Tuesday, August 9, 2016

409A Audit Could Be Coming to Your Company

All the way back in 2004, Congress passed and President George W. Bush signed into law the American Jobs Creation Act (Jobs Act). While it does not appear to have created many jobs, the Jobs Act added Section 409A to the Internal Revenue Code. The reasons were twofold -- first, to ensure that participants in nonqualified deferred compensation plans (NQDC) would never be advantaged over those in qualified plans; and second, to raise revenue for the federal government.

Thus far, the addition of 409A has done a pretty good job at the first of those goals by imposing a very strict set of rules on participants, usually executives, in NQDC arrangements. With regard to raising revenue, however, 409A has been fairly impotent to date.

Several years ago, the IRS rolled out an audit initiative of 409A plans. It had some teeth, but mostly with regard to larger plans (more participants) of larger companies. While there were exceptions, for the most part, if your company has less than about 5,000 employees or if your NQDC plans in total have less than about 100 covered participants, you've been mostly immune from this audit initiative.

Reports are now that the IRS has stepped up their audits. They are doing more of them and they are investigating more and more plans of companies that did seem immune in the early years of the program. In fact, I heard from an NQDC recordkeeper that a client of theirs with only 19 NQDC participants is currently under a 409A audit. I spoke with that recordkeeper, but between us, we couldn't determine what the pattern of companies that have recently come under 409A audit has been. That recordkeeper's anecdotal evidence, though, suggests that in other than very large companies, the primary target plans have been in order:

  • Nonqualified defined benefit pension plans that do not have the same formula as a broad-based DB plan in which the covered executives also participate;
  • Other nonqualified DB plans that simply make up for IRS limits (415 and 401(a)(17));
  • Deferred compensation plans that look different from the company's 401(k) plans; and
  • 401(k) mirror plans.
In other words, the target seems to be executive retirement plans.

To understand what the solutions might be, your first need to understand the problems. Generally, there are two ways that you can violate 409A -- either by failing to have or failing to have an appropriate written plan document, or by failing to follow both the plan document and the law and regulations.

In either case, the penalties are severe. But, those penalties are not imposed on the company. Instead, they are imposed on the executive, even if he had neither influence on nor knowledge of the defect from which that penalty will arise.

How bad is the penalty? It's this bad:
  • An additional 20% income surtax on the amounts deferred and not compliant for all taxable years in which that was the case; plus
  • Interest on previously unpaid taxes (due to failure to include the deferred amounts in income in the year in which they were deferred) at the Federal Underpayment Rate plus 1%.
And, that's in addition to ordinary income (and other) taxes that would be owed on those amounts. They add up quickly.

For most 409A defects, however, there are correction methods, structured somewhat analogously to those under the EPCRS program for qualified plans.

Many of you will seek help from counsel and from tax advisers. That may be a good solution for you. A problem that can occur in either case, though, is that it's very possible that neither has significant experience with determination of 409A benefits or with the administration of those benefits.If they do, that's great. But, if they don't, you probably need to look for additional expertise.

Thursday, August 4, 2016

Thinking About Compensation -- Cash and Otherwise

Suppose someone asks you how much you get paid. Probably the first thought that comes to mind for you is something like that your base pay is some amount of money per year or that you earn some amount per hour. You might include bonuses in your thoughts, or if you are hourly paid, you might include some overtime that you typically get. Let's just say, hypothetically, and because it's an easy number to work with, that your base pay is $100,000 per year and that you are not bonus eligible.

You're pretty happy in your job, but one evening, you get a call out of the blue from a recruiter or headhunter, if you prefer, who tells you that she would like to talk to you about a job in your field that has a budget of $110,000 per year. My question for you would be whether relative to your $100,000, is that $110,000 a good deal?

It seems obvious, doesn't it? You'd be getting a raise. But, it's not really that simple. Your current employer has a defined benefit pension plan and a 401(k) plan. They also provide you with a good health care program, four weeks of vacation per year, and some other benefits that probably don't seem like they will make a difference to you. Your potential new employer just has pretty basic health care and a garden variety 401(k) plan. They will start you at two weeks of vacation, but you work your way up to four weeks after ten years with the new company.

What should you do?

To people who often read my blog, the analysis is pretty simple, but to the average person, it's not. They often don't understand the value of these various benefits. And, that's why they tend to look at pay alone and perhaps the amount of vacation time that they are getting and whether or not their work schedule or work site (office versus home) will have any flexibility. That's work in 2016.

Suppose you are the employer and you happen to be the employer that offers good benefits, but doesn't pay quite as much as some of the employers against whom you compete for talent. I have an idea for you. Suppose you created a tool, or model if you prefer, to help prospective employees to compare what they are currently receiving with what you are offering them. It sounds like you've already made the commitment that you're not going to win on pay alone, so you have to find a way to make them understand the value.

Let them input all these various components side-by-side and see which one is the winner, especially if the pay you are offering is sufficient for them to live on. If you want to get even more sophisticated, you could tax-effect it.

Interestingly, the same concept works in executive compensation.

A company recently asked me to benchmark their executive retirement benefits (of course, those benefits are pay related). So, if their plans are 50th percentile, but their pay is only 40th percentile, then in reality, their plans fall short (50th percentile applies to 40th percentile gets you to somewhere less than 50th percentile retirement value), and conversely if you pay above the 50th percentile and provide 50th percentile retirement benefits.

It's surprising to me how often looking at things this way is a revelation. Perhaps you need that revelation.