election to defer all or a portion of the recurring
[[Page 19305]]
part-year compensation to be earned during a particular service period
is considered to meet the requirements of this paragraph (a) if the
election is made before the services for which the recurring part-year
compensation is paid begin, and the election does not defer payment of
any of the recurring part-year compensation to a date beyond the last
day of the 13th month following the first date of the service period.
For purposes of this paragraph (a)(14), the term recurring part-year
compensation means compensation paid for services rendered in a
position that the service recipient and service provider reasonably
anticipate will continue on similar terms and conditions in subsequent
years, and will require services to be provided during successive
service periods each of which comprises less than 12 months (for
example, a teacher providing services during a school year comprised of
10 consecutive months), and each of which periods begins in one taxable
year of the service provider and ends in the next such taxable year.
The rules of this paragraph (a)(14) apply to a particular amount of
compensation only once, so that an amount deferred under this rule may
not again be treated as recurring part-year compensation for purposes
of this paragraph and subject to a second deferral election under this
paragraph (a)(14).
(15) USERRA rights. The requirements of this paragraph (a) are
deemed satisfied to the extent an initial deferral election is provided
to satisfy the requirements of the Uniformed Service Employment and
Reemployment Rights Act of 1994, as amended, 38 U.S.C. 4301-4334.
(b) Subsequent changes in time and form of payment--(1) In general.
A plan that permits under a subsequent election a delay in a payment or
a change in the form of payment (a subsequent deferral election),
including a subsequent deferral election made by a service provider or
a service recipient, satisfies the requirements of section
409A(a)(4)(C) only if the conditions of this paragraph (b) are met. For
purposes of this paragraph (b), except as otherwise expressly provided
in this section, a subsequent deferral election is not considered made
until such election becomes irrevocable under the terms of the plan.
Accordingly, a plan may provide that a subsequent deferral election may
be changed at any time before the last permissible date for making such
a subsequent deferral election. Where a plan permits a subsequent
deferral election, the requirements of this paragraph are satisfied
only if the following conditions are met:
(i) The plan requires that such election not take effect until at
least 12 months after the date on which the election is made.
(ii) In the case of an election related to a payment not described
in Sec. 1.409A-3(a)(2) (payment on account of disability), Sec.
1.409A-3(a)(3) (payment on account of death), or Sec. 1.409A-3(a)(6)
(payment on account of the occurrence of an unforeseeable emergency),
the plan requires that the payment with respect to which such election
is made be deferred for a period of not less than five years from the
date such payment would otherwise have been paid (or in the case of a
life annuity or installment payments treated as a single payment, five
years from the date the first amount was scheduled to be paid).
(iii) The plan requires that any election related to a payment
described in Sec. 1.409A-3(a)(4) (payment at a specified time or
pursuant to a fixed schedule) be made not less than 12 months before
the date the payment is scheduled to be paid (or in the case of a life
annuity or installment payments treated as a single payment, 12 months
before the date the first amount was scheduled to be paid).
(2) Definition of payments for purposes of subsequent changes in
the time or form of payment--(i) In general. Except as provided in
paragraphs (b)(2)(ii) and (iii) of this section, the term payment
refers to each separately identified amount to which a service provider
is entitled to payment under a plan on a determinable date, and
includes amounts applied for the benefit of the service provider. An
amount is separately identified only if the amount may be objectively
determined under a nondiscretionary formula. For example, an amount
identified as 10 percent of the account balance as of a specified
payment date would be a separately identified amount. A payment
includes the provision of any taxable benefit, including payment in
cash or in kind. In addition, a payment includes, but is not limited
to, the transfer, cancellation, or reduction of an amount of deferred
compensation in exchange for benefits under a welfare benefit plan, a
fringe benefit excludible under section 119 or section 132, or any
other benefit that is excludible from gross income. For additional
rules relating to the application of this paragraph (b) to amounts
payable at a fixed time or pursuant to a fixed schedule, see Sec.
1.409A-3(i)(1).
(ii) Life annuities--(A) In general. The entitlement to a life
annuity is treated as the entitlement to a single payment. Accordingly,
an election to delay payment of a life annuity, or to change the form
of payment of a life annuity, must be made at least 12 months before
the scheduled commencement of the life annuity, and must defer the
payment for a period of not less than five years from the originally
scheduled commencement of the life annuity. For purposes of Sec.
1.409A-1, this section, and Sec. Sec. 1.409A-3 through 1.409A-6, the
term life annuity means a series of substantially equal periodic
payments, payable not less frequently than annually, for the life (or
life expectancy) of the service provider, or a series of substantially
equal periodic payments, payable not less frequently than annually, for
the life (or life expectancy) of the service provider, followed upon
the death or end of the life expectancy of the service provider by a
series of substantially equal periodic payments, payable not less
frequently then annually, for the life (or life expectancy) of the
service provider's designated beneficiary (if any). A change in
designated beneficiary before any annuity payment has been made under
the plan is not a change in the time or form of payment. A change in
the form of a payment before any annuity payment has been made under
the plan, from one type of life annuity to another type of life annuity
with the same scheduled date for the first annuity payment, is not
considered a change in the time and form of a payment, provided that
the annuities are actuarially equivalent applying reasonable actuarial
methods and assumptions. For purposes of this paragraph (b)(2)(ii), a
requirement that a service provider obtain the consent of a spouse or
other potential recipient of a survivor annuity to change a beneficiary
or form of payment is disregarded, so that any annuity form that the
service recipient could elect to receive with such consent is
considered currently available.
(B) Certain features disregarded. Notwithstanding the foregoing
provisions of this paragraph (b)(2)(ii), the following features are
disregarded for purposes of determining whether a payment form is a
life annuity within the meaning of this paragraph (b)(2)(ii), but are
not disregarded for purposes of determining whether a life annuity is
the actuarial equivalent of another life annuity except as otherwise
provided in this paragraph (b)(2)(ii):
(1) Term certain features under which annuity payments continue for
the longer of the life of the annuitant or a fixed period of time.
(2) Pop-up features under which payments increase upon the death of
the
[[Page 19306]]
beneficiary or another event that eliminates the right to a survivor
annuity.
(3) Cash refund features under which payment is provided upon the
death of the last annuitant in an amount that is not greater than the
excess of the present value of the annuity at the annuity starting date
over the total of payments before the death of the last annuitant.
(4) Features under which an annuity form of payment provides higher
periodic payments before the expected commencement of benefits under
the Social Security Act (42 U.S.C. ch. 7) or the Railroad Retirement
Act (45 U.S.C. 231 et seq.) and lower periodic payments after such
expected commencement date, so that the combined periodic payments
under the arrangement and the Social Security Act or the Railroad
Retirement Act, as applicable, are approximately level before and after
such expected commencement date (Social Security or Railroad Retirement
leveling features).
(5) Features providing for an increase in the annuity payment in a
manner described in Sec. 1.401(a)(9)-6, Q&A-14(a)(1) or (2) (eligible
cost-of-living adjustments).
(C) Subsidized joint and survivor annuities. For purposes of this
paragraph (b)(2)(ii), a joint and survivor annuity will not fail to be
treated as actuarially equivalent to a single life annuity due solely
to the value of a subsidized survivor annuity benefit, provided that
the annual lifetime annuity benefit available to the service provider
under the joint and survivor annuity is not greater than the annual
lifetime annuity benefit available to the service provider under the
single life annuity alternative, and provided that the annual survivor
annuity benefit is not greater than the annual lifetime annuity benefit
available to the service provider under the joint and survivor annuity.
(D) Actuarial assumptions and methods. For purposes of this
paragraph (b)(2)(ii), at any given time the same actuarial assumptions
and methods must be used in valuing each annuity payment option, in
determining whether the payments are actuarially equivalent and such
assumptions must be reasonable. This requirement applies over the
entire term of the service provider's participation in the plan, such
that the annuity payment must be actuarially equivalent at all times
for the annuity payment options to be treated as one time and form of
payment. There is no requirement that the same actuarial methods and
assumptions be used over the term of a service provider's participation
in a plan. Accordingly, a plan may change the actuarial assumptions and
methods used to determine the life annuity payments provided that all
of the actuarial assumptions and methods are reasonable.
(iii) Installment payments. The entitlement to a series of
installment payments that is not a life annuity is treated as the
entitlement to a single payment, unless the plan provides at all times
with respect to the amount deferred that the right to the series of
installment payments is to be treated as a right to a series of
separate payments. For purposes of Sec. 1.409A-1, this section, and
Sec. Sec. 1.409A-3 through 1.409A-6, a series of installment payments
refers to an entitlement to the payment of a series of substantially
equal periodic amounts to be paid over a predetermined period of years,
except to the extent any increase (or decrease) in the amount reflects
reasonable earnings (or losses) through the date the amount is paid.
For this purpose, a series of installment payments over a predetermined
period and a series of installment payments over a shorter or longer
period, or a series of installment payments over the same predetermined
period but with a different commencement date, are different times and
forms of payment. Accordingly, a change in the predetermined period or
the commencement date is a change in the time and form of payment.
Notwithstanding the foregoing, a schedule of payments does not fail to
be an installment payment solely because such plan provides for an
immediate payment of all remaining installments if the present value of
the deferred amount to be paid in the remaining installment payments
falls below a predetermined amount, and the immediate payment of such
amount does not constitute an accelerated payment for purposes of Sec.
1.409A-3(j), provided that such feature including the predetermined
amount is established by no later than the time and form of payment is
otherwise required to be established, and provided further that any
change in such feature including the predetermined amount is a change
in the time and form of payment.
(iv) Transition rule. For purposes of this section, a plan that was
adopted and effective before December 31, 2007, whether written or
unwritten, that fails to make a designation as to whether the
entitlement to a series of payments is to be treated as an entitlement
to a series of separate payments under paragraph (b)(2)(iii) of this
section, may make such designation on or before December 31, 2007,
provided such designation is set forth in writing on or before December
31, 2007.
(3) Beneficiaries. The rules of this paragraph (b) governing
changes in the time and form of payment apply to elections by
beneficiaries with respect to the time and form of payment, as well as
elections by service providers or service recipients with respect to
the time and form of payment to beneficiaries. An election to change
the identity of a beneficiary does not constitute a change in the time
and form of payment merely because the election changes the identity of
the recipient of the payment, if the time and form of the payment is
not otherwise changed. In addition, an election to change the identity
of a beneficiary before the initial payment of a life annuity does not
constitute a change in the time and form of payment if the change in
the time of payments stems solely from the different life expectancy of
the new beneficiary, such as in the case of a joint and survivor
annuity.
(4) Domestic relations orders. The rules of this paragraph (b)
governing changes in the time and form of payment do not apply to
elections by individuals other than a service provider, with respect to
payments to a person other than the service provider, to the extent
such elections are reflected in, or made in accordance with, the terms
of a domestic relations order (as defined in section 414(p)(1)(B)).
(5) Coordination with prohibition against acceleration of payments.
For purposes of applying the prohibition against the acceleration of
payments in Sec. 1.409A-3(j), the definition of payment is the same as
the definition in paragraph (b)(2) of this section. Accordingly, a
change in the form of a payment that results in a more rapid schedule
for payments generally will not constitute an acceleration of a
payment, if the change in the form of payment is made in compliance
with the subsequent deferral rules. For example, a change in form from
a 10-year installment payment treated as a single payment to a lump-sum
payment would not constitute an acceleration if the change in the form
of the payment is made in compliance with the requirements of paragraph
(b)(1) of this section, generally meaning that the election to change
to a lump-sum payment must be made at least 12 months before the
installment payments were scheduled to commence and the lump-sum
payment could not be made until at least five years after the date the
installment payments were scheduled to commence. See Sec. 1.409A-
3(j)(4)(i) with respect to situations in which the failure to
accelerate a payment or the
[[Page 19307]]
modification of a plan term relating to certain accelerated payments
will not be subject to the rules of this paragraph (b).
(6) Application to multiple payment events. In the case of a plan
that permits a payment upon each of a number of potential permissible
payment events, such as the earlier of a fixed date or separation from
service, the requirements of paragraph (b)(1) of this section are
applied separately to each payment (as defined in paragraph (b)(2) of
this section) due upon each payment event. Notwithstanding the
foregoing, the addition or deletion of a permissible payment event to a
plan under which amounts were previously deferred is subject to the
rules of this paragraph (b) where the addition or deletion of the
permissible payment event may result in a change in the time or form of
payment of the amount deferred. For application of the rules governing
accelerations of payments to the addition of a permissible payment
event to amounts deferred, see Sec. 1.409A-3(j).
(7) Delay of payments under certain circumstances. A payment may be
delayed to a date after the designated payment date under any of the
circumstances described in this paragraph (b)(7), and the provision
will not fail to meet the requirements of establishing a permissible
payment event and the delay in the payment will not constitute a
subsequent deferral election, so long as the service recipient treats
all payments to similarly situated service providers on a reasonably
consistent basis.
(i) Payments subject to section 162(m). A payment may be delayed to
the extent that the service recipient reasonably anticipates that if
the payment were made as scheduled, the service recipient's deduction
with respect to such payment would not be permitted due to the
application of section 162(m), provided that the payment is made either
during the service provider's first taxable year in which the service
recipient reasonably anticipates, or should reasonably anticipate, that
if the payment is made during such year, the deduction of such payment
will not be barred by application of section 162(m) or during the
period beginning with the date of the service provider's separation
from service and ending on the later of the last day of the taxable
year of the service recipient in which the service provider separates
from service or the 15th day of the third month following the service
provider's separation from service, and provided further that where any
scheduled payment to a specific service provider in a service
recipient's taxable year is delayed in accordance with this paragraph,
the delay in payment will be treated as a subsequent deferral election
unless all scheduled payments to that service provider that could be
delayed in accordance with this paragraph are also delayed. Where the
payment is delayed to a date on or after the service provider's
separation from service, the payment will be considered a payment upon
a separation from service for purposes of the rules under Sec. 1.409A-
3(i)(2) (payments to specified employees upon a separation from
service) and, in the case of a specified employee, the date that is six
months after a service provider's separation from service is
substituted for any reference to a service provider's separation from
service in the first sentence of this paragraph. No election may be
provided to the service provider with respect to the timing of the
payment under this paragraph (b)(7)(i).
(ii) Payments that would violate Federal securities laws or other
applicable law. A payment may be delayed where the service recipient
reasonably anticipates that the making of the payment will violate
Federal securities laws or other applicable law; provided that the
payment is made at the earliest date at which the service recipient
reasonably anticipates that the making of the payment will not cause
such violation. The making of a payment that would cause inclusion in
gross income or the application of any penalty provision or other
provision of the Internal Revenue Code is not treated as a violation of
applicable law.
(iii) Other events and conditions. A service recipient may delay a
payment upon such other events and conditions as the Commissioner may
prescribe in generally applicable guidance published in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter). For
additional rules applicable to certain delayed payments pursuant to a
change in control event, see Sec. 1.409A-3(i)(5)(iv). For additional
rules applicable to amounts payable because of an unforeseeable
emergency, see Sec. 1.409A-3(i)(3).
(8) USERRA rights. The requirements of this paragraph (b) are
deemed met to the extent an election to change the time or form of a
payment of deferred compensation is provided to satisfy the
requirements of the Uniformed Services Employment and Reemployment
Rights Act of 1994, as amended, 38 U.S.C. 4301-4344.
