Employee Fringe Benefits and Sect. 409A Deferred Compensation: Tax - - PowerPoint PPT Presentation

Employee Fringe Benefits and Sect. 409A Deferred Compensation: Tax Issues

Evaluating Exclusions or Potential Federal Taxability

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WEDNESDAY, JUNE 12, 2013

Presenting a live 110-minute teleconference with interactive Q&A

Tara Silver-Malyska, Tax Principal, UHY Advisors, Dallas James Davis, Shareholder and Chairman, Tax Practice Group, Gunster, Fort Lauderdale, Fla. Stefan Smith, Partner, Locke Lord, Dallas Cynthia A. Moore, Member, Dickinson Wright, Troy, Mich.

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Employee Fringe Benefits and Sect. 409A Deferred Compensation: Tax Issues Seminar

Tara Silver-Malyska, UHY Advisors tsilver-malyska@uhy-us.com James Davis, Gunster June 12, 2013 Cynthia A. Moore, Dickinson Wright cmoore@dickinsonwright.com Stefan Smith, Locke Lord ssmith@lockelord.com jdavis@gunster.com

Today’s Program

Categories Of Fringe Benefits Getting A U.S. Tax Exclusion [Cynthia A. Moore] Fringe Benefits That Can Trigger A Tax Bill [Tara Silver-Malyska] Situations Of Employer Fringe Benefit Withholding Liability [Stefan Smith] Material Terms Of Sect. 409A Regarding Taxability [James Davis] Slide 8 – Slide 24 Slide 62 – Slide 99 Slide 25 – Slide 38 Slide 39 – Slide 61

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

CATEGORIES OF FRINGE BENEFITS GETTING A U.S. TAX EXCLUSION

Cynthia A. Moore, Dickinson Wright

Categories Of Fringe Benefits

Conceptually, all benefits provided by an employer to employees other than cash wages or salary May be divided into three broad categories:

• Benefits provided as future cash payments or property rights, such

as qualified or non-qualified deferred compensation plans and equity-based plans

• Benefits provided in the form of insurance or unfunded welfare

benefits, such as health, life or disability insurance

• Benefits provided currently, including property made available, job-

related working conditions and incidental benefits such as use of company car

9

Tax Consequences Of Fringe Benefits

IRC Sect. 61(a): “… gross income means all income from whatever source derived, including (not limited to) the following items: (1) compensation for services, including fees, commissions, fringe benefits and similar items.” Applies to cash and non-cash compensation Must be an express exclusion in the Internal Revenue Code to exclude a fringe benefit from employee income

10

Deferred Compensation Benefits

• IRC Sect. 402: Contributions to a qualified retirement plan are not

taxable until distributed.

• An employer’s unsecured promise to pay deferred compensation also

defers tax until distributions are made, subject to compliance with IRC

• Sect. 409A. Deferred compensation plans of tax-exempt employers that

do not comply with the rules of IRC Sect. 457(b) are taxable when they are no longer subject to a substantial risk of forfeiture under IRC Sect. 457(f).

• Under IRC Sect. 83, property that is subject to a substantial risk of

forfeiture is taxable when the risk of forfeiture lapses, unless the employee makes an 83(b) election to recognize income on the date the property is transferred to him or her.

• Note that the taxation of these benefits is deferred, not excluded from

income.

11

Welfare Benefit Plan Exclusions

• IRC Sect. 79: Group-term life insurance up to $50,000
• IRC Sect. 105/106: Accident and health benefits. Employer contributions

are excludible (up to certain limits noted below) under IRC Sect.106. Benefit payments for medical care of the employee, spouse and dependents are excluded from income under IRC Sect. 105(b).

• A self-insured medical reimbursement plan cannot discriminate in favor
• f highly compensated individuals, under IRC Sect. 105(h).
• Contributions to a health savings account are limited to $3,250 for self-
• nly coverage and $6,450 for family coverage; employer contributions

must be “comparable.”

• Employee pre-tax contributions to a health flexible spending account are

limited to $2,500 for plan years on or after Jan. 1, 2013. An employer may contribute an additional “flex credit” to a health FSA.

12

Welfare Benefit Exclusions (Cont.)

• IRC Sect. 125: Cafeteria plan allows employees to make pre-tax

contributions for qualified benefits.

