A Service to Go with a Sad Story

I am going to pitch a service here that all employers should consider. If you are spending money to provide additional benefits for your executives, that money should go to them and not to the government.

Sometimes a good idea comes out of a sad story. And, I'm happy to report that in this case, it's sad because a company wasted money providing a generous benefit for its executives and then didn't tell the executives the pitfalls, but it's not sad in the context of someone going bankrupt or suffering a tragedy.

I got a call yesterday afternoon from someone who found me on the internet, probably through this blog. His wife is a participant in a SERP. Her employment with the company ended in July (I don't know how or why, I just know that it ended).

In early 2007, the wife received a communication from her employer. It told her that her SERP was being split into two pieces -- a 409A-grandfathered piece and a non-grandfathered piece. This was a not uncommon strategy. In addition, the non-grandfathered piece had a default payment of a lump sum of the present value of the accrued benefit payable six months after termination. A participant could elect a different form and or timing of payment (within limits defined in the plan). All of this is very normal in the world of SERPs post-409A.

Apparently, that is all the communication told her. It didn't explain the complexities of 409A. From what I could gather, her employer didn't want to give too much information because they were worried about potential litigation. So, they probably figured that giving no guidance at all meant that they gave no incorrect guidance.

When I answered the phone, the unhappy husband told me that he and his wife assumed that she could change her option when she terminated. So, she accepted the default and went on her merry way. Now, she will be receiving a lump sum that they don't really need right now and paying about half of it to various governments in the form of taxes.

Here's the idea. An employer could choose to go all the way or just do part of this.

Get an outsider like me who understands executive rewards and the 409A and other tax implications to help communicate to your executive group. In what I would term a perfect world (assuming that the employer chooses to not do the communication themselves), here is what would be entailed:

• Provide the outside consultant with the plan provisions and data for all the parts of the rewards package that you would like covered (SERP, deferred compensation plan, equity compensation, cash compensation, severance, change in control, etc.)
• Invite your executive group to a meeting. In that meeting, the outside consultant presents to the group generically on those elements of the rewards package. In that meeting, each executive, will get a summary/informal statement of their rewards package showing values and costs. The executives will place greater value on their rewards packages when they know how much they are worth and how much you are spending on them.
• With signed waivers (consulting, not legal, tax or accounting advice), allow executives to have individual meetings with the outside consultant after the group meeting. Let them ask questions about what they can change and when, what are their options, and what are their restrictions?
• These meetings can cover as much or as little of the executive rewards package as you would like, but the idea is to use the money that you are spending on executives for executives, not for the government.

Consider it. Let me help.

Your Eyes Are Not Failing You -- We Have GOOD 409A News

The IRS and the Treasury Department have released Notice 2010-80: Modification to the Relief and Guidance on Corrections of Certain Failures of a Nonqualified Deferred Compensation Plan to Comply with § 409A(a) [of the Code]. You can read it for yourself here: http://www.irs.gov/pub/irs-drop/n-10-80.pdf

That's a lot of words, and you might have to be a cryptographer to figure out what it all means, but trust me, this is good news -- very good news. The regulators in Washington have read comments, and while other remarks -- both verbal and in writing -- have gotten no official observance from the regulators, this writer thinks that those remarks have been noticed as well.

So, what's the buzz, tell me what's a happening (apologies to Andrew Lloyd Webber for reusing his Jesus Christ Superstar lyrics in a slightly different context).

Here is a summary of the news:

• Documentary failures under linked nonqualified plans (NQ linked to other NQ and or NQ linked to qualified) are now eligible for relief under Notice 2010-6, so long as the linkage does not affect the timing or form of payments under the plans. For many companies, on a scale of 10, this relief qualifies as an 11. 
• Documentary failures for certain stock rights are now eligible for Notice 2010- relief.
• An additional method of correction is now available for certain separation payments that are subject to a release of claims, and this method is very workable.
• There is relief from the extremely onerous service provider (employee) reporting requirements for the Notice 2010-6 transition relief for "freebie" correction under Notice 2010-6.
• There is relief for service recipients (employers) with respect to the information that they need to provide to service providers (employees) for Notice 2008-113 corrections made during the same taxable year.

The fourth and fifth (last two bullets) may look like small potatoes, but I am aware of multiple Fortune 500 companies that chose to have 409A failures rather than go through the 2008-113 or 2010-6 correction processes because of the requirements to provide information. So, these small potatoes are actually bigger than the eye perceives.

On to the nitty-gritty ...

The Linked Plans Issue

In my experience, this was the worst provision of the 409A regulations. No practitioners that I work with saw this seemingly innocent failure coming. Let's consider two fairly simple and common types of failures.

Example 1. Company A provides Executive E with a qualified defined benefit plan under which E is entitled to an annual benefit not to exceed the 415 limit of 1% of 5-year final average pay (not in excess of the pay cap) per year of service. A also provides E with an 'excess' plan (nonqualified) under which E receives an annual benefit under the same formula, but without regard to the 415 limit and pay cap, and further offset by the qualified plan benefit. 

Pause for a slap on the wrist.

Now, suppose that E has elected a lump sum payment upon separation from service from the nonqualified plan, but that the amount of this lump sum could be affected by the timing and form of the qualified plan payment. This appears to violate the 409A regulations, and there was no fix available under Notice 2010-6. Notice 2010-80 allows for correction under Notice 2010-6.

Example 2. The facts are the same as in Example 1, except that E does not have a lump sum option in the excess plan, but E also participates in a top-hat plan (SERP) with a richer benefit formula (offset by all other defined benefits) that does have a lump sum option. E has made a bona fide initial deferral election in the excess plan to take a 50% Joint and Survivor Annuity (with his wife as beneficiary) and a lump sum on the last day of his tax year following or coincident with separation from service from the SERP. 

Here we appear to have two violations of the 409A regulations, so pause for 40 lashes.

Again, Notice 2010-6 would not have allowed for correction of this 'defect', but Notice 2010-80 amends Notice 2010-6 to allow for such documentary corrections.

Separation Payments Contingent on Employment-Related Actions

This is another biggie. Again, Notice 2010-6 is amended by allowing for additional methods of correction. Suppose the service provider (again, this is usually the employee) needs to complete certain action(s) such as executing and submitting a non-compete in order to receive his separation payments. Paying the benefit upon separation from service eliminates the teeth in the non-compete; that is, the service provider could take his payment and decide to not sign the non-compete. Delaying payment violates 409A. 

But now, the fix is in, and it's a good one. The document can be amended to allow for payment [in general terms] either 60 or 90 days following the separation (permissible payment event) so long as in the event that the 90-day period spans two taxable years, the payment will be made during the second of those taxable years.

*            *               *                *                    *                       *                   *                    *               *

There's more -- of course there is -- much more in the Notice, but this should give you an overview of what I think readers may need to know. This stuff is pretty complex though, especially on the defined benefit side, and if you are dealing with it and don't have the in-house expertise (most companies don't), I suggest that you engage someone who is expert in both defined benefit plans and nonqualified plans to help. But, I repeat, this is good news. 

Don't wait. Act quickly. Get these things fixed.

The author is not an attorney or accountant and does not provide legal, accounting or tax advice.