(9) Examples. The following examples illustrate the application of
the provisions of this section. For purposes of these examples, each
employee is an individual with a calendar year taxable year, and is
employed by the specified employer:
Example 1. Initial election to defer salary. Employer ZZ
sponsors a plan under which Employee A may elect to defer a
percentage of Employee A's salary. Employee A has participated in
the plan in prior years. To satisfy the requirements of this section
with respect to salary earned in calendar year 2008, if Employee A
elects to defer any amount of such salary, the deferral election
(including an election as to the time and form of payment) must be
made no later than December 31, 2007.
Example 2. Designation of time and form of payment where an
initial deferral election is not provided. Employer YY has a taxable
year ending September 30. On July 1, 2008, Employer YY enters into a
legally binding obligation to pay Employee B a $10,000 bonus. The
amount is not subject to a substantial risk of forfeiture and does
not qualify as performance-based compensation as described in Sec.
1.409A-1(e). Employer YY does not provide Employee B an election as
to the time and form of payment. Unless the amount is to be paid in
accordance with the short-term deferral rule of Sec. 1.409A-
1(b)(4), Employer YY must specify the time and form of payment on or
before July 1, 2008, to satisfy the requirements of this section.
Example 3. Initial election to defer bonus payable based on
services during calendar year. Employer XX has a taxable year ending
September 30. Employee C participates in a bonus plan under which
Employee C is entitled to a bonus for services performed during the
calendar year that, absent an election by Employee C, will be paid
on March 15 of the following year. The amount is not subject to a
substantial risk of forfeiture and does not qualify as performance-
based compensation as described in Sec. 1.409A-1(e). If Employee C
elects to defer the payment of the bonus with respect to services
rendered during calendar year 2008, Employee C must elect the time
and form of payment not later than December 31, 2007, to satisfy the
requirements of this section.
Example 4. Initial election to defer bonus payable based on
services during fiscal year other than calendar year. Employer WW
has a taxable year ending September 30. Employee D participates in a
bonus plan under which Employee D is entitled to a bonus for
services performed during Employer WW's fiscal year that, absent an
election by Employee D, will be paid on December 15 of the calendar
year in which the fiscal year ends. The amount is not subject to a
substantial risk of forfeiture and does not qualify as performance-
based compensation as described in Sec. 1.409A-1(e). The amount
qualifies as fiscal year compensation. If Employee D elects to defer
the payment of the amount related to the fiscal year ending
September 30, 2009, to satisfy the requirements of this section
Employee D must elect the time and form of payment not later than
September 30, 2008.
Example 5. Initial election to defer bonus payable only if
service provider completes at least 12 months of services after the
election. Employer VV has a calendar year taxable year. On March 1,
2008, Employer VV grants Employee E a $10,000 bonus, payable on
[[Page 19308]]
March 1, 2010 (with reasonable interest), provided that Employee E
continues performing services as an employee of Employer VV through
March 1, 2010. The amount does not qualify as performance-based
compensation as described in Sec. 1.409A-1(e), and Employee E
already participates in another account balance nonqualified
deferred compensation plan. Employee E may make an initial deferral
election on or before March 31, 2008 (within 30 days after obtaining
a legally binding right), because at least 12 months of additional
services are required after the date of election for the risk of
forfeiture to lapse.
Example 6. Initial election to defer bonus that would otherwise
constitute a short-term deferral. The same facts as Example 5,
except that Employee E does not make an initial deferral election on
or before March 31, 2008. Because the right to the compensation
would not be treated as a deferral of compensation pursuant to Sec.
1.409A-1(b)(4) absent a deferral election (because the arrangement
would be treated as a short-term deferral), Employee E may make an
initial deferral election provided that the election may not become
effective for 12 months and must defer the payment at least 5 years
from March 1, 2010 (the first date the payment could become
substantially vested). Accordingly, Employee E may make an election
before March 1, 2009, provided that the election defers the payment
to a date on or after March 1, 2015 (other than a payment due to
death, disability, unforeseeable emergency, or a change in control
event).
Example 7. Initial election to defer sales commissions. Employer
UU has a calendar year taxable year. As part of Employee F's
services for Employer UU, Employee F sells refrigerators to
customers unrelated to Employee F or Employer UU. Under the
employment arrangement, Employee F is entitled to 10% of the sales
price of any refrigerator Employee F sells, payable only upon the
receipt of payment from the customer who purchased the refrigerator.
For purposes of the initial deferral rule, Employee F is treated as
performing the services related to each refrigerator sale in the
calendar year in which each customer pays for the refrigerator.
Example 8. Initial election to defer renewal sales commissions.
The same facts as Example 7, except that Employee F also sells
warranties related to the refrigerators sold. Under the warranty
arrangement, refrigerator warranty customers are entitled in a
future year to extend the warranty for an additional cost to be paid
at the time of the extension. Under Employee F's arrangement with
Employer UU, Employee F is entitled to 10% of the amount paid for an
extension of any warranty, payable upon the receipt of payment from
the customer extending the warranty. For purposes of the initial
deferral election rule, Employee F is treated as performing the
services related to the amount paid for the extension of the
warranty in the taxable year in which the customer pays for the
warranty extension.
Example 9. Initial election to defer investment commissions.
Employer TT is in the trade or business of managing financial assets
for customer accounts. Customers who deposit funds in an account
with Employer TT are entitled to remove the account balance of such
account upon 60 days notice to Employer TT. Employee G sells
financial products and provides continuing customer service to
certain unrelated customers involving the deposit and maintenance of
funds in customer accounts managed by Employer TT. Under the
employment arrangement, Employee G is entitled to a set percentage
of the aggregate value of the assets held in the accounts of
customers to whom Employee G sold financial products and provides
customer service. Under the arrangement, the aggregate value of the
assets held in the accounts is determined as of June 30 of each
year, and unless Employee G elects to defer the payment, the amount
is payable to Employee G in a lump sum on December 31 of the year in
which the valuation is made. Employee G has no control over the
valuation of the assets held in the accounts, or the calculation of
the amount due Employee G. For purposes of the initial deferral
rule, Employee G is treated as providing the services to which a
payment relates during the July 1 through June 30 period ending on
the June 30 date as of which the assets held in the account are
valued.
Example 10. Initial election to defer part-year compensation.
Employee H provides services as a teacher to Employer SS, a school
system. The period of services routinely begins on the second Monday
of August of one year and ends on the first Friday of June of the
subsequent year. Employer SS provides an election to Employee H to
receive the compensation for the period of services ratably over the
period beginning on the second Monday of August of one year and
ending on the last day of August of the subsequent year. Because the
compensation constitutes recurring part-year compensation, as
defined in paragraph (a)(14) of this section, and because the
schedule will provide that all of the recurring part-year
compensation is paid no later than September 30 of the subsequent
year, Employee H will be deemed to have made a timely deferral
election with respect to such recurring part-year compensation if
Employee H elects before the first day of the service period to have
the recurring part-year compensation paid under such schedule.
Example 11. Initial election to defer negotiated separation pay.
Employer RR decides to terminate Employee J's employment
involuntarily. As part of the process of terminating Employee J,
Employer RR enters into bona fide, arm's length negotiations with
respect to the terms of Employee J's termination of employment. As
part of the process, Employer RR offers Employee J an amount that is
in addition to any amounts to which Employee J is otherwise
entitled, payable either as a lump sum payment at the end of 3 years
or in 3 annual payments starting at the date of termination of
employment. The election of the time and form of payment by Employee
J may be made at any time before Employee J accepts the offer and
obtains a legally binding right to the additional amount. The
election may not apply to any amount to which Employee J already had
a legally binding right.
Example 12. Election of time and form of payments under a window
program. Employer QQ establishes a window program, as defined in
Sec. 1.409A-1(b)(9)(vi). Individuals who elect to terminate
employment under the window program are entitled to receive an
amount equal to 2 weeks pay multiplied by every year of service with
Employer QQ. The individuals participating in the window program may
elect to receive the payment as either a lump sum payment payable on
the first day of the month after making the election to participate
in the window program, or as a payment of 3 equal annual
installments on each January 1 of the first 3 years following the
election to participate in the window program. Employee K is
eligible to participate in the window program. Employee K will be
treated as making a timely deferral election if the election as to
the time and form of payment is made on or before the date Employee
K's election to participate in the window program becomes
irrevocable.
Example 13. Initial election to defer salary earned during final
payroll period beginning in one calendar year and ending in the
subsequent calendar year. Employer PP pays the salary of its
employees, including Employee L, on a bi-weekly basis. One bi-weekly
payroll period runs from December 24, 2008, through January 6, 2009,
with a scheduled payment date of January 13, 2009. Employer PP
sponsors, and Employee L participates in, a nonqualified deferred
compensation plan under which Employee L may defer a specified
percentage of his annual salary. The plan does not specify that any
salary compensation paid for the payroll period in which falls
January 1 is to be treated as compensation for services performed
during the year preceding the year in which falls that January 1.
For purposes of applying the initial deferral election rules,
Employee L is deemed to have performed the services for the payroll
period December 24, 2008, through January 6, 2009, during the
calendar year 2009.
Example 14. Application of deferral election rules and anti-
acceleration rules to a nonqualified deferred compensation plan
linked to a qualified plan. Employee M participates in a qualified
retirement plan that is a defined benefit plan that offers a
subsidized early retirement benefit to employees who have attained
age 55 and completed 30 years of service. Employee M, who has
attained age 55 and completed 30 years of service, also participates
in a nonqualified deferred compensation plan, under which the
benefit payable is calculated under a formula, with that benefit
then reduced by any benefit that Employee M has accrued under the
qualified retirement plan. In 2008, Employee M fails to elect the
subsidized early retirement benefit under the qualified retirement
plan, with the effect that the amounts payable under the
nonqualified deferred compensation plan are increased by an amount
equal to the reduction in the benefit payable under the qualified
plan. In 2009, Employer NN amends the qualified retirement plan to
increase benefits under the plan, resulting in a decrease in the
amounts payable under the nonqualified deferred
[[Page 19309]]
compensation plan equal to the increase in the benefit payable under
the qualified plan. Neither of these actions constitutes a deferral
election or an acceleration of a payment under the nonqualified
deferred compensation plan.
Example 15. Subsequent deferral election. Employee N
participates in a nonqualified deferred compensation plan. Employee
N elects to be paid in a lump sum payment at the earlier of age 65
or separation from service. Employee N anticipates that he will work
after age 65, and wishes to defer payment to a later date. Provided
that Employee N continues in employment and makes the election by
his 64th birthday, Employee N may elect to receive a lump sum
payment at the earlier of age 70 or separation from service.
Example 16. Subsequent deferral election rule--change in form of
payment from lump sum payment to life annuity. Employee P
participates in a nonqualified deferred compensation plan. Employee
P elects to be paid in a lump sum payment at age 65. Employee P
wishes to change the payment form to a life annuity. Provided that
Employee P makes the election on or before his 64th birthday,
Employee P may elect to receive a life annuity commencing at age 70.
Example 17. Subsequent deferral election rule--change in form of
payment from life annuity to lump sum payment. Employee Q
participates in a nonqualified deferred compensation plan. Employee
Q elects to be paid in a life annuity at age 65. Employee Q wishes
to change the payment form to a lump sum payment. Provided that
Employee Q makes the election on or before his 64th birthday,
Employee Q may elect to receive a lump sum payment at age 70.
Example 18. Subsequent deferral election rule--installment
payments designated as separate payments. Employee R, whose taxable
year is the calendar year, participates in a nonqualified deferred
compensation plan that provides for payment in a series of 5 equal
annual amounts, each designated as a separate payment. The first
payment is scheduled to be made on January 1, 2010. Provided that
Employee R makes the election on or before January 1, 2009, Employee
R may elect for the first payment scheduled to be made on January 1,
2010, to be made on January 1, 2015. If Employee R makes that
election, but does not elect to defer the remaining payments, the
remaining payments continue to be due upon January 1 of the 4
consecutive calendar years commencing on January 1, 2011.
Example 19. Subsequent deferral election rule--change in form of
payment from installment payments not designated as separate
payments to lump sum payment. Employee S participates in a
nonqualified deferred compensation plan that provides for payment in
a series of 5 equal annual amounts that are not designated as a
series of 5 separate payments. The first amount is scheduled to be
paid on January 1, 2010. Employee S wishes to receive the entire
amount equal to the sum of all 5 of the amounts to be paid as a lump
sum payment. Provided that Employee S makes the election on or
before January 1, 2009, Employee S may elect to receive a lump sum
payment on or after January 1, 2015.
Example 20. Subsequent deferral election rule--change in form of
payment from installment payments designated as separate payments to
lump sum payment. Employee T participates in a nonqualified deferred
compensation plan that provides for payment in a series of 5 equal
annual amounts each of which is designated as a separate payment.
The first amount is scheduled to be paid on January 1, 2010.
Employee T wishes to receive the entire amount equal to the sum of
all 5 of the amounts in a single lump sum payment. Provided that
Employee T makes the election on or before January 1, 2009, Employee
T may elect to receive a lump sum payment on or after January 1,
2019.
Example 21. Subsequent deferral election rule--change in form of
payment from one life annuity form to another life annuity form.
Employee U participates in a nonqualified deferred compensation plan
that permits Employee U to elect before Employee U's separation from
service whether to be paid in the form of a single life annuity
beginning on the first day of the month following Employee U's
separation from service, or an annuity beginning on the first day of
the month following Employee U's separation from service under which
annuity payments continue for Employee U's lifetime but not less
than 10 years. The two types of annuities are actuarially equivalent
at all times applying reasonable actuarial methods and assumptions.
For purposes of this section, the two types of annuities are treated
as a single form of payment. Accordingly, the election provided
under the plan is not treated as providing a subsequent deferral
election or accelerated payment, and an election by Employee U under
the plan between the two annuity options made before the first
scheduled payment date for an annuity payment is not treated as a
subsequent deferral election or an acceleration of a payment.
Example 22. Subsequent deferral election rule--change in time of
payment from payment at specified age to payment at later of
specified age or separation from service. Employee V participates in
a nonqualified deferred compensation plan that provides for a lump
sum payment at age 65. Employee V wishes to modify the plan so that
the deferred amount will be payable upon the later of Employee V's
attainment of a specified age or separation from service. Provided
that Employee V makes such election on or before his 64th birthday,
Employee V may modify the plan so Employee V will receive a lump sum
payment upon the later of age 70 or separation from service.
Example 23. Subsequent deferral election rule--change in time of
payment from payment at separation from service to payment at later
of separation from service or specified age. Employee W participates
in a nonqualified deferred compensation plan that provides for a
lump sum payment at separation from service. Employee W wishes to
make the payment payable upon the later of separation from service
or a predetermined age. Provided that Employee W makes such election
on or before the date 1 year before a separation from service,
Employee W may elect to receive a lump sum payment upon the later of
the date 5 years following a separation from service or at a
specified age.