• IRC Sect. 127: An educational assistance program allows an

employee to exclude up to $5,250 per year.

• IRC Sect. 129: A dependent care assistance program allows an

employee to exclude up to $5,000 per year.

• IRC Sect. 137: An adoption assistance program allows an employee

to exclude a cumulative limit of $12,970 in 2013.

13

Incidental Fringe Benefits

IRC Sect. 132: Eight categories of excludible benefits

• Working condition fringes
• No-additional cost services
• Qualified employee discounts
• De minimis fringes
• Qualified transportation fringes
• Qualified moving expense reimbursements
• Qualified retirement planning services
• Qualified military base realignment and closure fringes

14

Working Condition Fringes

Definition: Any property or service that, if the employee had paid for it, would be deductible under IRC sections 162 or 167. Examples:

• Business use of company car or airplane
• Office décor
• Employer-provided cell phone
• Professional memberships, dues and publications
• Job-related educational assistance
• Security arrangements (if the need for security is substantiated)
• Outplacement services (if the employer derives a substantial

business benefit from the service)

15

No-Additional Cost Services

Definition: A service provided to an employee for which the employer does not incur any substantial additional cost Examples:

• Space-available travel on an airplane, train or bus
• Use of available hotel rooms

16

Qualified Employee Discounts

Definition: An employee discount on qualified property or services. The maximum excludible discount on services is 20% of the price at which the employer offers the service to non-employee customers. The maximum excludible discount on property or merchandise is the employer’s “gross profit percentage” (the excess of the aggregate sales price of the products sold to non-employee customers over the aggregate cost of the property divided by the aggregate sales price). “Qualified property or services” means property or services offered for sale to customers in the ordinary course of business of the line of business of the employer in which the employee provides services. Does NOT include real property or personal property of a kind held for investment

17

De Minimis Fringe Benefits

Definition: The fair market value (FMV) of the property or service is so small that accounting for the property or service would be unreasonable or administratively impracticable. The frequency with which the benefit is provided is also considered. Examples:

• Occasional use of office support staff and equipment (such as

copiers)

• Occasional payment of supper money and taxi fare, if an employee

is required to work overtime.

• Holiday gifts of low FMV (such as a turkey or ham)
• Occasional theater or sports tickets
• Dependent life insurance up to $2,000

18

Qualified Transportation Fringes

Four categories of excludible benefits: (1)Transportation in a commuter highway vehicle in connection with travel between the employee’s residence and place of employment (2)Transit passes (3)Qualified parking (4)Qualified bicycle commuting reimbursement Monthly exclusion from wages in 2013:

• $245/month for combined commuter highway vehicle transportation

and transit passes

• $245/month for qualified parking
• $20/number of qualified bicycle commuting months in a year

19

Qualified Moving Expense Reimbursements

Definition: Any amount an individual receives from an employer as a payment for (or reimbursement of) moving expenses that the individual could deduct under IRC Sect. 217, if those expenses had been paid directly Examples:

• Moving household goods and personal effects from the former home

to the new home

• Traveling (including lodging) from the former home to the new home

For more information, see IRS Publication 521 (moving expenses)

20

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Qualified Retirement Planning Services

Definition: Any retirement planning advice or information provided to an employee or spouse by an employer maintaining a qualified retirement plan The exclusion is not limited to advice related to the qualified plan, but does not extend to tax preparation, accounting, legal or brokerage services.

22

Qualified Military Base Realignment And Closure Fringes

Excludes certain housing assistance payments (such as compensation for losses sustained in a private sale or foreclosure of a home) made with respect to military base realignment and closures Limited applicability, due to numerous technical requirements

23

Other Developments/Resources

• IRS commenced a three-year employment tax national research

project in February 2010. Information collected during the project will help the IRS select and audit future employment tax returns with the greatest compliance risk. Fringe benefits were one of the areas identified by the IRS as a primary focus of the project. Results of the project could lead to increased scrutiny of the tax treatment of fringe benefits during an audit.

• Helpful resource: IRS Publication 15-B (employer’s tax guide to

fringe benefits)

24

FRINGE BENEFITS THAT CAN TRIGGER A U.S. TAX BILL

Tara Silver-Malyska, UHY Advisors

An independent member of UHY International

The next level of service

EMPLOYER-PROVIDED PERQUISITES

Perquisites or fringe benefits are non-cash benefits provided to executives at no cost or at a very modest cost. Taxation of fringe benefits has always been important, but why the focus

• r discussion now?

