The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Gerald S. Deutsch, Esq.
Glen Head, NY
Section 409A has severe penalties if the rules for deferred compensation plans are not followed. These penalties include an excise tax of 20% of the compensation that was required to be included in income.
That section sets forth when payments can be made to comply with its provisions. Of course, one such payment event would be separation from service. However, in the case of a key employee of a publicly traded corporation, the payment cannot be made before the date which is six months after the date of separation from service.
If the key employee is on good terms with the company for whom he worked, this six-month delay might not be a problem. However, what if there has been a buyout or other “change in control” and the new management, for whatever reason, has become disenchanted with the deal and refuses to make any further payments to old management including the deferred compensation due to former key employees? It's not a comfortable position to be in for those expecting their deferred compensation which has been earned, perhaps over many years.
Well, one of the other events that will permit deferred compensation payments to be made is 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. So perhaps deferred compensation plans should provide for payments in such cases. No waiting for six months relying on new management to meet the obligation. The payment will, however, have to be made even if the key employee continues to work in the new organization.
It should be noted that while having the payments made upon a change of control may satisfy the harsh §409A rules, it may, however, cause the payments to be subject to the golden parachute rules of §§280G and 4999. These rules can (i) deny a deduction to the employer and (ii) impose a penalty tax on the recipient.
But there are some differences between the deferred compensation rules and the golden parachute rules regarding “change of control.”
For one thing, the golden parachute rules don't apply to an S corporation. The rules also do not apply to a non public corporation if the shareholders approve the payment.
It will be important to use the deferred compensation definition to avoid the harsh §409A penalties and by doing so it is possible that the payment may not constitute a golden parachute under its rules. For example, in the case of an affiliated group, for purposes of the deferred compensation §409A rules, the focus is on the actual employing corporation alone, or another corporation that is responsible for the payment, or a parent. Under the golden parachute rules, however, the test is for all of the affiliated group.
However, in other respects, the §409A rules have a higher threshold. Under the definitions of “change in effective control” and “change in ownership of a substantial portion of assets,” certain changes in ownership can trigger the golden parachute rules, and yet not be a permissible event for distribution for purposes of §409A. In such cases, this suggestion will not work, and careful drafting will be needed. The agreement will have to provide for a payment on termination, and the key employee will have to observe the six month delay rule for his payment. The key employee will have to rely on new management to fulfill the obligation.
However, in the case of most sales of companies, the test for change of control will be satisfied for both §409A and the golden parachute rules, so the suggested approach should be considered.
For more information, in the Tax Management Portfolios, see Brisendine and Drigotas, 385 T.M., Deferred Compensation Arrangements, and in Tax Practice Series, see ¶5720, Golden Parachutes.
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