Example 24. Subsequent deferral election rule--change in time of
payment from payment at separation from service to payment at a
change in control event. Employee X participates in a nonqualified
deferred compensation plan that provides for a lump sum payment at
separation from service. Employee X wishes to change the payment
provision such that the payment is payable upon a change in control
event. A change in the distribution provision to provide for a
payment only upon a change in control event will violate the rules
governing payment provisions, because the change could result in an
acceleration if the change in control event occurs before Employee X
separates from service, or a subsequent deferral if the change in
control does not occur until after Employee X separates from
service. However, provided that Employee X makes such election on or
before the date 1 year before a separation from service, Employee X
may elect to receive a payment upon the later of a change in control
event or 5 years following a separation from service.
(c) Special rules for certain resident aliens. For the first
taxable year of an individual in which such individual is a resident
alien, a nonqualified deferred compensation plan is deemed to meet the
requirements of paragraph (a) of this section if, with respect to
compensation payable for services performed during that first taxable
year or with respect to compensation the right to which is subject to a
substantial risk of forfeiture as of the first day of that first
taxable year, an initial deferral election is made by the end of such
first taxable year, provided that the initial deferral election may not
apply to amounts that have already been paid or made available to the
service provider before the election is made. For any year after the
first taxable year in which an individual is classified as a resident
alien, this paragraph (c) does not apply, provided that a taxable year
may again be treated as the first taxable year in which an individual
is classified as a resident alien if such individual is classified as a
resident alien in that taxable year and has not been classified as a
resident alien for the three consecutive taxable years immediately
preceding that taxable year.
Sec. 1.409A-3 Permissible payments.
(a) In general. The requirements of section 409A(a)(2)(A) are met
only if the plan provides that an amount of deferred compensation under
the plan may be paid only upon an event or at a time set forth in this
paragraph (a):
(1) The service provider's separation from service (as defined in
Sec. 1.409A-1(h) and in accordance with paragraph (i)(2) of this
section).
[[Page 19310]]
(2) The service provider becoming disabled (in accordance with
paragraph (i)(4) of this section).
(3) The service provider's death.
(4) A time or a fixed schedule specified under the plan (in
accordance with paragraph (i)(1) of this section).
(5) A change in the ownership or effective control of the
corporation, or in the ownership of a substantial portion of the assets
of the corporation (in accordance with paragraph (i)(5) of this
section).
(6) The occurrence of an unforeseeable emergency (in accordance
with paragraph (i)(3) of this section).
(b) Designation of payment upon a permissible payment event. Except
as otherwise specified in this section, a plan provides for the payment
upon an event described in paragraph (a)(1), (2), (3), (5), or (6) of
this section if the plan provides the date of the event is the payment
date, or specifies another payment date that is objectively
determinable and nondiscretionary at the time the event occurs. A plan
may also provide that a payment upon an event described in paragraph
(a)(1), (2), (3), (5), or (6) of this section is to be made in
accordance with a schedule that is objectively determinable and
nondiscretionary based on the date the event occurs and that would
qualify as a fixed schedule under paragraph (i)(1) of this section if
the payment event were instead a fixed date, provided that the schedule
must be fixed at the time the permissible payment event is designated.
In addition, a plan may provide that a payment, including a payment
that is part of a schedule, is to be made during a designated taxable
year of the service provider that is objectively determinable and
nondiscretionary at the time the payment event occurs such as, for
example, a schedule of three substantially equal payments payable
during the first three taxable years following the taxable year in
which a separation from service occurs. A plan may also provide that a
payment, including a payment that is part of a schedule, is to be made
during a designated period objectively determinable and
nondiscretionary at the time the payment event occurs, but only if the
designated period both begins and ends within one taxable year of the
service provider or the designated period is not more than 90 days and
the service provider does not have a right to designate the taxable
year of the payment (other than an election that complies with the
subsequent deferral election rules of Sec. 1.409A-2(b)). Where a plan
provides for a period of more than one day following a payment event
during which a payment may be made, such as within 90 days following
the date of the event, the payment date for purposes of the subsequent
deferral rules under Sec. 1.409A-2(b) is treated as the first possible
date upon which a payment could be made under the terms of the plan. A
plan may provide for payment upon the earliest or latest of more than
one event or time, provided that each event or time is described in
paragraphs (a)(1) through (6) of this section. For examples
illustrating the provisions of this paragraph, see paragraph (i)(1)(vi)
of this section.
(c) Designation of alternative specified dates or payment schedules
based upon date of permissible event. Except as otherwise provided in
this paragraph (c), a plan may designate only one time and form of
payment upon the occurrence of each event described in paragraph
(a)(1), (2), (3), (5), or (6) of this section. For example, a plan does
not satisfy the requirements of this paragraph (c) if it provides for
one payment date or schedule of payments if a specified event occurs on
a Monday, but another payment date or schedule of payments if the event
occurs on any other day of the week. However, a plan that provides for
a payment upon an event described in paragraph (a)(2), (3), (5), or (6)
of this section may allow for an alternative payment schedule if the
event occurs on or before one (but not more than one) specified date,
provided that the addition or deletion of such a different time and
form of payment applicable to an existing deferral is subject to Sec.
1.409A-2(b) (subsequent deferral elections) and paragraph (j) of this
section (accelerated payments). For example, a plan may provide that a
service provider will receive a lump sum payment of the service
provider's entire benefit under the plan on the first day of the month
following a change in control event that occurs before the service
provider attains age 55, but will receive 5 substantially equal annual
payments commencing on the first day of the month following a change in
control event that occurs on or after the service provider attains age
55. In the case of a plan that provides that a payment upon an event
described in paragraph (a)(1) of this section (a payment upon a
separation from service), a different time and form of payment may be
designated with respect to a separation from service under each of the
following conditions, provided that the addition or deletion of such a
different time and form of payment applicable to an existing deferral
is subject to Sec. 1.409A-2(b) and paragraph (j) of this section:
(1) A separation from service during a limited period of time not
to exceed two years following a change in control event (as defined in
paragraph (i)(5) of this section).
(2) A separation from service before or after a specified date (for
example, the attainment of a specified age), or a separation from
service before or after a combination of a specified date, such as
attaining a specified age, and a specified period of service determined
under a predetermined, nondiscretionary, objective formula or pursuant
to the method for crediting service under a qualified plan sponsored by
the service recipient.
(3) A separation from service not described in paragraphs (c)(1) or
(c)(2) of this section.
(d) When a payment is treated as made upon the designated payment
date. Except as otherwise specified in this section, a payment is
treated as made upon the date specified under the plan (including a
date specified under paragraph (a)(4) of this section) if the payment
is made at such date or a later date within the same taxable year of
the service provider or, if later, by the 15th day of the third
calendar month following the date specified under the plan and the
service provider is not permitted, directly or indirectly, to designate
the taxable year of the payment. In addition, a payment is treated as
made upon the date specified under the plan (including a date specified
under paragraph (a)(4) of this section) and is not treated as an
accelerated payment if the payment is made no earlier than 30 days
before the designated payment date and the service provider is not
permitted, directly or indirectly to designate the taxable year of the
payment. For purposes of this paragraph, if the date specified is only
a designated taxable year of the service provider, or a period of time
during such a taxable year, the date specified under the plan is
treated as the first day of such taxable year or the first day of the
period of time during such taxable year, as applicable. The payment
with respect to a stock right generally occurs upon the exercise of the
stock right, so that where a stock right designates a fixed exercise
date, the stock right will be deemed to have been paid at such date if
the exercise and payment occur on such date or a later date within the
same taxable year of the service provider or, if later, by the 15th day
of the third calendar month following the exercise date specified under
the plan. If calculation of the amount of the payment is not
administratively practicable due to events beyond the control of the
service provider (or
[[Page 19311]]
service provider's beneficiary), the payment will be treated as made
upon the date specified under the plan if the payment is made during
the first taxable year of the service provider in which the calculation
of the amount of the payment is administratively practicable. For
purposes of this paragraph, the inability of a service recipient to
calculate the amount or timing of a payment due to a failure of a
service provider (or service provider's beneficiary) to provide
reasonably available information necessary to make such calculation
does not constitute an event beyond the control of the service
provider. Similarly, if the making of the payment at the date specified
under the plan would jeopardize the ability of the service recipient to
continue as a going concern, the payment will be treated as made upon
the date specified under the plan if the payment is made during the
first taxable year of the service provider in which the making of the
payment would not have such effect.
(e) Designation of time and form of payment with respect to
earnings. A nonqualified deferred compensation plan that provides for
actual or notional earnings to be credited on amounts of deferred
compensation may specify, in accordance with the requirements of Sec.
1.409A-2(a) (initial deferral elections), that such earnings are
treated separately from the right to the other amounts deferred under
the plan for purposes of designating the time and form of payments
under such plan, provided that to satisfy the requirements of this
paragraph (e), actual or notional earnings must be credited at least
annually. For these purposes, a right to dividend equivalents may be
treated analogously to a right to actual or notional earnings on an
amount of deferred compensation. For purposes of this paragraph (e),
the term dividend equivalents means the right to an amount equal to all
or a specified portion of dividends declared and paid, if any, on a
specified number of shares of stock.
(f) Substitutions. Except as otherwise provided under these
regulations, the payment of an amount as a substitute for a payment of
deferred compensation will be treated as a payment of the deferred
compensation. A forfeiture or voluntary relinquishment of an amount of
deferred compensation will not be treated as a payment of the
compensation, but there is no forfeiture or voluntary relinquishment
for this purpose if an amount is paid, or a legally binding right to a
payment is created, that acts as a substitute for the forfeited or
voluntarily relinquished amount. Whether a payment or a right to a
payment acts as a substitute for a payment of deferred compensation is
determined based on all the facts and circumstances. However, where the
payment of an amount results in an actual or potential reduction of, or
current or future offset to, an amount of deferred compensation, or if
the service provider receives a loan the repayment of which is secured
by or may be accomplished through an offset of or a reduction in an
amount deferred under a nonqualified deferred compensation plan, the
payment or loan is a substitute for the deferred compensation. In
addition, where a service provider's right to deferred compensation is
made subject to anticipation, alienation, sale, transfer, assignment,
pledge, encumbrance, attachment, or garnishment by creditors of the
service provider or the service provider's beneficiary, the deferred
compensation is treated as having been paid. For the treatment of
certain offsets, see paragraph (j)(4)(xiii) of this section. Even where
there is no explicit reduction or offset, the payment of an amount or
creation of a new right to a payment proximate to the purported
forfeiture or voluntary relinquishment of a right to deferred
compensation is presumed to be a substitute for the deferred
compensation. The presumption is rebuttable by a showing that the
compensation paid would have been received regardless of the forfeiture
or voluntary relinquishment of the right to deferred compensation.
Factors indicating that a payment would have been received regardless
of such forfeiture or voluntarily relinquishment include that the
amount paid is materially less than the forfeited or relinquished
amount, or consists of a type of payment customarily made in the
ordinary course of business of the service recipient to service
providers who do not forfeit or relinquish deferred compensation (for
example, a payment of accrued but unused leave or a payment for a
release of actual or potential claims). See Sec. 1.409A-1(b)(9)(i)
with respect to certain separation pay plans.
(g) Disputed payments and refusals to pay. If a service recipient
fails to make a payment in whole or in part as of the date specified
under a plan, either intentionally or unintentionally, other than with
the express or implied consent of the service provider, the payment
will be treated as made upon the date specified under the plan if the
service provider accepts the portion (if any) of the payment that the
service recipient is willing to make (unless such acceptance will
result in a relinquishment of the claim to all or part of the remaining
amount), makes prompt and reasonable, good faith efforts to collect the
remaining portion of the payment, and any further payment (including
payment of a lesser amount that satisfies the obligation to make the
payment) is made no later than the end of the first taxable year of the
service provider in which the service recipient and the service
provider enter into a legally binding settlement of such dispute, the
service recipient concedes that the amount is payable, or the service
recipient is required to make such payment pursuant to a final and
nonappealable judgment or other binding decision. For purposes of this
paragraph (g), efforts to collect the payment will be presumed not to
be prompt, reasonable, good faith efforts, unless the service provider
provides notice to the service recipient within 90 days of the latest
date upon which the payment could have been timely made in accordance
with the terms of the plan and these regulations, and unless, if not
paid, the service provider takes further enforcement measures within
180 days after such latest date. For purposes of this paragraph (g), a
service recipient is not treated as having failed to make a payment
where pursuant to the terms of the plan the service provider is
required to request payment, or otherwise provide information or take
any other action, and the service provider has failed to take such
action. In addition, for purposes of this paragraph (g), the service
provider is deemed to have requested that a payment not be made, rather
than the service recipient having failed to make such payment, where
the service recipient's decision to refuse to make the payment is made
by the service provider or a member of the service provider's family
(as defined in section 267(c)(4) applied as if the family of an
individual includes the spouse of any member of the family), or any
person or group of persons over whom the service provider or service
provider's family member has effective control, or any person any
portion of whose compensation is controlled the service provider or
service provider's family member.
(h) Special rule for certain resident aliens. An agreement, method,
program, or other arrangement that is, or constitutes part of, a
nonqualified deferred compensation plan is deemed to meet the
requirements of this section with respect to any amount payable in the
first taxable year of the service provider in which a service provider
is a resident alien, and with respect to any
[[Page 19312]]
amount payable in a subsequent taxable year if no later than the last
day of the first taxable year of the service provider in which the
service provider is a resident alien, the plan is amended as necessary
so that the times and forms of payment of amounts payable in a
subsequent year comply with the provisions of this section. For any
year after the first taxable year of an individual in which the
individual is a resident alien, this paragraph (h) does not apply,
provided that a taxable year may again be treated as the first taxable
year in which an individual is a resident alien if such individual has
not been a resident alien for at least three consecutive taxable years
immediately preceding the taxable year in which the service provider is
again a resident alien.
(i) Definitions and special rules--(1) Specified time or fixed
schedule--(i) In general. Amounts are payable at a specified time or
pursuant to a fixed schedule if objectively determinable amounts are
payable at a date or dates that are nondiscretionary and objectively
determinable at the time the amount is deferred. An amount is
objectively determinable for this purpose if the amount is specifically
identified or if the amount may be determined at the time payment is
due pursuant to an objective, nondiscretionary formula specified at the
time the amount is deferred (for example, 50 percent of a specified
account balance). Except as otherwise provided in paragraph (i)(1) of
this section, an amount is not objectively determinable if the amount
of the payment is based all or in part upon the occurrence of an event,
including the consummation of a transaction by, or a payment of an
amount to, a service recipient. If an amount is payable in a service
provider's taxable year (or pursuant to a fixed schedule of taxable
years of the service provider) that is designated at the time the
amount is deferred and that is objectively determinable, the amount is
treated as payable at a specified time (or pursuant to a fixed
schedule), provided that for purposes of the application of the
subsequent deferral rules contained in Sec. 1.409A-2(b), the specified
time or fixed schedule of payments is deemed to refer to the first day
of the relevant taxable year or years. A specified time or fixed
schedule also includes the designation at the time the amount is
deferred of a defined period or periods within the service provider's
taxable year or taxable years that are objectively determinable,
provided that no such defined period may begin within one taxable year
and end within another taxable year, and provided further that for
purposes of the application of the subsequent deferral rules contained
in Sec. 1.409A-2(b), the specified time or fixed schedule of payments
is deemed to refer to the first day of the relevant period in which the
payment will be made. A plan may provide that a payment upon the lapse
of a substantial risk of forfeiture is to be made in accordance with a
fixed schedule that is objectively determinable based on the date the
substantial risk of forfeiture lapses (disregarding any discretionary
acceleration of the lapse of the substantial risk of forfeiture),
provided that the schedule must be fixed on the date the time and form
of payment are designated, and any change in the fixed schedule will
constitute a change in the time and form of payment. For example, a
plan that provides for a bonus payment subject to the condition that
the service provider complete three years of service, and subject to
the further condition that such requirement of continued services will
lapse upon the occurrence of an initial public offering, which
condition if applied alone would constitute a substantial risk of
forfeiture, may provide that a service provider is entitled to
substantially equal payments on each of the first three anniversaries
of the date the substantial risk of forfeiture lapses (the earlier of
three years of service or the date of an initial public offering).