− IRS released six audit techniques guides focusing on executive compensation.

• Included in this group is the Fringe Benefits Audit Techniques Guide.

− Taxation of executive compensation is currently included in routine corporate audits of large and mid-size business (LMSB) taxpayers and as evidenced by related IDRs − In January 2013, the IRS issued the FSLG Fringe Benefit Guide.

26

An independent member of UHY International

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TAXABLE FRINGE BENEFITS

Tax treatment of the particular fringe benefit varies, depending upon facts and circumstances, and it is important to follow the three-step analysis when examining a particular item. First, identify the fringe benefit and start with the assumption that its value will be taxable as compensation to the employee Second, check to see if there are any statutory provisions that exclude the fringe benefit from the executive’s gross income Third, value any portion of the benefit that is not excludable for inclusion in the executive’s gross income Also, consider valuation and non-discrimination rules

27

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Statutory provisions that exclude all or a part of the value of the fringe benefit from the executive’s gross income:

Accident and health benefits Group-term life insurance Achievement awards Health savings accounts HSAs Adoption assistance Lodging on business premises Athletic facilities Meals Cafeteria plan Military base realignment and closure De minimis benefits Moving expense reimbursements Dependent care assistance No-additional-cost services Educational assistance Retirement planning services Employee discounts Transportation benefits Employee stock options Tuition reduction Employer-provided cell phones Working condition benefits

28

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Travel and transportation Company cars − If used exclusively for business and substantiation requirements are met excludable as a working condition fringe − Personal use is taxable and valued under the one of the special valuation methods

• Automobile lease valuation rule
• Vehicle cents-per-mile rule
• Commuting rule

29

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Automobile lease valuation rule (ALV) Compute the value as follows: − Determine the FMV of the vehicle on the first day it is made available to the employee − Use the table in Reg. Sec. 1.61-21(d)(2)(iii) or Pub. 15-B to compute the annual lease value − Multiply the annual lease value by the percentage of personal use computed in the first step − If fuel is provided, add 5.5 cents per mile driven by the employee to the table lease value.

30

An independent member of UHY International

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Vehicle cents-per-mile rule requires that one of the following tests must be met: The employer reasonably expects the vehicle to be regularly used in the trade or business throughout the calendar year, or − At least 50% or more of the total annual mileage each year is in the employer’s business, or − It is generally used each workday to transport at least three employees to and from work, in an employer-sponsored commuting vehicle pool. The mileage test is met − Driven by employees at least 10,000 miles per year, and − Use of the vehicle is primarily by employees

TAXABLE FRINGE BENEFITS (CONT.)

31

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Commuting valuation rule values personal use for commuting at $1.50 each way if all of the following are met: The vehicle is owned or leased by the employer. The vehicle is provided to the employee for business use. The employer requires the employee to commute in the vehicle for bona fide, non-compensatory business reasons. The employer has a written policy prohibiting personal use. The employee does not use the vehicle for other than de minimis personal use. The employee who uses the vehicle is not a control employee.

32

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Travel on company-owned aircraft Any personal use of an employer’s airplane will be taxable to the employee. Valuation for travel on company-owned aircraft, in lieu of FMV of chartering aircraft /purchasing the flight − Standard industry fare level (SIFL) statistics CAB/DOT and three-step calculation

• First, the number of miles flown times the SIFL cents-per-mile charge
• This figure times the appropriate aircraft multiple from the table
• Terminal charge in effect is added to the product determined above.

− Lower SIFL if at least half the regular seating capacity is filed with business travelers when he/she boards and deplanes the aircraft

33

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Spousal travel Employer’s cost for an accompanying spouse, dependent or friend results in income to the employee, unless that person is performing substantive duties for the employer. − Disallowance of deductibility of related travel expenses for spouse, dependent or other individual accompanying the taxpayer unless:

• Bona fide employee of person/entity paying/reimbursing travel

expenses

• Is also traveling for a bona fide business purpose
• Would otherwise be able to deduct the expenses

Employer choice between taxing the worker and absorbing a deduction loss with respect to bona fide business travel by the spouse

