July 27, 2016
Authored by: Chris Rylands and Katharine Finley
On the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!” Of course, his news was rarely good. More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect. So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.
The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations. And the news is mostly good. Additionally, taxpayers can rely on the proposed regulations.
The changes are legion, so we are breaking up our coverage into a series of blog posts. This fourth in our series is about payment-related changes. See our first three posts, “Firing Squad,” “Taking (and Giving) Stock,” and “Don’t Fear the (409A) Reaper.” Check back for one more post on these regulations.
What’s a Payment? That’s not merely a philosophical question. The current regulations use “payment” a great many times, but without definition. The proposed regulations state that a payment, for 409A purposes, is generally made when a taxable benefit is actually or constructively received. For this purpose, if something is included in income under 457(f), it is now treated as a payment for all purposes under 409A. Additionally, a transfer of nonvested property is not a payment, unless the recipient makes an election to include the current value in income under Section 83(b).
Additional Permitted Delays for Short-Term Deferral Payments. Amounts paid shortly after the service provider obtains the right to the payment or becomes vested are exempt from 409A as “short-term deferrals.” The deadline is the 15th day of the third month following the year in which the right arises or the service provider becomes vested (often, March 15). If an amount is paid after that date, it is subject to 409A and must comply with 409A’s rules to avoid adverse tax consequences.
The regulations provided a few limited exceptions where payment could be delayed and still have the payment qualify as a short-term deferral. Now there are two more! Under the proposed rules, if payment by the short-term deferral deadline would violate Federal securities laws or other laws, then the payment can be delayed until such violation would not occur. Unfortunately, this exception does not appear to extend to insider trading policies of the company, but in our experience, that is not often a hurdle for the settlement of equity awards that were previously granted.
Teachers, Professors, et al. Get a Break. Often times, educators and related professions have the choice of being paid over the school year or electing instead to have their 9- or 10-month salary spread out over 12 months. Since these elections can result in a deferral of compensation, they are potentially subject to 409A (as an aside, it’s hard to see how this is in any way related to the perceived executive compensation abuses that 409A was ostensibly designed to address, but we digress). The existing rules treated these elections as exempt and thus outside 409A, but only if a small amount of compensation was to be shifted to the next tax year based on this election. The new proposed rules provide some additional flexibility.
Under the new proposed rules, these elections are still exempt as long as two conditions are met. First, the compensation cannot be deferred beyond the 13th month following the first day of the service period (e.g., the beginning of the school year). Second, the service provider’s total compensation for the year cannot exceed the 401(a)(17) limit ($265,000, adjusted annually).