(ii) Payment schedules with formula and fixed limitations--(A)
Individual limitations. A schedule of payments does not fail to be a
fixed schedule of payments where the amount of a payment or payments
that may be paid at a specified time or during a specified period is
limited by an objective nondiscretionary formula or a specified amount
that is not under the effective control of the service provider and is
not subject to the exercise of discretion by the service recipient,
where such limitation is established on or before the date the time and
form of payment is otherwise required to be set under these
regulations, and the plan specifies the time and form of any payment
that will be made or completed after its original payment date due to
the application of the limitation. A change in the limitation or a
change in the time and form of any payment that exceeds the limitation
is subject to the requirements of Sec. 1.409A-2(b) (subsequent
deferral elections) and paragraph (j) of this section (accelerated
payments). For purposes of this paragraph, a plan provision that
reduces a schedule of periodic payments on a dollar-for-dollar basis by
the amount of Social Security payments received or receivable may be
treated as a nondiscretionary, objective formula limitation, if such
reduction does not otherwise affect the time of payment of the deferred
compensation (other than a forfeiture due to the reduction), including
changes based on the service provider's eligibility or elections
related to Social Security benefits. Similarly, a plan provision that
reduces a schedule of periodic payments on a dollar-for-dollar basis by
the amount of bona fide disability pay (within the meaning of Sec.
1.409A-1(a)(5)) received or receivable may be treated as a
nondiscretionary, objective formula limitation, if the disability
payments are made pursuant to a plan sponsored by the service recipient
that covers a substantial number of service providers and was
established before the service provider became disabled, and if such
reduction does not otherwise affect the time of payment of the deferred
compensation (other than a forfeiture due to the reduction). Whether an
amendment to, or other change in the benefit payable under, such bona
fide disability plan results in an acceleration of a payment for
purposes of paragraph (j) of this section or a subsequent election to
delay the time or change the form of payment for purposes of Sec.
1.409A-2(b) is determined based on all of the relevant facts and
circumstances.
(B) Limitations on aggregate payments to all participants in
substantially identical plans. A schedule of payments does not fail to
be a fixed schedule of payments where the amount of the aggregate
payments that will be made during a specified period of time to all
participants in substantially identical plans is limited by an
objective nondiscretionary formula or specified amount that is not
under the effective control of the service provider and is not subject
to the exercise of discretion by the service recipient, where the limit
is established on or before the date the time and form of payment of
the amount deferred is otherwise required to be set under these
regulations, the method of allocating payments among the participants
where there is an overall limitation on the aggregate amount that may
be paid to a group of service providers during a specified period is an
objective nondiscretionary allocation method that is not under the
effective control of the service provider and is not subject to the
exercise of discretion by the service recipient, the method is
established on or before the date the time and form of payment of the
amount deferred is otherwise required to be set,
[[Page 19313]]
and the plan specifies the time and form of any payment of any amount
that will be paid after its original payment date due to the
application of the limitation. A change in the limitation or a change
in the time and form of payment of any payment that is not otherwise
made at the scheduled payment date due to application of the formula
limitation is subject the requirements of Sec. 1.409A-2(b) (subsequent
deferral elections) and paragraph (j) of this section (accelerated
payments).
(iii) Payment schedules determined by timing of payments received
by the service recipient. A payment schedule determined by reference to
the timing of payments received by the service recipient (not including
payments from one entity to another entity where both entities are
treated as part of a single service recipient), meets the requirements
of a specified date or fixed schedule of payments if the following
conditions are met:
(A) The payments due to the service recipient arise from bona fide
and routine transactions in the ordinary course of business of the
service recipient.
(B) The service provider does not have effective control of the
service recipient, the person from whom such amounts are due, or the
collection of any of the amounts due to the service recipient.
(C) The payment schedule provides an objective, nondiscretionary
method of identification of the payments to the service recipient from
which the amount of the payment from the service recipient to the
service provider is determined.
(D) The payment schedule provides an objective, nondiscretionary
schedule under which the payments will be made to the service provider.
(E) The payments to the service recipient from which the amount of
the payments from service recipient to the service provider are
determined result from sales of a type that the service recipient is in
the trade or business of making and makes frequently, and either all
such sales by the service recipient are taken into account for purposes
of determining the payment to the service provider, or there is a
legitimate, non-tax business reason for identifying the specific sales
taken into account.
(iv) Reimbursement or in-kind benefit plans--(A) General rule. A
plan that provides for reimbursements of expenses incurred by a service
provider, or in-kind benefits, meets the requirements of a specified
date or fixed schedule of payments with respect to such reimbursements
or benefits if the following conditions are met:
(1) The plan provides an objectively determinable nondiscretionary
definition of the expenses eligible for reimbursement or of the in-kind
benefits to be provided.
(2) The plan provides for the reimbursement of expenses incurred or
for the provision of the in-kind benefits during an objectively and
specifically prescribed period (including the lifetime of the service
provider).
(3) The plan provides that the amount of expenses eligible for
reimbursement, or in-kind benefits provided, during a service
provider's taxable year may not affect the expenses eligible for
reimbursement, or in-kind benefits to be provided, in any other taxable
year.
(4) The reimbursement of an eligible expense is made on or before
the last day of the service provider's taxable year following the
taxable year in which the expense was incurred.
(5) The right to reimbursement or in-kind benefits is not subject
to liquidation or exchange for another benefit.
(B) Medical reimbursement arrangements. Notwithstanding the
foregoing, an arrangement providing for the reimbursement of expenses
referred to in section 105(b) will not be deemed to fail to meet the
requirements of paragraph (i)(1)(iv)(A)(3) of this section solely
because the arrangement provides for a limit on the amount of expenses
that may be reimbursed under such arrangement over some or all of the
period in which the reimbursement arrangement remains in effect.
(v) Tax gross-up payments. A plan providing a right to a tax gross-
up payment will be treated as providing for payment at a specified time
or on a fixed schedule of payments if the plan provides that payment
will be made, and the payment is made, by the end of the service
provider's taxable year next following the service provider's taxable
year in which the service provider remits the related taxes. For
purposes of this paragraph (i)(1)(v), the term tax gross-up payment
refers to a payment to reimburse the service provider in an amount
equal to all or a designated portion of the Federal, state, local, or
foreign taxes imposed upon the service provider as a result of
compensation paid or made available to the service provider by the
service recipient, including the amount of additional taxes imposed
upon the service provider due to the service recipient's payment of the
initial taxes on such compensation. In addition, a right to the
reimbursement of expenses incurred due to a tax audit or litigation
addressing the existence or amount of a tax liability, whether Federal,
state, local, or foreign, satisfies the requirement of a fixed time and
form of payment if the right to the reimbursement provides that payment
will be made, and the payment is made, by the end of the service
provider's taxable year following the service provider's taxable year
in which the taxes that are the subject of the audit or litigation are
remitted to the taxing authority, or where as a result of such audit or
litigation no taxes are remitted, the end of the service provider's
taxable year following the service provider's taxable year in which the
audit is completed or there is a final and nonappealable settlement or
other resolution of the litigation. Nothing in this paragraph (i)(1)(v)
otherwise alters the application of section 409A to the underlying
compensation arrangement or other arrangement that results in the taxes
subject to the right to the tax gross-up payment.
(vi) Examples. The following examples (in which each employee is an
individual whose taxable year is the calendar year) illustrate the
principles of paragraphs (a), (b), (c), (d), and (i)(1) of this
section:
Example 1. Employee A provides services as an employee of
Employer Z, but is not a specified employee. Employee A participates
in a nonqualified deferred compensation plan providing for a lump
sum payment payable on or before December 31 of the calendar year in
which Employee A separates from service. The plan provides for a
payment upon a separation from service in compliance with this
section.
Example 2. Employee B provides services as an employee of
Employer Y, but is not a specified employee. Employee B participates
in a nonqualified deferred compensation plan providing for a lump
sum payment payable on or before the 90th day immediately following
the date upon which Employee B separates from service. Employer Y
retains the sole discretion to determine when during the 90-day
period the payment will be made. Although the plan does not specify
a period during one calendar year in which the payment will be made,
the plan provides for a payment upon a separation from service in
compliance with this section because the period over which the
payment may be made is not longer than 90 days.
Example 3. Employee C provides services as an employee of
Employer X, but is not a specified employee. Employee C participates
in a nonqualified deferred compensation plan providing for a lump
sum payment payable on or before the 180th day following the date
upon which Employee C separates from service. Employer X retains the
sole discretion to determine when during the 180-day period the
payment will be made. Because the plan does not specify a period
during one calendar year in which the payment will be made, and
because the
[[Page 19314]]
period over which the payment may be made is longer than 90 days,
the plan does not provide for a payment upon a separation from
service that complies with this section.
Example 4. Employee D provides services as an employee of
Employer W, but is not a specified employee. Employee D participates
in a nonqualified deferred compensation plan providing for 10
installment payments payable on the first 10 anniversaries of the
date Employee D separates from service, provided that no installment
payment in any year may be more than 1% of Employer W's net income
for the previous calendar year, and provided further that the excess
over such limit that would otherwise be payable but is not paid due
to application of the limit will become payable as of the first
installment payment date at which time such amount, in combination
with any installment payment otherwise due Employee D, does not
exceed 1% of Employer W's net income for the previous calendar year.
Provided that Employee D does not retain effective control of the
calculation of Employer W's net income or the amount that Employee D
will not be paid due to application of the limit, the plan provides
for a schedule of payments upon a separation from service that
complies with this section.
Example 5. Employee E and Employee F provide services as
employees of Employer V, but neither is a specified employee.
Employee E and Employee F both participate in substantially
identical nonqualified deferred compensation plans providing for 10
installment payments payable on the first 10 anniversaries of the
date the respective employee separates from service, provided that
the total amount of installment payments in any year may not be more
than 1% of Employer V's net income for the previous year, that where
any payments are not made due to application of the limit the
determination of the amount not paid to a particular employee will
be made by applying the overall limit proportionately based upon the
installment payment due the employee that year, and that the excess
over such limit that would otherwise be payable but is not paid due
to application of the limit will become payable as of the first
installment payment date at which time such amount, in combination
with any installment payments otherwise due the participants, does
not exceed 1% of Employer V's net income for the previous calendar
year. Provided that neither Employee E nor Employee F retains
effective control of the calculation of Employer V's net income or
the amount that the respective employee will not be paid due to
application of the limit, the plan provides for a schedule of
payments upon a separation from service that complies with this
section.
Example 6. Employee G provides services as an employee of
Employer U, but is not a specified employee. As a bona fide part of
this employment relationship, Employee G provides professional
services to clients of Employer U as part of the bona fide, ordinary
course of Employer U's trade or business. Under an arrangement
between Employee G and Employer U, Employer U agrees to pay Employee
G upon Employee G's separation from service an amount equal to 5% of
any amount collected from Company T, a client of Employer U for
which Employee G performed services during his employment with
Employer U, during the 36 months following Employee G's separation
from service. Under the arrangement, the amounts due to Employee G
based upon payments received by Employer U during any calendar year
are payable to Employee G on April 1 of the subsequent calendar
year. Provided that Employee G does not have effective control of
Employer U, Company T, or the collection of any amounts due Employer
Y from Company T, the arrangement provides for a schedule of
payments upon a separation from service that complies with this
section.
Example 7. Employee H provides services as an employee of
Employer S, but is not a specified employee. Under a plan sponsored
by Employer S, Employee H has a legally binding right upon a
separation from service to the reimbursement of country club dues
paid in the calendar year of the separation from service and each of
the next 3 calendar years following the separation from service in
an amount not to exceed $30,000 in any calendar year, provided that
the amount of dues paid in any calendar year that are eligible for
reimbursement equals only the amount actually expended during such
calendar year, and the maximum amount available for reimbursement in
any calendar year will not be increased or decreased to reflect the
amount expended or reimbursed in a prior or subsequent calendar
year. The plan further provides that any reimbursement must be paid
to Employee H by December 31 of the calendar year following the year
in which Employee H pays the country club dues. The reimbursement
plan provides for a schedule of payments upon a separation from
service that complies with this section.
Example 8. Employee J provides services as an employee of
Employer Q, but is not a specified employee. Under a plan sponsored
by Employer Q, Employee J has a legally binding right upon a
separation from service to the reimbursement of country club dues
paid during the calendar year in which the separation from service
occurs and the next 3 calendar years in a total amount not to exceed
$90,000. The plan further provides that any reimbursement must be
paid to Employee J by December 31 of the calendar year following the
year in which Employee J pays the country club dues. Because the
reimbursement of a payment of country club dues in one calendar year
may affect the amount of country club dues available for
reimbursement in another calendar year, the plan does not provide
for a schedule of payments upon a separation from service that
complies with this section.
(2) Separation from service--required delay in payment to a
specified employee pursuant to a separation from service--(i) In
general. In the case of any service provider who is a specified
employee (as defined in Sec. 1.409A-1(i)) as of the date of a
separation from service, the requirements of paragraph (a)(1) of this
section permitting a payment upon a separation from service are
satisfied only if payments may not be made before the date that is six
months after the date of separation from service (or, if earlier than
the end of the six-month period, the date of death of the specified
employee). For this purpose, a service provider who is not a specified
employee as of the date of a separation from service will not be
treated as subject to this requirement even if the service provider
would have become a specified employee if the service provider had
continued to provide services through the next specified employee
effective date. Similarly, a service provider who is treated as a
specified employee as of the date of a separation from service will be
subject to this requirement even if the service provider would not have
been treated as a specified employee after the next specified employee
effective date had the specified employee continued providing services
through the next specified employee effective date. Notwithstanding the
foregoing, this paragraph (i)(2)(i) does not apply to a payment made
under the circumstances described in paragraph (j)(4)(ii) (domestic
relations order), (j)(4)(iii) (conflicts of interest), or (j)(4)(vi)
(payment of employment taxes) of this section.
(ii) Application of payment rules to delayed payments. The required
delay in payment is met if payments to which a specified employee would
otherwise be entitled during the first six months following the date of
separation from service are accumulated and paid on the first day of
the seventh month following the date of separation from service, or if
each payment to which a specified employee is otherwise entitled upon a
separation from service is delayed by six months. A service recipient
may retain discretion to choose which method will be implemented,
provided that no direct or indirect election as to the method may be
provided to the service provider. For an affected specified employee, a
date upon which the plan or the service recipient designates that the
payment will be made after the six-month delay is treated as a fixed
payment date for purposes of paragraph (d) of this section once the
separation from service has occurred.