34

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Security protection Expenditures “primarily for the safety of employees” are excludable as working condition fringes, if safety precautions are necessary and detailed regular requirements and valuation rules are satisfied. − Exclusion amount is the difference between the amount paid for the transportation and the amount paid absent the security concerns. Substantiation requires demonstration of the existence of a bona fide business-oriented security concern. − Must establish external circumstances requiring security, and − Establish an “overall security program”

35

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An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Country club memberships No deduction is allowed for the payment of dues to any club organized for business, pleasure, recreation or other social purpose. A club is defined as any membership organization with a principal purpose

• f:

− Conducting entertainment activities for members of the organization or their guests, or − Providing members or their guest with access to entertainment facilities. − Business leagues, trade associations and professional organizations are not clubs. Employer choice to not tax the employee without deduction, or to treat as employee comp and tax and deduct the club dues

37

An independent member of UHY International

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TAXABLE FRINGE BENEFITS (CONT.)

Additional benefits subject to current tax: Vacations and holidays Tuition payment and tuition reduction plans Financial counselling Interest-free or low-interest loans Gifts and awards Unrelated employer facility benefits Commuting Excess moving expense reimbursements Housing assistance benefits Leave sharing programs Employer-provided cell phones

38

SITUATIONS OF EMPLOYER FRINGE BENEFIT WITHHOLDING LIABILITY

Stefan Smith, Locke Lord

40

Wages

• Code Sect. 61(a)(1) provides that, except as otherwise provided in

Subtitle A of the Code, gross income includes compensation for services including fees, commissions, fringe benefits, and similar

• items. (Treas. Reg. 1.61-21(a))

Wages (Cont.)

• For purposes of FICA, FUTA and collection of income taxes at the

source, the term “wages” means all remuneration for services performed by and employee for his or her employee, including the cash value of all remuneration (including benefits) paid in any medium other than cash. (Code sections 3121(a), 3306(b), and 3401(a))

41

The Withholding Period

• Employers may elect to treat fringe benefits as paid on a pay period,

quarterly, semi-annual, or other basis. – At a minimum, the benefits MUST be treated as paid no less frequently than annually. – Employers need not make the same withholding election for all employees. – Employers may change their elections as frequently as desired.

42

The Withholding Period (Cont.)

• The value of a single fringe benefit may be treated as having been

paid on one or multiple dates. – Example: Employee receives a benefit valued at $1,000 in a single pay period.

• The employer may treat the full $1,000 value as having been

paid in a single pay period.

• The employer may also elect to treat the benefit has having

been paid in four equal $250 amounts over four pay periods.

43

The Withholding Period (Cont.)

• The election for reporting and withholding does not apply to a fringe

benefit that is a transfer of tangible or intangible personal property of a kind normally held for investment or a transfer of real property. – For this kind of fringe benefit, the employer MUST use the actual date on which the property was transferred to the employee.

44

The Withholding Period (Cont.)

• Special rule for fringe benefits provided during November and

December – The employer may choose to treat the value of fringe benefits actually provided during the last two months of the calendar year as paid during the subsequent calendar year. – The special rule does not permit an employer that elects to treat benefits as provided during the last two months to defer the entire value of all benefits to the next year.

45

The Withholding Period (Cont.)

– If this special rule is elected, the affected employee must be notified of the period in which it was used.

• This notice must be given at or near the date the Form W-2 is

provided, but not earlier than with the employee's last paycheck of the calendar year.

• If the employer uses this special rule, the employee also

must use it for the same period, and the employee cannot use the special rule unless the employer does.

46

The Withholding Period (Cont.)

• The IRS need not be notified of any employer elections with respect

to the period(s) in which fringe benefits will be treated as having been paid.

47

Withholding And Deposits

• How much should be withheld?

– The employer may add the value of the fringe benefit to other wages for the period, and withhold based on the total. – Alternatively, the employer may withhold on the value of fringe benefits at the flat 25% rate that applies to supplemental wages.

• This flat rate increases to 39.6% when supplemental wage

payments to an individual exceed $1 million during the year.

48

Withholding And Deposits (Cont.)

– The employee tax rate for Social Security is 6.2% for 2013.

• The employer tax rate for Social Security remains unchanged

at 6.2%.

• The 2013 Social Security wage base limit is $113,700.

49

Withholding And Deposits (Cont.)