(3) Unforeseeable emergency--(i) Definition. For purposes of
Sec. Sec. 1.409A-1 and 1.409A-2, this section, and Sec. Sec. 1.409A-4
through 1.409A-6, an unforeseeable emergency is a severe financial
hardship to the service provider resulting from an illness or accident
of the service provider, the service provider's spouse, the service
provider's beneficiary, or the service provider's dependent (as defined
in section 152, without regard to section 152(b)(1), (b)(2), and
(d)(1)(B)); loss of
[[Page 19315]]
the service provider's property due to casualty (including the need to
rebuild a home following damage to a home not otherwise covered by
insurance, for example, not as a result of a natural disaster); or
other similar extraordinary and unforeseeable circumstances arising as
a result of events beyond the control of the service provider. For
example, the imminent foreclosure of or eviction from the service
provider's primary residence may constitute an unforeseeable emergency.
In addition, the need to pay for medical expenses, including non-
refundable deductibles, as well as for the costs of prescription drug
medication, may constitute an unforeseeable emergency. Finally, the
need to pay for the funeral expenses of a spouse, a beneficiary, or a
dependent (as defined in section 152, without regard to section
152(b)(1), (b)(2), and (d)(1)(B)) may also constitute an unforeseeable
emergency. Except as otherwise provided in this paragraph (i)(3)(i),
the purchase of a home and the payment of college tuition are not
unforeseeable emergencies. Whether a service provider is faced with an
unforeseeable emergency permitting a distribution under this paragraph
(i)(3)(i) is to be determined based on the relevant facts and
circumstances of each case, but, in any case, a distribution on account
of unforeseeable emergency may not be made to the extent that such
emergency is or may be relieved through reimbursement or compensation
from insurance or otherwise, by liquidation of the service provider's
assets, to the extent the liquidation of such assets would not cause
severe financial hardship, or by cessation of deferrals under the plan.
A plan may provide for a payment upon a specific type or types of
unforeseeable emergency, without providing for payment upon all
unforeseeable emergencies, provided that any event upon which a payment
may be made qualifies as an unforeseeable emergency.
(ii) Amount of payment permitted upon an unforeseeable emergency.
Distributions because of an unforeseeable emergency must be limited to
the amount reasonably necessary to satisfy the emergency need (which
may include amounts necessary to pay any Federal, state, local, or
foreign income taxes or penalties reasonably anticipated to result from
the distribution). Determinations of amounts reasonably necessary to
satisfy the emergency need must take into account any additional
compensation that is available if the plan provides for cancellation of
a deferral election upon a payment due to an unforeseeable emergency.
See paragraph (j)(4)(viii) of this section. However, the determination
of amounts reasonably necessary to satisfy the emergency need is not
required to take into account any additional compensation that due to
the unforeseeable emergency is available under another nonqualified
deferred compensation plan but has not actually been paid, or that is
available due to the unforeseeable emergency under another plan that
would provide for deferred compensation except due to the application
of the effective date provisions under Sec. 1.409A-6. The payment may
be made from any plan in which the service provider participates that
provides for payment upon an unforeseeable emergency, provided that the
plan under which the payment was made must be designated at the time of
payment.
(iii) Payments due to an unforeseeable emergency. A service
provider may retain discretion with respect to whether to apply for a
payment upon an unforeseeable emergency, and a service recipient may
retain discretion with respect to whether to make a payment available
under the plan due to an unforeseeable emergency. A service provider
who has experienced an unforeseeable emergency will not be treated as
making a subsequent deferral election under Sec. 1.409A-2(b)
(subsequent deferral election rules) if the service provider does not
apply for or elect to receive a payment available under the plan. A
service recipient will not be treated as making a subsequent deferral
election under Sec. 1.409A-2(b) (subsequent deferral election rules)
if the service recipient exercises its discretion not to make a payment
otherwise available due to an unforeseeable emergency.
(4) Disability--(i) In general. For purposes of Sec. Sec. 1.409A-1
and 1.409A-2, this section, and Sec. Sec. 1.409A-4 through 1.409A-6,
except as otherwise specifically provided, a service provider is
considered disabled if the service provider meets one of the following
requirements:
(A) The service provider is unable to engage in any substantial
gainful activity by reason of any medically determinable physical or
mental impairment that can be expected to result in death or can be
expected to last for a continuous period of not less than 12 months.
(B) The service provider is, by reason of any medically
determinable physical or mental impairment that can be expected to
result in death or can be expected to last for a continuous period of
not less than 12 months, receiving income replacement benefits for a
period of not less than three months under an accident and health plan
covering employees of the service provider's employer.
(ii) Limited plan definition of disability. A plan may provide for
a payment upon any disability, and need not provide for a payment upon
all disabilities, provided that any disability upon which a payment may
be made under the plan complies with the provisions of this paragraph
(i)(4).
(iii) Determination of disability. A plan may provide that a
service provider will be deemed disabled if determined to be totally
disabled by the Social Security Administration or Railroad Retirement
Board. A plan may also provide that a service provider will be deemed
disabled if determined to be disabled in accordance with a disability
insurance program, provided that the definition of disability applied
under such disability insurance program complies with the requirements
of this paragraph (i)(4).
(5) Change in the ownership or effective control of a corporation,
or a change in the ownership of a substantial portion of the assets of
a corporation--(i) In general. Pursuant to section 409A(a)(2)(A)(v), a
plan may permit a payment upon the occurrence of a change in the
ownership of the corporation (as defined in paragraph (i)(5)(v) of this
section), a change in effective control of the corporation (as defined
in paragraph (i)(5)(vi) of this section), or a change in the ownership
of a substantial portion of the assets of the corporation (as defined
in paragraph (i)(5)(vii) of this section) (collectively referred to as
a change in control event). To qualify as a change in control event,
the occurrence of the event must be objectively determinable and any
requirement that any other person or group, such as a plan
administrator or compensation committee, certify the occurrence of a
change in control event must be strictly ministerial and not involve
any discretionary authority. The plan may provide for a payment on a
particular type or types of change in control events, and need not
provide for a payment on all such events, provided that each event upon
which a payment is provided qualifies as a change in control event. For
rules regarding the ability of the service recipient to terminate the
plan and pay amounts of deferred compensation upon a change in control
event, see paragraph (j)(4)(ix)(B) of this section.
(ii) Identification of relevant corporation--(A) In general. To
constitute a change in control event with respect to the service
provider, the change in control event must relate to--
[[Page 19316]]
(1) The corporation for whom the service provider is performing
services at the time of the change in control event;
(2) The corporation that is liable for the payment of the deferred
compensation (or all corporations liable for the payment if more than
one corporation is liable) but only if either the deferred compensation
is attributable to the performance of service by the service provider
for such corporation (or corporations) or there is a bona fide business
purpose for such corporation or corporations to be liable for such
payment and, in either case, no significant purpose of making such
corporation or corporations liable for such payment is the avoidance of
Federal income tax; or
(3) A corporation that is a majority shareholder of a corporation
identified in paragraph (i)(5)(ii)(A)(1) or (2) of this section, or any
corporation in a chain of corporations in which each corporation is a
majority shareholder of another corporation in the chain, ending in a
corporation identified in paragraph (i)(5)(ii)(A)(1) or (2) of this
section.
(B) Majority shareholder. For purposes of this paragraph
(i)(5)(ii), a majority shareholder is a shareholder owning more than 50
percent of the total fair market value and total voting power of such
corporation.
(C) Example. The following example illustrates the rules of this
paragraph (i)(5)(ii):
Example. Corporation A is a majority shareholder of Corporation
B, which is a majority shareholder of Corporation C. A change in
ownership of Corporation B constitutes a change in control event to
service providers performing services for Corporation B or
Corporation C, and to service providers for which Corporation B or
Corporation C is solely liable for payments under the plan (for
example, former employees), but is not a change in control event as
to Corporation A or any other corporation of which Corporation A is
a majority shareholder unless the sale constitutes a change in the
ownership of a substantial portion of Corporation A's assets (see
paragraph (i)(5)(vii) of this section).
(iii) Attribution of stock ownership. For purposes of paragraph
(i)(5) of this section, section 318(a) applies to determine stock
ownership. Stock underlying a vested option is considered owned by the
individual who holds the vested option (and the stock underlying an
unvested option is not considered owned by the individual who holds the
unvested option). For purposes of the preceding sentence, however, if a
vested option is exercisable for stock that is not substantially vested
(as defined by Sec. 1.83-3(b) and (j)), the stock underlying the
option is not treated as owned by the individual who holds the option.
(iv) Special rules for certain delayed payments pursuant to a
change in control event--(A) Certain transaction-based compensation.
Payments of compensation related to a change in control event described
in paragraph (i)(5)(v) of this section (change in the ownership of a
corporation) or paragraph (i)(5)(vii) of this section (change in the
ownership of a substantial portion of a corporation's assets), that
occur because a service recipient purchases its stock held by the
service provider or because the service recipient or a third party
purchases a stock right held by a service provider, or that are
calculated by reference to the value of stock of the service recipient
(collectively, transaction-based compensation), may be treated as paid
at a designated date or pursuant to a payment schedule that complies
with the requirements of section 409A if the transaction-based
compensation is paid on the same schedule and under the same terms and
conditions as apply to payments to shareholders generally with respect
to stock of the service recipient pursuant to a change in control event
described in paragraph (i)(5)(v) of this section (change in the
ownership of a corporation) or as apply to payments to the service
recipient pursuant to a change in control event described in paragraph
(i)(5)(vii) of this section (change in the ownership of a substantial
portion of a corporation's assets), and to the extent that the
transaction-based compensation is paid not later than five years after
the change in control event, the payment of such compensation will not
violate the initial or subsequent deferral election rules set out in
Sec. 1.409A-2(a) and (b) solely as a result of such transaction-based
compensation being paid pursuant to such schedule and terms and
conditions. If before and in connection with a change in control event
described in paragraph (i)(5)(v) or (i)(5)(vii) of this section,
transaction-based compensation that would otherwise be payable as a
result of such event is made subject to a condition on payment that
constitutes a substantial risk of forfeiture (as defined in Sec.
1.409A-1(d), without regard to the provisions of that section under
which additions or extensions of forfeiture conditions are disregarded)
and the transaction-based compensation is payable under the same terms
and conditions as apply to payments made to shareholders generally with
respect to stock of the service recipient pursuant to a change in
control event described in paragraph (i)(5)(v) of this section or to
payments to the service recipient pursuant to a change in control event
described in paragraph (i)(5)(vii) of this section, for purposes of
determining whether such transaction-based compensation is a short-term
deferral the requirements of Sec. 1.409A-1(b)(4) are applied as if the
legally binding right to such transaction-based compensation arose on
the date that it became subject to such substantial risk of forfeiture.
(B) Certain nonvested compensation. Notwithstanding the provisions
of Sec. 1.409A-1(d) (definition of a substantial risk of forfeiture)
that disregard the extension or modification of a condition for
purposes of determining whether a condition on payment constitutes a
substantial risk of forfeiture, a condition that is a substantial risk
of forfeiture that otherwise would lapse as a result of a change in
control event described in paragraph (i)(5)(v) or (i)(5)(vii) of this
section may be extended or modified before and in connection with such
event to provide for a condition on payment that will not lapse as a
result of such change in control event, and such extended or modified
condition will be treated as continuing to subject the amount to a
substantial risk of forfeiture, provided that the transaction
constituting the change in control event is a bona fide arm's length
transaction between the service recipient or its shareholders and one
or more parties who are unrelated to the service recipient and service
provider (applying the rules of Sec. 1.409A-1(f)(2)(ii)) and the
modified or extended condition to which the payment is subject would
otherwise be treated as a substantial risk of forfeiture under Sec.
1.409A-1(d) (without regard to the provisions disregarding additions or
extensions of forfeiture conditions). In such a case, the continued
application of a fixed schedule of payments based upon the lapse of the
substantial risk of forfeiture, so that payments commence upon the
lapse of the modified or extended condition on payment, will not be
treated as a change in the fixed schedule of payments for purposes of
Sec. 1.409A-2(b) (subsequent deferral elections) or paragraph (j) of
this section (prohibition on the acceleration of payments).
(v) Change in the ownership of a corporation--(A) In general.
Except as provided in paragraph (i)(5)(vi)(C) of this section, a change
in the ownership of a corporation occurs on the date that any one
person, or more than one person acting as a group (as defined in
paragraph (i)(5)(v)(B) of this section), acquires ownership of stock of
the corporation that, together with stock held by such person or group,
[[Page 19317]]
constitutes more than 50 percent of the total fair market value or
total voting power of the stock of such corporation. A nonqualified
deferred compensation plan may provide that amounts payable upon a
change in the ownership of a corporation will be paid only if the
conditions in the preceding sentence are satisfied but substituting a
percentage specified in the plan that is higher than 50 percent for the
words ``50 percent'' in the preceding sentence, but only if the
provision is set forth in the plan no later than the date by which the
time and form of payment must be established under Sec. 1.409A-2.
However, if any one person, or more than one person acting as a group,
is considered to own more than 50 percent of the total fair market
value or total voting power of the stock of a corporation (or such
higher percentage specified in accordance with the preceding sentence),
the acquisition of additional stock by the same person or persons is
not considered to cause a change in the ownership of the corporation
(or to cause a change in the effective control of the corporation
(within the meaning of paragraph (i)(5)(vi) of this section)). An
increase in the percentage of stock owned by any one person, or persons
acting as a group, as a result of a transaction in which the
corporation acquires its stock in exchange for property will be treated
as an acquisition of stock for purposes of this section. This section
applies only when there is a transfer of stock of a corporation (or
issuance of stock of a corporation) and stock in such corporation
remains outstanding after the transaction (see paragraph (i)(5)(vii) of
this section for rules regarding the transfer of assets of a
corporation). See Sec. 1.280G-1, Q&A-27(d), Example 1, Example 2,
Example 5, and Example 6.
(B) Persons acting as a group. For purposes of paragraph
(i)(5)(v)(A) of this section, persons will not be considered to be
acting as a group solely because they purchase or own stock of the same
corporation at the same time, or as a result of the same public
offering. However, persons will be considered to be acting as a group
if they are owners of a corporation that enters into a merger,
consolidation, purchase or acquisition of stock, or similar business
transaction with the corporation. If a person, including an entity,
owns stock in both corporations that enter into a merger,
consolidation, purchase or acquisition of stock, or similar
transaction, such shareholder is considered to be acting as a group
with other shareholders only with respect to the ownership in that
corporation before the transaction giving rise to the change and not
with respect to the ownership interest in the other corporation. See
Sec. 1.280G-1, Q&A-27(d), Example 3 and Example 4.