– In addition to withholding Medicare tax at 1.45%, the employer must withhold a 0.9% additional Medicare tax from wages paid to an employee in excess of $200,000 in a calendar year.

• This obligation begins when aggregate wages for the year

reach $200,000.

• There is no corresponding employer portion of this additional

tax.

50

Withholding And Deposits (Cont.)

– For 2013, the FUTA tax rate is 6.0%.

• The tax applies to the first $7,000 paid to each employee as

wages during the year.

• The $7,000 is the federal wage base. The state wage base

may be different.

• Generally, a credit may be taken against FUTA for amounts

paid into state unemployment funds. – The credit may be as much as 5.4% of FUTA taxable wages. – If a taxpayer is entitled to the maximum 5.4% credit, the FUTA tax rate after credit is 0.6%.

51

Withholding And Deposits (Cont.)

• Special rule for use of highway vehicle

– An employer may choose not to withhold income tax on the value of an employee's personal use of a highway motor vehicle. – This choice need not be made for all employees. – The employer must, however, withhold the applicable Social Security and Medicare taxes on such benefits.

52

Withholding And Deposits (Cont.)

– Requirements for using this special rule

• Notify the employee in writing of the choice not to withhold by
• Jan. 31 of the election year or, if later, within 30 days after a

vehicle is first provided to the employee; and

• Include the value of the benefits in boxes 1, 3, 5 and 14 on a

timely furnished Form W-2

53

Reporting

• The actual value of fringe benefits provided during a calendar year

(or other period) must be determined by Jan. 31 of the following year.

• Report the actual value on Forms 941 (or Form 944) and W-2
• An employer may use a separate Form W-2 for fringe benefits and

any other benefit information.

54

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Special Social Security And Medicare Rule

• Paying Social Security and Medicare taxes on behalf of an

employee – Step 1: Divide the stated pay (the amount that you pay without taking into account your payment of Social Security and Medicare taxes) by a factor for that year.

• For 2013, the factor is .9235 for stated pay of $105,001.95 or

less.

56

Special Social Security And Medicare Rule (Cont.)

– Step 2: Figure the correct wages (wages plus employer-paid employee taxes) to report by dividing the stated pay by .9235

• This will give you the wages to report in Box 1 and the Social

Security and Medicare wages to report in Boxes 3 and 5 of Form W-2. – Step 3: Figure the correct Social Security tax to enter in Box 4 by multiplying the amount in Box 3 by the Social Security withholding rate of 6.2%, and enter the result in Box 4

57

Special Social Security And Medicare Rule (Cont.)

– Step 4: Figure the correct Medicare tax to enter in Box 6 by multiplying the amount in Box 5 by the Medicare withholding rate

• f 1.45%, and enter the result in Box 6

58

Special Social Security And Medicare Rule (Cont.)

• What if the stated pay is greater than $105,001.95?

– The portion of stated wages subject to Social Security tax is $105,001.95 (the first $113,700 of wages × .9235).

• Stated pay in excess of $105,001.95 is not subject to Social

Security tax, since the tax only applies to the first $113,700 of wages.

• Enter $113,700 in Box 3 of Form W-2

59

Special Social Security And Medicare Rule (Cont.)

• The Social Security tax to enter in Box 4 is $7,049.40

($113,700 x .062). – To figure the correct Medicare wages for Box 5, subtract $105,001.95 from the stated pay, divide the result by .9855, and add $113,700

• Enter this amount in Box 5
• The Medicare tax to enter in Box 6 is then obtained by

multiplying the amount from Box 5 by .0145.

60

Special Social Security And Medicare Rule (Cont.)

• Although these employment tax amounts are not actually withheld

from the employee's pay, the employer reports them as withheld on Form 941 and deposits the calculated amounts as Social Security and Medicare taxes.

61

MATERIAL TERMS OF SECT. 409A REGARDING TAXABILITY

James Davis, Gunster

GUNSTER

CONSEQUENCES OF 409A VIOLATION

IRC 409A(a)

63

• Constructive receipt §409A(a)(1)
• Plan failure defined
• Failure of plan to meet the following requirements:
• Timing of distributions must be permissible.
• Acceleration of benefits must not be permitted.
• Changes of deferral and payment elections must comply.
• Failure to operate in accordance with requirements
• Consequences of plan failure:
• All deferred compensation included in SP’s taxable year that was not

subject to a SROF and not included in a prior taxable year

• Interest on the tax deficiency at underpayment rate plus 1%
• 20% excise tax on amount included in income
• Payment of federal, state or local taxes by the employer is subject to

interest and excise taxes, and no deduction is permitted to employer for payroll tax payments.

GUNSTER

NONQUALIFIED DEFERRED COMPENSATION PLAN DEFINED REG.

1.409-1

“Plan” defined: … any “plan” that provides for the “deferral of compensation” from the service recipient (SR) once the service provider (SP) obtains a “legally enforceable right” under it.* * Regulations are effective for taxable years beginning on or after Jan. 1, 2008

64

GUNSTER

PLAN DEFINED (CONT.)

65

What is not a §409A plan:

• §401(a) qualified plan and §501(a) trust
• §403(a) and (b) plans and annuities
• Simplified employee pension (SEP) §408(k)
• Simple retirement account §408(p)
• Pre- June 25, 1959 plans and trusts
• §457(b) plans
• Qualified governmental excess benefit arrangements §415(m)
• Certain Puerto Rican plans §1022(i)(2)
• Certain broad-based foreign retirement plans
• Incentive stock options §422
• Employee stock purchase plans §423
• Certain welfare benefit plans, e.g., health, life, disability §§105, 106
• Archer MSAs, HSAs §§220, 223
• Cafeteria plans §125

GUNSTER

PLAN DEFINED (CONT.)

66

• General rules for a §409A plan:
• Includes any agreement, method, program or other

arrangement; including any agreement, method, program or

• ther arrangement that applies to one person or individual
• May be adopted unilaterally by the SR or agreed to by the SR

and SP

• Does not have to be an employee benefit plan under ERISA

§3(3)

• §409A is applied as if there is a separate plan for each SP.
• General provisions of a plan that purport to nullify non-

compliant plan terms or to supply any specific plan terms required are disregarded. Reg. 1.409A-1(c)(1)

GUNSTER

PLAN DEFINED (CONT.)

67

• Aggregation. All of the following “plans” are aggregated and

treated as a single plan as to that category.

• Elective deferrals into an “account plan”
• Non-elective deferrals into an “account plan”
• Non-elective deferrals into a “non account plan”
• Separation pay plans
• Expense reimbursement plans
• Split-dollar life insurance plans
• Establishment of plan
• Compliant plans must be established and maintained by a SR

in accordance with regs. 1.409A-1, -2, -3 and -6.

• A plan is established on the latest of (i) date on which

adopted, (ii) effective date or (iii) date on which material terms are adopted. Note: No signatures are required.

GUNSTER

PLAN DEFINED (CONT.)

68

• Regardless of the foregoing, a plan will be deemed to be established

as of the date the SP obtains a legally binding right to deferral of compensation.

GUNSTER

DEFERRAL OF COMPENSATION DEFINED

69

• “A plan provides for the deferral of compensation if the SP had a legally

binding right during a taxable year to compensation that may be payable to the SP in a later taxable year.” Reg. 1.401A-1(b)(1)

• Deferred compensation also includes any right to earnings on the

compensation so deferred.

• A SP does not have a legally binding right to compensation, to the

extent that it may be eliminated or reduced by the SR, unless SP or family controls SR. Example: The ability to terminate SP’s employment by SR without cause that would forfeit SP’s severance compensation

GUNSTER

DEFERRAL (CONT.)

70

• Exceptions to deferred compensation definition
• Short-term (S-T) deferrals
• Any payment is actually or constructively received (§83) by SR by the

15th day of the third month after the end of the later of (i) the SP’s first taxable year, or (ii) the SR’s first taxable year in which the payment is no longer subject to a substantial risk of forfeiture (SROF) (“applicable 2 ½ month period”) Reg. 1.409A-1(b)(4)

• S-T deferral exception does not apply to a deferred payment, i.e., a

payment that will or may occur after the end of the applicable 2 ½- month period such as on account of separation from service, death, disability, change in control event, specific time or scheduled payment or unforeseeable emergency.

• Certain delayed payments: Payments made after the applicable 2 ½-

month period if the “taxpayer” establishes that it was administratively impracticable to make the payment within such period and was unforeseeable or payment would have jeopardized the ability of the SR to continue as a going concern. Reg. 1.401A-1(b)(4)ii)

GUNSTER

DEFERRAL (CONT.)