(vi) Change in the effective control of a corporation--(A) In
general. Notwithstanding that a corporation has not undergone a change
in ownership under paragraph (i)(5)(v) of this section, a change in the
effective control of the corporation occurs only on either of the
following dates:
(1) The date any one person, or more than one person acting as a
group (as determined under paragraph (i)(5)(v)(B) of this section),
acquires (or has acquired during the 12-month period ending on the date
of the most recent acquisition by such person or persons) ownership of
stock of the corporation possessing 30 percent or more of the total
voting power of the stock of such corporation. A nonqualified deferred
compensation plan may provide that amounts payable upon an effective
change in control of a corporation will be paid only if the conditions
in the preceding sentence are satisfied but substituting a percentage
specified in the plan that is higher than 30 percent for the word ``30
percent'' in the preceding sentence, but only if the percentage is set
forth in the plan no later than the date by which the time and form of
payment must be established under Sec. 1.409A-2).
(2) The date a majority of members of the corporation's board of
directors is replaced during any 12-month period by directors whose
appointment or election is not endorsed by a majority of the members of
the corporation's board of directors before the date of the appointment
or election, provided that for purposes of this paragraph (i)(5)(vi)(A)
the term corporation refers solely to the relevant corporation
identified in paragraph (i)(5)(ii) of this section for which no other
corporation is a majority shareholder for purposes of that paragraph.
For example, if Corporation A is a publicly held corporation with no
majority shareholder, and Corporation A is the majority shareholder of
Corporation B, which is the majority shareholder of Corporation C, the
term corporation for purposes of this paragraph (i)(5)(vi)(A)(2) would
refer solely to Corporation A. A nonqualified deferred compensation
plan may provide that amounts payable upon a change in the effective
control of a corporation will be paid only if the conditions in the
first sentence of this paragraph are satisfied substituting a portion
of the members of the corporation's board of directors that is higher
than the words ``a majority of the members of the corporation's board
of directors'' in the first sentence of this paragraph, but only if the
higher portion is set forth in the plan no later than the date by which
the time and form of payment must be established under Sec. 1.409A-
2(a)).
(B) Multiple change in control events. A change in effective
control may occur in a transaction in which one of the two corporations
involved in the transaction has a change in control event under
paragraph (i)(5)(v) or (i)(5)(vii) of this section. Thus, for example,
assume Corporation P transfers more than 40 percent of the total gross
fair market value of its assets to Corporation O in exchange for 35
percent of O's stock. P has undergone a change in ownership of a
substantial portion of its assets under paragraph (i)(5)(vii) of this
section and O has a change in effective control under this paragraph
(i)(5)(vi).
(C) Acquisition of additional control. If any one person, or more
than one person acting as a group, is considered to effectively control
a corporation (within the meaning of this paragraph (i)(5)(vi)), the
acquisition of additional control of the corporation by the same person
or persons is not considered to cause a change in the effective control
of the corporation (or to cause a change in the ownership of the
corporation within the meaning of paragraph (i)(5)(v) of this section).
(D) Persons acting as a group. Persons will not be considered to be
acting as a group solely because they purchase or own stock of the same
corporation at the same time, or as a result of the same public
offering. However, persons will be considered to be acting as a group
if they are owners of a corporation that enters into a merger,
consolidation, purchase or acquisition of stock, or similar business
transaction with the corporation. If a person, including an entity,
owns stock in both corporations that enter into a merger,
consolidation, purchase or acquisition of stock, or similar
transaction, such shareholder is considered to be acting as a group
with other shareholders in a corporation only with respect to the
ownership in that corporation before the transaction giving rise to the
change and not with respect to the ownership interest in the other
corporation. See Sec. 1.280G-1, Q&A-27(d), Example 4.
(vii) Change in the ownership of a substantial portion of a
corporation's assets--(A) In general. A change in the ownership of a
substantial portion of a corporation's assets occurs on the date that
any one person, or more than one person acting as a group (as
determined in paragraph (i)(5)(v)(B) of this section), acquires (or has
acquired during the 12-
[[Page 19318]]
month period ending on the date of the most recent acquisition by such
person or persons) assets from the corporation that have a total gross
fair market value equal to or more than 40 percent of the total gross
fair market value of all of the assets of the corporation immediately
before such acquisition or acquisitions (or such higher amount
specified by the plan no later than the date by which the time and form
of payment must be established under Sec. 1.409A-2). For this purpose,
gross fair market value means the value of the assets of the
corporation, or the value of the assets being disposed of, determined
without regard to any liabilities associated with such assets.
(B) Transfers to a related person--(1) There is no change in
control event under this paragraph (i)(5)(vii) when there is a transfer
to an entity that is controlled by the shareholders of the transferring
corporation immediately after the transfer, as provided in this
paragraph (i)(5)(vii)(B). A transfer of assets by a corporation is not
treated as a change in the ownership of such assets if the assets are
transferred to--
(i) A shareholder of the corporation (immediately before the asset
transfer) in exchange for or with respect to its stock;
(ii) An entity, 50 percent or more of the total value or voting
power of which is owned, directly or indirectly, by the corporation;
(iii) A person, or more than one person acting as a group, that
owns, directly or indirectly, 50 percent or more of the total value or
voting power of all the outstanding stock of the corporation; or
(iv) An entity, at least 50 percent of the total value or voting
power of which is owned, directly or indirectly, by a person described
in paragraph (i)(5)(vii)(B)(1)(iii) of this section.
(2) For purposes of this paragraph (i)(5)(vii)(B) and except as
otherwise provided in this paragraph (i), a person's status is
determined immediately after the transfer of the assets. For example, a
transfer to a corporation in which the transferor corporation has no
ownership interest before the transaction, but that is a majority-owned
subsidiary of the transferor corporation after the transaction is not
treated as a change in the ownership of the assets of the transferor
corporation.
(C) Persons acting as a group. Persons will not be considered to be
acting as a group solely because they purchase assets of the same
corporation at the same time. However, persons will be considered to be
acting as a group if they are owners of a corporation that enters into
a merger, consolidation, purchase or acquisition of assets, or similar
business transaction with the corporation. If a person, including an
entity shareholder, owns stock in both corporations that enter into a
merger, consolidation, purchase or acquisition of assets, or similar
transaction, such shareholder is considered to be acting as a group
with other shareholders in a corporation only to the extent of the
ownership in that corporation before the transaction giving rise to the
change and not with respect to the ownership interest in the other
corporation. See Sec. 1.280G-1, Q&A-27(d), Example 4.
(6) Certain back-to-back arrangements--(i) In general. This
paragraph (i)(6) applies where a service provider is providing services
to a service recipient (the intermediate service recipient), who in
turn is providing services to another service recipient (the ultimate
service recipient), the services provided by the service provider to
the intermediate service recipient are closely related to the services
provided by the intermediate service recipient to the ultimate service
recipient, there is a nonqualified deferred compensation plan providing
for payments by the ultimate service recipient to the intermediate
service recipient (the ultimate service recipient plan), there is a
nonqualified deferred compensation plan or other agreement, method,
program, or other arrangement providing for payments of compensation by
the intermediate service recipient to the service provider (the
intermediate service recipient plan), and the intermediate service
recipient plan provides for a payment upon the occurrence of an event
described in paragraph (a)(1), (2), (3), (5), or (6) of this section.
In such a case, notwithstanding the generally applicable limits on
payments in paragraph (a) of this section, the ultimate service
recipient plan may provide for a payment to the intermediate service
recipient upon the occurrence of a payment event under the intermediate
service recipient plan described in paragraph (a)(1), (2), (3), (5), or
(6) of this section if the time and form of payment is defined as the
same time and form of payment provided under the intermediate service
recipient plan, the amount of the payment under the ultimate service
recipient plan does not exceed the amount of the payment under the
intermediate service recipient plan, and the ultimate service recipient
plan and the intermediate service recipient plan otherwise satisfy the
requirements of section 409A (regardless of whether such plan is
subject to section 409A).
(ii) Example. The provisions of paragraph (i)(6)(i) of this section
are illustrated by the following example:
Example. Company B (intermediate service recipient) provides
services to Company C (ultimate service recipient). Employee A
(service provider) provides services to Company B that are closely
related to the services Company B provides to Company C. Pursuant to
a nonqualified deferred compensation plan meeting the requirements
of section 409A, Employee A is entitled to a payment of deferred
compensation upon a separation from service with Company B (the
intermediate service recipient plan). Under an arrangement between
Company B and Company C (the ultimate service recipient plan),
Company C agrees to pay an amount of deferred compensation to
Company B upon Employee A's separation from service with Company B,
in accordance with the time, form and amount of payment provided in
the intermediate service recipient plan. Provided that the
intermediate service recipient plan and the ultimate service
recipient plan otherwise comply with the requirements of section
409A (regardless of whether such arrangements are subject to section
409A), Company C's payment to Company B of the amount due under the
ultimate service recipient plan upon the separation from service of
Employee A from Company B may constitute a permissible payment event
for purposes of paragraph (a) of this section.
(j) Prohibition on acceleration of payments--(1) In general. Except
as provided in paragraph (j)(4) of this section, a nonqualified
deferred compensation plan may not permit the acceleration of the time
or schedule of any payment or amount scheduled to be paid pursuant to
the terms of the plan, and no such accelerated payment may be made
whether or not provided for under the terms of such plan. For purposes
of determining whether a payment of deferred compensation has been
made, the rules of paragraph (f) of this section (substituted payments)
apply. For purposes of this paragraph (j), an impermissible
acceleration does not occur if payment is made in accordance with plan
provisions or an election as to the time and form of payment in effect
at the time of initial deferral (or added in accordance with the rules
applicable to subsequent deferral elections under Sec. 1.409A-2(b))
pursuant to which payment is required to be made on an accelerated
schedule as a result of an intervening event that is an event described
in paragraph (a)(1), (2), (3), (5), or (6) of this section. For
example, a plan may provide that a participant will receive six
installment payments commencing at separation from service, and also
provide that if the participant dies after such payments
[[Page 19319]]
commence but before all payments have been made, all remaining amounts
will be paid in a lump sum payment. Additionally, it is not an
acceleration of the time or schedule of payment of a deferral of
compensation if a service recipient waives or accelerates the
satisfaction of a condition constituting a substantial risk of
forfeiture applicable to such deferral of compensation, provided that
the requirements of section 409A (including the requirement that the
payment be made upon a permissible payment event) are otherwise
satisfied with respect to such deferral of compensation. For example,
if a nonqualified deferred compensation plan provides for a lump sum
payment of the vested benefit upon separation from service, and the
benefit vests under the plan only after 10 years of service, it is not
a violation of the requirements of section 409A if the service
recipient reduces the vesting requirement to five years of service,
even if a service provider becomes vested as a result and receives a
payment in connection with a separation from service before the service
provider would have completed 10 years of service. However, if the plan
in this example had provided for a payment at a fixed date, rather than
at separation from service, the date of payment could not be
accelerated due to the accelerated vesting. For the definition of a
payment for purposes of this paragraph (j), see Sec. 1.409A-2(b)(5)
(coordination of the subsequent deferral election rules with the
prohibition on acceleration of payments). For other permissible
payments, see Sec. 1.409A-2(b)(2)(iii) (certain immediate payments of
remaining installments) and paragraph (d) of this section (certain
payments made no more than 30 days before the designated payment date).
(2) Application to multiple payment events. Generally, the addition
of a permissible payment event, the deletion of a permissible payment
event, or the substitution of one permissible payment event for another
permissible payment event, results in an acceleration of a payment if
the addition, deletion, or substitution could result in the payment
being made at an earlier date than such payment would have been made
absent such addition, deletion, or substitution. Notwithstanding the
previous sentence, the addition of death, disability (as defined in
paragraph (i)(4) of this section), or an unforeseeable emergency (as
defined in paragraph (i)(3) of this section), as a potentially earlier
alternative payment event to an amount previously deferred will not be
treated as resulting in an acceleration of a payment, even if such
addition results in the payment being paid at an earlier time than such
payment would have been made absent the addition of the payment event.
However, the addition of such a payment event as a potentially later
alternative payment event generally is subject to the rules governing
changes in the time and form of payment (see Sec. 1.409A-2(b)).
(3) Beneficiaries. The rules of this paragraph (j) apply to
elections by beneficiaries with respect to the time and form of
payment, as well as elections by service providers or service
recipients with respect to the time and form of payment to
beneficiaries. An election to change the identity of a beneficiary does
not constitute an acceleration of a payment merely because the election
changes the identity of the recipient of the payment, if the time and
form of the payment is not otherwise changed. In addition, an election
before the commencement of a life annuity to change the identity of a
beneficiary does not constitute an acceleration of a payment if the
change in the time of payments stems solely from the different life
expectancy of the new beneficiary, such as in the case of a joint and
survivor annuity, and does not change the commencement date of the life
annuity.
(4) Exceptions--(i) In general. Except as otherwise expressly
provided, a plan may provide for the acceleration of a payment in
accordance with paragraphs (j)(4)(ii) through (xiv) of this section, or
may provide a service recipient discretion to accelerate payments in
accordance with the provisions of paragraphs (j)(4)(ii) through (xiv)
of this section. A plan may not provide a service provider discretion
with respect to whether a payment will be accelerated, and a service
recipient may not provide a service provider a direct or indirect
election as to whether the service recipient's discretion to accelerate
a payment will be exercised, even if such acceleration would be
permitted under paragraphs (j)(4)(ii) through (xiv) of this section.
Whether a service recipient has provided a service provider an election
as to whether the service recipient's discretion to accelerate a
payment will be exercised is determined based on all the facts and
circumstances, including whether similarly situated service providers
have been treated differently. Except as otherwise provided in
paragraphs (j)(4)(ii) through (xiv) of this section, the plan need not
set forth the exception in writing, and provided all other requirements
of this section are met, the making of such a payment or the addition
of a plan term permitting the making of such a payment will not
constitute the acceleration of a payment, and the failure to make such
a payment or the deletion or modification of a plan term permitting the
making of such a payment will not be subject to the rules regarding a
change in the time and form of payment under Sec. 1.409A-2(b).
(ii) Domestic relations order. A plan may provide for acceleration
of the time or schedule of a payment under the plan to an individual
other than the service provider, or a payment under such plan may be
made to an individual other than the service provider, to the extent
necessary to fulfill a domestic relations order (as defined in section
414(p)(1)(B)).
(iii) Conflicts of interest--(A) Compliance with ethics agreements
with the Federal government. A plan may provide for acceleration of the
time or schedule of a payment under the plan, or a payment may be made
under a plan, to the extent necessary for any Federal officer or
employee in the executive branch to comply with an ethics agreement
with the Federal government.
(B) Compliance with ethics laws or conflicts of interest laws. A
plan may provide for acceleration of the time or schedule of a payment
under the plan, or a payment may be made under a plan, to the extent
reasonably necessary to avoid the violation of an applicable Federal,
state, local, or foreign ethics law or conflicts of interest law
(including where such payment is reasonably necessary to permit the
service provider to participate in activities in the normal course of
his or her position in which the service provider would otherwise not
be able to participate under an applicable rule). A payment is
reasonably necessary to avoid the violation of a Federal, state, local,
or foreign ethics law or conflicts of interest law if the payment is a
necessary part of a course of action that results in compliance with a
Federal, state, local, or foreign ethics law or conflicts of interest
law that would be violated absent such course of action, regardless of
whether other actions would also result in compliance with the Federal,
state, local, or foreign ethics law or conflicts of interest law. For
this purpose, a provision of foreign law is considered applicable only
to foreign earned income (as defined under section 911(b)(1) without
regard to section 911(b)(1)(B)(iv) and without regard to the
requirement that the income be attributable to services performed
during the period described in section 911(d)(1)(A) or (B)) from
sources within the foreign country that promulgated such law.
[[Page 19320]]
(iv) Section 457 plans. A plan subject to section 457(f) may
provide for an acceleration of the time or schedule of a payment to a
service provider, or a payment may be made under such a plan, to pay
Federal, state, local, and foreign income taxes due upon a vesting
event, provided that the amount of such payment is not more than an
amount equal to the Federal, state, local, and foreign income tax
withholding that would have been remitted by the employer if there had
been a payment of wages equal to the income includible by the service
provider under section 457(f) at the time of the vesting.
(v) Limited cashouts. A plan may require or provide a service
recipient discretion to require (or be amended to require or to provide
a service recipient discretion to require), a mandatory lump sum
payment of amounts deferred under the plan that do not exceed a
specified amount, provided that such plan term or amendment is executed
and effective, and any required exercise of service recipient
discretion is evidenced in writing, no later than the date of such
payment, and provided that--
(A) The payment results in the termination and liquidation of the
entirety of the service provider's interest under the plan, including
all agreements, methods, programs, or other arrangements with respect
to which deferrals of compensation are treated as having been deferred
under a single nonqualified deferred compensation plan under Sec.
1.409A-1(c)(2); and
(B) The payment is not greater than the applicable dollar amount
under section 402(g)(1)(B).
(vi) Payment of employment taxes. A plan may provide for the
acceleration of the time or schedule of a payment, or a payment may be
made under the plan, to pay the Federal Insurance Contributions Act
(FICA) tax imposed under section 3101, section 3121(a), and section
3121(v)(2), or the Railroad Retirement Act tax imposed under section
3201, section 3211, section 3231(e)(1), and section 3231(e)(8), where
applicable, on compensation deferred under the plan (the FICA or RRTA
amount). Additionally, a plan may provide for the acceleration of the
time or schedule of a payment, or a payment may be made under the plan,
to pay the income tax at source on wages imposed under section 3401 or
the corresponding withholding provisions of applicable state, local, or
foreign tax laws as a result of the payment of the FICA or RRTA amount,
and to pay the additional income tax at source on wages attributable to
the pyramiding section 3401 wages and taxes. However, the total payment
under this acceleration provision must not exceed the aggregate of the
FICA or RRTA Amount, and the income tax withholding related to such
FICA or RRTA amount.
(vii) Payment upon income inclusion under section 409A. A plan may
provide for the acceleration of the time or schedule of a payment, or a
payment under such plan may be made, at any time the plan fails to meet
the requirements of section 409A and these regulations. Such payment
may not exceed the amount required to be included in income as a result
of the failure to comply with the requirements of section 409A and
these regulations.
(viii) Cancellation of deferrals following an unforeseeable
emergency or hardship distribution. A plan may provide for a
cancellation of a service provider's deferral election, or such a
cancellation may be made, due to an unforeseeable emergency or a
hardship distribution pursuant to Sec. 1.401(k)-1(d)(3). The deferral
election must be cancelled, not merely postponed or otherwise delayed.
Accordingly, any later deferral election will be subject to the
provisions governing initial deferral elections. See Sec. 1.409A-2(a).
(ix) Plan terminations and liquidations. A plan may provide for the
acceleration of the time and form of a payment, or a payment under such
plan may be made, where the acceleration of the payment is made
pursuant to a termination and liquidation of the plan in accordance
with one of the following:
(A) The service recipient's termination and liquidation of the plan
within 12 months of a corporate dissolution taxed under section 331, or
with the approval of a bankruptcy court pursuant to 11 U.S.C. Sec.
503(b)(1)(A), provided that the amounts deferred under the plan are
included in the participants' gross incomes in the latest of the
following years (or, if earlier, the taxable year in which the amount
is actually or constructively received).
(1) The calendar year in which the plan termination and liquidation
occurs.
(2) The first calendar year in which the amount is no longer
subject to a substantial risk of forfeiture.
(3) The first calendar year in which the payment is
administratively practicable.
(B) The service recipient's termination and liquidation of the plan
pursuant to irrevocable action taken by the service recipient within
the 30 days preceding or the 12 months following a change in control
event (as defined in paragraph (i)(5) of this section), provided that
this paragraph will only apply to a payment under a plan if all
agreements, methods, programs, and other arrangements sponsored by the
service recipient immediately after the time of the change in control
event with respect to which deferrals of compensation are treated as
having been deferred under a single plan under Sec. 1.409A-1(c)(2) are
terminated and liquidated with respect to each participant that
experienced the change in control event, so that under the terms of the
termination and liquidation all such participants are required to
receive all amounts of compensation deferred under the terminated
agreements, methods, programs, and other arrangements within 12 months
of the date the service recipient irrevocably takes all necessary
action to terminate and liquidate the agreements, methods, programs,
and other arrangements. Solely for purposes of this paragraph
(j)(4)(ix)(B), where the change in control event results from an asset
purchase transaction, the applicable service recipient with the
discretion to liquidate and terminate the agreements, methods,
programs, and other arrangements is the service recipient that is
primarily liable immediately after the transaction for the payment of
the deferred compensation.
(C) The service recipient's termination and liquidation of the
plan, provided that--
(1) The termination and liquidation does not occur proximate to a
downturn in the financial health of the service recipient;
(2) The service recipient terminates and liquidates all agreements,
methods, programs, and other arrangements sponsored by the service
recipient that would be aggregated with any terminated and liquidated
agreements, methods, programs, and other arrangements under Sec.
1.409A-1(c) if the same service provider had deferrals of compensation
under all of the agreements, methods, programs, and other arrangements
that are terminated and liquidated;
(3) No payments in liquidation of the plan are made within 12
months of the date the service recipient takes all necessary action to
irrevocably terminate and liquidate the plan other than payments that
would be payable under the terms of the plan if the action to terminate
and liquidate the plan had not occurred;
(4) All payments are made within 24 months of the date the service
recipient takes all necessary action to irrevocably terminate and
liquidate the plan; and
(5) The service recipient does not adopt a new plan that would be
aggregated with any terminated and liquidated plan under Sec. 1.409A-
1(c) if the same service provider participated
[[Page 19321]]
in both plans, at any time within three years following the date the
service recipient takes all necessary action to irrevocably terminate
and liquidate the plan.
(D) Such other events and conditions as the Commissioner may
prescribe in generally applicable guidance published in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
(x) Certain distributions to avoid a nonallocation year under
section 409(p). A plan may provide for an acceleration of the time and
form of a payment, or a payment may be made under such plan, to prevent
the occurrence of a nonallocation year (within the meaning of section
409(p)(3)) in the plan year of an employee stock ownership plan next
following the plan year in which such payment is made, provided that
the amount distributed may not exceed 125 percent of the minimum amount
of distribution necessary to avoid the occurrence of a nonallocation
year. Solely for purposes of determining permissible distributions
under this paragraph (j)(4)(x), synthetic equity (within the meaning of
section 409(p)(6)(C) and Sec. 1.409(p)-1(f)) granted during the plan
year of the employee stock ownership plan in which such payment is made
is disregarded for purposes of determining whether the subsequent plan
year would result in a nonallocation year.
(xi) Payment of state, local, or foreign taxes. A plan may provide
for an acceleration of the time and form of a payment, or a payment may
be made under such plan, to reflect payment of state, local, or foreign
tax obligations arising from participation in the plan that apply to an
amount deferred under the plan before the amount is paid or made
available to the participant (the state, local, or foreign tax amount).
Such payment may not exceed the amount of such taxes due as a result of
participation in the plan. Such payment may be made by distributions to
the participant in the form of withholding pursuant to provisions of
applicable state, local, or foreign law or by distribution directly to
the participant. Additionally, an arrangement may provide for the
acceleration of the time or schedule of payment, or a payment may be
made under such arrangement, to pay the income tax at source on wages
imposed under section 3401 as a result of such payment and to pay the
additional income tax at source on wages imposed under section 3401
attributable to such additional section 3401 wages and taxes. However,
the total payment under this acceleration provision must not exceed the
aggregate of the state, local, and foreign tax amount, and the income
tax withholding related to such state, local, and foreign tax amount.
(xii) Cancellation of deferral elections due to disability. A plan
may provide for a cancellation of a service provider's deferral
election, or a cancellation of such election may be made, where such
cancellation occurs by the later of the end of the taxable year of the
service provider or the 15th day of the third month following the date
the service provider incurs a disability. For purposes of this
paragraph, a disability refers to any medically determinable physical
or mental impairment resulting in the service provider's inability to
perform the duties of his or her position or any substantially similar
position, where such impairment can be expected to result in death or
can be expected to last for a continuous period of not less than six
months.
(xiii) Certain offsets. A plan may provide for the acceleration of
the time or schedule of a payment, or a payment may be made under such
plan, as satisfaction of a debt of the service provider to the service
recipient, where such debt is incurred in the ordinary course of the
service relationship between the service recipient and the service
provider, the entire amount of reduction in any of the service
recipient's taxable years does not exceed $5,000, and the reduction is
made at the same time and in the same amount as the debt otherwise
would have been due and collected from the service provider.
(xiv) Bona fide disputes as to a right to a payment. A plan may
provide for the acceleration of the time or schedule of one or more
payments, or a payment may be made under such plan, where such payments
occur as part of a settlement between the service provider and the
service recipient of an arm's length, bona fide dispute as to the
service provider's right to the deferred amount. Discretion to
accelerate payments, other than due to an arm's length settlement of a
bona fide dispute as to the service provider's right to the deferred
amount, is not permitted under this paragraph (j)(4)(xiv). Whether a
payment qualifies for the exception under this paragraph is based on
all relevant facts and circumstances. A payment will be presumed not to
meet this exception unless the payment is subject to a substantial
reduction in the value of the payment made in relation to the amount
that would have been payable had there been no dispute as to the
service provider's right to the payment. For this purpose, a reduction
that is less than 25 percent of the present value of the deferred
amount in dispute generally is not a substantial reduction. In
addition, a payment will be presumed not to meet this exception if the
payment is made proximate to a downturn in the financial health of the
service recipient.
(5) Nonqualified deferred compensation plans linked to qualified
employer plans or certain other arrangements. If a nonqualified
deferred compensation plan provides that the amount deferred under the
plan is the amount determined under the formula determining benefits
under a qualified employer plan (as defined in Sec. 1.409A-1(a)(2)),
or a broad-based foreign retirement plan (as defined in Sec. 1.409A-
1(a)(3)(v)) maintained by the service recipient but applied without
regard to one or more limitations applicable to the qualified employer
plan under the Internal Revenue Code or to the broad-based foreign
retirement plan under other applicable law, or that the amount deferred
under the nonqualified deferred compensation plan is determined as an
amount offset by some or all of the benefits provided under the
qualified employer plan or broad-based foreign retirement plan, a
decrease in amounts deferred under the nonqualified deferred
compensation plan that results directly from changes in benefit
limitations applicable to the qualified employer plan or the broad-
based foreign retirement plan under the Internal Revenue Code or other
applicable law does not constitute an acceleration of a payment under
the nonqualified deferred compensation plan, provided that such
operation does not otherwise result in a change in the time or form of
a payment under the nonqualified deferred compensation plan, and
provided further that the change in the amounts deferred under the
nonqualified deferred compensation plan does not exceed such change in
the amounts deferred under the qualified employer plan or the broad-
based foreign retirement plan, as applicable. In addition, with respect
to such a nonqualified deferred compensation plan, the following
actions or failures to act will not constitute an acceleration of a
payment under the nonqualified deferred compensation plan even if in
accordance with the terms of the nonqualified deferred compensation
plan, the actions or inactions result in a decrease in the amounts
deferred under the plan, provided that such actions or inactions do not
otherwise affect the time or form of payment under the nonqualified
deferred compensation plan, and provided further that with respect to
actions or inactions described in paragraphs (j)(5)(i) and (ii) of this
section, the change in the amount
[[Page 19322]]
deferred under the nonqualified deferred compensation plan does not
exceed the change in the amounts deferred under the qualified employer
plan or the broad-based foreign retirement plan, as applicable:
(i) A service provider's action or inaction under the qualified
employer plan or broad-based foreign retirement plan with respect to
whether to elect to receive a subsidized benefit or an ancillary
benefit under the qualified employer plan or broad-based foreign
retirement plan.
(ii) The amendment of a qualified employer plan or broad-based
foreign retirement plan to increase benefits provided under such plan,
or to add or remove a subsidized benefit or an ancillary benefit.
(iii) A service provider's action or inaction under a qualified
employer plan with respect to elective deferrals and other employee
pre-tax contributions subject to the contribution restrictions under
section 401(a)(30) or section 402(g), including an adjustment to a
deferral election under such qualified employer plan, provided that for
any given taxable year, the service provider's action or inaction does
not result in a decrease in the amounts deferred under all nonqualified
deferred compensation plans in which the service provider participates
(other than amounts described in paragraph (j)(5)(iv) of this section)
in excess of the limit with respect to elective deferrals under section
402(g)(1)(A), (B), and (C) in effect for the taxable year in which such
action or inaction occurs.
(iv) A service provider's action or inaction under a qualified
employer plan with respect to elective deferrals and other employee
pre-tax contributions subject to the contributions restrictions under
section 401(a)(30) or section 402(g), and after-tax contributions by
the service provider to a qualified employer plan that provides for
such contributions that affects the amounts that are credited under one
or more nonqualified deferred compensation plans as matching amounts or
other similar amounts contingent on such elective deferrals, pre-tax
contributions, or after-tax contributions, provided that the total of
such matching or contingent amounts, as applicable, never exceeds 100
percent of the matching or contingent amounts that would be provided
under the qualified employer plan absent any plan-based restrictions
that reflect limits on qualified plan contributions under the Internal
Revenue Code.
(6) Changes in elections under a cafeteria plan. A change in an
election under a cafeteria plan (as defined in section 125(d)) does not
result in an accelerated payment of an amount deferred under a
nonqualified deferred compensation plan to the extent that the change
in the amount deferred under the nonqualified deferred compensation
plan results solely from the application of the change in amount
eligible to be treated as compensation under the terms of the
nonqualified deferred compensation plan resulting from the election
change under the cafeteria plan, to a benefit formula under the
nonqualified deferred compensation plan based upon the service
provider's eligible compensation, and only to the extent that such
change applies in the same manner as any other increase or decrease in
compensation would apply to such benefit formula.
Sec. 1.409A-4 Calculation of income inclusion [Reserved]
Sec. 1.409A-5 Funding [Reserved]
Sec. 1.409A-6 Application of section 409A and effective dates.
(a) Statutory application and effective dates--(1) Application to
amounts deferred--(i) In general. Except as otherwise provided in this
section, section 409A applies with respect to amounts deferred in
taxable years beginning after December 31, 2004, and with respect to
amounts deferred in taxable years beginning before January 1, 2005, if
the plan under which the deferral is made is materially modified after
October 3, 2004. For amounts deferred in taxable years beginning before
January 1, 2005, under a plan that is materially modified after October
3, 2004, whether the plan complies with the requirements of section
409A and these regulations is determined by reference to the terms of
the plan in effect as of, and any actions taken under the plan on or
after, the date of the material modification. Section 409A is
applicable with respect to earnings on amounts deferred only to the
extent that section 409A is applicable with respect to the amounts
deferred. Accordingly, section 409A does not apply with respect to
earnings on amounts deferred before January 1, 2005, unless section
409A applies with respect to the amounts deferred. For this purpose, a
right to earnings that is subject to a substantial risk of forfeiture
(as defined in Sec. 1.83-3(c)) or a requirement to perform further
services, on an amount deferred that is not subject to a substantial
risk of forfeiture (as defined in Sec. 1.83-3(c)) or a requirement to
perform further services, is not treated as earnings on the amount
deferred, but a separate right to compensation. Except as otherwise
provided in applicable guidance (see Sec. 601.601(d)(2) of this
chapter), the provisions of Sec. Sec. 1.409A-1 through 1.409A-5 and
this section provide the exclusive means of identifying agreements,
methods, programs, or other arrangements subject to section 409A, and
the exclusive means of satisfying the requirements of section 409A with
respect to such agreements, methods, programs, or other arrangements.
(ii) Collectively bargained plans. Section 409A does not apply with
respect to amounts deferred under a plan maintained pursuant to one or
more bona fide collective bargaining agreements in effect on October 3,
2004, for the period ending on the earlier of the date on which the
last of such collective bargaining agreements terminates (determined
without regard to any extension thereof after October 3, 2004) or
December 31, 2009.
(2) Identification of date of deferral for statutory effective date
purposes. For purposes of determining whether section 409A is
applicable with respect to an amount, the amount is considered deferred
before January 1, 2005, if before January 1, 2005, the service provider
had a legally binding right to be paid the amount, and the right to the
amount was earned and vested. For purposes of this paragraph (a)(2), a
right to an amount was earned and vested only if the amount was not
subject to a substantial risk of forfeiture (as defined in Sec. 1.83-
3(c)) or a requirement to perform further services. Amounts to which
the service provider did not have a legally binding right before
January 1, 2005 (for example, because the service recipient retained
discretion to reduce the amount), will not be considered deferred
before January 1, 2005. In addition, amounts to which the service
provider had a legally binding right before January 1, 2005, but the
right to which was subject to a substantial risk of forfeiture or a
requirement to perform further services after December 31, 2004, are
not considered deferred before January 1, 2005, for purposes of the
effective date. Notwithstanding the foregoing, an amount to which the
service provider had a legally binding right before January 1, 2005,
but for which the service provider was required to continue performing
services to retain the right only through the completion of the payroll
period (as defined in Sec. 1.409A-1(b)(3)) that includes December 31,
2004, is not treated as subject to a requirement to perform further
services (or a substantial risk of forfeiture) for purposes of the
effective date. For purposes of this paragraph (a)(2), a stock option,
stock appreciation
[[Page 19323]]
right, or similar compensation that on or before December 31, 2004, was
immediately exercisable for cash or substantially vested property (as
defined in Sec. 1.83-3(b)) is treated as earned and vested, regardless
of whether the right would terminate if the service provider ceased
providing services for the service recipient.
(3) Calculation of amount of compensation deferred for statutory
effective date purposes--(i) Nonaccount balance plans. The amount of
compensation deferred before January 1, 2005, under a nonqualified
deferred compensation plan that is a nonaccount balance plan (as
defined in Sec. 1.409A-1(c)(2)(i)(C)), equals the present value of the
amount to which the service provider would have been entitled under the
plan if the service provider voluntarily terminated services without
cause on December 31, 2004, and received a payment of the benefits
available from the plan on the earliest possible date allowed under the
plan to receive a payment of benefits following the termination of
services, and receive the benefits in the form with the maximum value.
Notwithstanding the foregoing, for any subsequent taxable year of the
service provider, the grandfathered amount may increase to equal the
present value of the benefit the service provider actually becomes
entitled to, in the form and at the time actually paid, determined
under the terms of the plan (including applicable limits under the
Internal Revenue Code), as in effect on October 3, 2004, without regard
to any further services rendered by the service provider after December
31, 2004, or any other events affecting the amount of or the
entitlement to benefits (other than a participant election with respect
to the time or form of an available benefit). For purposes of
calculating the present value of a benefit under this paragraph
(c)(3)(i), reasonable actuarial assumptions and methods must be used.
Whether assumptions and methods are reasonable for this purpose is
determined as of each date the benefit is valued for purposes of
determining the grandfathered benefit, provided that any reasonable
actuarial assumptions and methods that were used by the service
recipient with respect to such benefit as of December 31, 2004, will
continue to be treated as reasonable assumptions and methods for
purposes of calculating the grandfathered benefit. Actuarial
assumptions and methods will be presumed reasonable if they are the
same as those used to value benefits under a qualified plan sponsored
by the service recipient the benefits under which are part of the
benefit formula under, or otherwise impact the amount of benefits
under, the nonaccount balance nonqualified deferred compensation plan.
(ii) Account balance plans. The amount of compensation deferred
before January 1, 2005, under a nonqualified deferred compensation plan
that is an account balance plan (as defined in Sec. 1.409A-
1(c)(2)(i)(A)), equals the portion of the service provider's account
balance as of December 31, 2004, the right to which is earned and
vested (as defined in paragraph (a)(2) of this section) as of December
31, 2004, plus any future contributions to the account, the right to
which was earned and vested (as defined in paragraph (a)(2) of this
section) as of December 31, 2004, to the extent such contributions are
actually made.
(iii) Equity-based compensation plans. For purposes of determining
the amounts deferred before January 1, 2005, under an equity-based
compensation plan, the rules of paragraph (a)(3)(ii) of this section
governing account balance plans are applied except that the account
balance is deemed to be the amount of the payment available to the
service provider on December 31, 2004 (or that would be available to
the service provider if the right were immediately exercisable) the
right to which is earned and vested (as defined in paragraph (a)(2) of
this section) as of December 31, 2004. For this purpose, the payment
available to the service provider excludes any exercise price or other
amount that must be paid by the service provider.
(iv) Earnings. Earnings on amounts deferred under a plan before
January 1, 2005, include only income (whether actual or notional)
attributable to the amounts deferred under a plan as of December 31,
2004, or to such income. For example, notional interest earned under
the plan on amounts deferred in an account balance plan as of December
31, 2004, generally will be treated as earnings on amounts deferred
under the plan before January 1, 2005. Similarly, an increase in the
amount of payment available pursuant to a stock option, stock
appreciation right, or other equity-based compensation above the amount
of payment available as of December 31, 2004, due to appreciation in
the underlying stock after December 31, 2004, or accrual of other
earnings such as dividends, is treated as earnings on the amount
deferred. In the case of a nonaccount balance plan, earnings include
the increase, due solely to the passage of time, in the present value
of the future payments to which the service provider has obtained a
legally binding right, the present value of which constituted the
amounts deferred under the plan before January 1, 2005. Thus, for each
year, there will be an increase (determined using the same interest
rate used to determine the amounts deferred under the plan before
January 1, 2005) resulting from the shortening of the discount period
before the future payments are made, plus, if applicable, an increase
in the present value resulting from the service provider's survivorship
during the year. However, an increase in the potential benefits under a
nonaccount balance plan due to, for example, an application of an
increase in compensation after December 31, 2004, to a final average
pay plan or subsequent eligibility for an early retirement subsidy,
does not constitute earnings on the amounts deferred under the plan
before January 1, 2005.
(v) Definition of plan. For purposes of paragraphs (a)(1), (2), and
(3) of this section, the term ``plan'' has the meaning provided in
Sec. 1.409A-1(c), except that the plan aggregation rules do not apply
for purposes of the actuarial assumptions and methods used in paragraph
(a)(3)(i) of this section. Accordingly, different reasonable actuarial
assumptions and methods may be used to calculate the amounts deferred
by a service provider in two different agreements, methods, programs,
or other arrangements each of which constitutes a nonaccount balance
plan.
(4) Material modifications--(i) In general. Except as otherwise
provided, a modification of a plan is a material modification if a
benefit or right existing as of October 3, 2004, is materially enhanced
or a new material benefit or right is added, and such material
enhancement or addition affects amounts earned and vested before
January 1, 2005. Such material benefit enhancement or addition is a
material modification whether it occurs pursuant to an amendment or to
the service recipient's exercise of discretion under the terms of the
plan. For example, an amendment to a plan to add a provision that
payments of deferred amounts earned and vested before January 1, 2005,
may be allowed upon request if service providers are required to
forfeit 20 percent of the amount of the payment (a haircut) would be a
material modification to the plan. Similarly, a material modification
would occur if a service recipient exercised discretion to accelerate
vesting of a benefit under the plan to a date on or before December 31,
2004. However, it is not a material modification for a service
recipient to
[[Page 19324]]
exercise discretion over the time and manner of payment of a benefit to
the extent such discretion is provided under the terms of the plan as
of October 3, 2004. It is not a material modification for a service
provider to exercise a right permitted under the plan as in effect on
October 3, 2004. The amendment of a plan to bring the plan into
compliance with the provisions of section 409A will not be treated as a
material modification. However, a plan amendment or the exercise of
discretion under the terms of the plan that materially enhances an
existing benefit or right or adds a new material benefit or right will
be considered a material modification even if the enhanced or added
benefit would be permitted under section 409A. For example, the
addition of a right to a payment upon an unforeseeable emergency of an
amount earned and vested before January 1, 2005, would be considered a
material modification. The reduction of an existing benefit is not a
material modification. For example, the removal of a haircut provision
generally would not constitute a material modification. The following
modifications also are not material modifications for purposes of this
paragraph (a)(4)(i):
(A) The establishment of or contributions to a trust or other
arrangement from which benefits under the plan are to be paid is not a
material modification of the plan, provided that the contribution to
the trust or other arrangement would not otherwise cause an amount to
be includible in the service provider's gross income.
(B) The modification of a provision requiring the immediate
cancellation of a current deferral election, to require the
cancellation of deferrals for the same length of time beginning with
the first date at which the application of such cancellation would not
violate section 409A (for example, the first date of the service
provider's first taxable year following the cancellation).
(C) Compliance with a domestic relations order (as defined in Sec.
1.409A-3(j)(4)(ii)) with respect to payments to an individual other
than the service provider, or an amendment to a plan to require
compliance with a domestic relations order with respect to payments to
an individual other than the service provider.
(D) The modification of a plan providing a life annuity form of
payment to permit an election between the existing life annuity form of
payment and other forms of annuity payments that would be treated as a
single form of payment with the existing life annuity form of payment
under Sec. 1.409A-2(b)(2)(ii).
(E) The modification of a grandfathered plan to add a limited
cashout feature consistent with Sec. 1.409A-3(j)(4)(v) (exception to
prohibition on accelerated payments).
(ii) Adoptions of new plans. It is presumed that the adoption of a
new plan or the grant of an additional benefit under an existing plan
after October 3, 2004, and before January 1, 2005, constitutes a
material modification of a plan. However, the presumption may be
rebutted by demonstrating that the adoption of the plan or grant of the
additional benefit was consistent with the service recipient's
historical compensation practices. For example, the presumption that
the grant of a discounted stock option on November 1, 2004, is a
material modification of a plan may be rebutted by demonstrating that
the grant was consistent with the historic practice of granting
substantially similar discounted stock options (both as to terms and
amounts) each November for a significant number of years.
Notwithstanding paragraph (a)(4)(i) of this section and this paragraph
(a)(4)(ii), the grant of an additional benefit under an existing plan
that consists of a deferral of additional compensation not otherwise
provided under the plan as of October 3, 2004, will be treated as a
material modification of the plan only as to the additional deferral of
compensation, if the plan explicitly identifies the additional deferral
of compensation and provides that the additional deferral of
compensation is subject to section 409A. Accordingly, amendments to
conform a plan to the requirements of section 409A with respect to
deferrals under a plan occurring after December 31, 2004, will not
constitute a material modification of the plan with respect to amounts
deferred that are earned and vested on or before December 31, 2004,
provided that there is no concurrent material modification with respect
to the amount of, or rights to, amounts deferred that were earned and
vested on or before December 31, 2004. Similarly, a grant of an
additional benefit under a new plan adopted after October 3, 2004, and
before January 1, 2005, will not be treated as a material modification
of an existing plan to the extent that the new plan explicitly
identifies additional deferrals of compensation and provides that the
additional deferrals of compensation are subject to section 409A.
(iii) Suspension or termination of a plan. A cessation of deferrals
under, or termination of, a plan, pursuant to the provisions of such
plan, is not a material modification. Amending a plan to provide
participants an election whether to terminate participation in a plan
generally constitutes a material modification of the plan.
(iv) Changes to investment measures--account balance plans. With
respect to an account balance plan (as defined in Sec. 1.409A-
1(c)(2)(i)(A)), it is not a material modification to change a notional
investment measure, or to add to an existing investment measure, to an
investment measure that qualifies as a predetermined actual investment
within the meaning of Sec. 31.3121(v)(2)-1(d)(2) of this chapter or,
for any given taxable year, reflects a reasonable rate of interest
(determined in accordance with Sec. 31.3121(v)(2)-1(d)(2)(i)(C) of
this chapter). For this purpose, if with respect to an amount deferred
for a period, a plan provides for a fixed rate of interest to be
credited, and the rate is to be reset under the plan at a specified
future date that is not later than the end of the fifth taxable year
that begins after the beginning of the period, the rate is reasonable
at the beginning of the period, and the rate is not changed before the
reset date, then the rate will be treated as reasonable in all future
periods before the reset date.
(v) Stock rights. The modification, extension, or renewal of a
stock right will not constitute a material modification of the stock
right, if the modification, extension, or renewal would not be treated
as the grant of a new stock right under Sec. 1.409A-1(b)(5)(v)(A), and
would not result in the stock right being treated as having had a
deferral feature from the date of grant pursuant to Sec. 1.409A-
1(b)(5)(v)(C).
(vi) Rescission of modifications. Any modification to the terms of
a plan that would inadvertently result in treatment as a material
modification under this section is not considered a material
modification of the plan to the extent the modification in the terms of
the plan is rescinded by the earlier of a date before the right is
exercised (if the change grants a discretionary right) or the last day
of the taxable year of the service provider during which such change
occurred. Thus, for example, if a service recipient modifies the terms
of a plan on March 1 to allow an individual employee to elect a new
change in the time or form of payment without realizing that such a
change constituted a material modification that would subject the plan
to the requirements of section 409A, and the modification is rescinded
on November 1, then if no change in the time or form of payment has
been made pursuant to the modification before November 1, the plan is
not considered materially modified under this section.
[[Page 19325]]
(vii) Definition of plan. For purposes of this paragraph (a)(4),
the term ``plan'' has the same meaning provided in Sec. 1.409A-1(c),
except that the plan aggregation rules of Sec. 1.409A-1(c)(2) do not
apply.
(b) Regulatory applicability date. Sec. 1.409A-1, Sec. 1.409A-2,
Sec. 1.409A-3 and this section are applicable for taxable years
beginning on or after January 1, 2008.
Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
Approved: March 20, 2007.
Eric Solomon,
Assistant Secretary of the Treasury.
[FR Doc. 07-1820 Filed 4-10-07; 8:45 am]
BILLING CODE 4830-01-P