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• Equity based compensation:
• Non-statutory stock options (NSOs): There is no deferral to the right to

purchase the SR’s stock if:

• The exercise price may never be less than the FMV of the underlying

stock as of the date the option is granted disregarding lapse restrictions and SROF;

• The transfer is taxed pursuant to §83; and
• The option does not include any feature for the deferral of

compensation until exercise of the option.

• Reg. 1.409A-1(b)(5)(i)(A)
• Stock appreciation rights (SARs): There is no deferral of compensation based
• n the appreciation in value of a specified number of shares of SR stock

between grant and exercise dates if:

• Compensation cannot be greater than the FMV of the stock on the

exercise date over the FMV on the grant date;

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DEFERRAL (CONT.)

72

• SAR exercise price can never be less than the FMV of the

underlying stock at the date it is granted; and

• Option does not include any feature for the deferral of

compensation until exercise of the option. Reg. 1.409A-1(b)(5)(i)(B)

• Dividends: A right to receive dividends contingent on the purchase of

stock from the NSO or SAR treated as a reduction or offset of the purchase price, i.e., deferred compensation and thus is subject to §409A. If dividends are not contingent upon purchase, it is not a deferral of compensation. Reg. 1.409A-1(b)(5)(i)(E)

• ISO and employee stock purchase plans: Plans under §§422 and 423 are

exempt from 409A; but if the plan is modified, extended or renewed, it may be treated as a new plan and not an ISO and thus subject to §409A.

• Reg. 1.409A-1(b)(5)(ii)
• Non-corporate entities: Equity interests other than a corporation

generally constitute SR stock, for purposes of 409A.

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DEFERRAL (CONT.)

73

• Substitutions and assumption from corporate transactions/modifications to

plans

• A change in the terms of a stock right or a change in the terms of the

plan that has the effect of reducing the exercise price is a modification and will be subject to §409A at the time of the change. Reg. 1.409A- 1(b)(5)(v)(B)

• An extension of the exercise period at a time when the exercise price
• f the stock right equals or exceeds the FMV of the SR stock is treated

as a new right.

• A substitution of stock from a corporate transaction will not itself

constitute a modification, provided the above does not occur.

• A change to a plan will not be considered a modification if the change

is rescinded before the earlier of the stock right exercise or the last day

• f the SP’s taxable year in which the change occurred. Reg. 1.409A-

1(b)(5)(v)(I)

• A change in the number of shares purchasable is not a modification, if

the exercise price is proportionately adjusted.

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DEFERRAL (CONT.)

74

• Restricted property; §402(b) trusts Reg. 1.409A-1(b)(6)(i)
• No deferral of income occurs merely because:
• Property is substantially non-vested,
• From a §83(b) election, or
• From income inclusion under §402(b)(4)(A)
• Tax equalization payments Reg. 1.409A-1(b)(6)(iii)
• Payments must be made no later than the end of the second taxable

year of the SP beginning after the taxable year of the SP in which the SP’s U. S. income tax return (including extensions) is to be filed for the year to which the compensation subject to the tax equalization relates or within such period after the SP’s foreign income tax return is to be filed.

• If litigation or audit occurs, payment must be made by the end of the

tax year following the year in which taxes are paid. Reg. 1.409A- 1(b)(8)(iii)

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DEFERRAL (CONT.)

75

• Severance pay plans Reg. 1.409A-1(b)(9)(i)
• A plan that provides compensation upon SFS provides for a deferral of

compensation, with the following exceptions:

• Collectively bargained plans
• Involuntary separation from service/window plans, provided that:

i) Separation pay does not exceed two times lesser of:

• Annualized compensation in preceding year, or
• §401(a)(17) compensation limit for qualified plans; and

ii)Must be paid no later than last day of taxable year following separation by SP

• Foreign separation pay plans

NOTE: These exceptions may be used in combination with

• ther compensation payments. Reg. §1.401A-1(b)(9)

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DEFERRAL (CONT.)

76

• Reimbursements/other separation payments (voluntary or involuntary

separation from service) Reg. 1.409A-1(b)(9)(v)

• Reimbursements for expenses SP could otherwise deduct under

§§162, 167, e.g., moving expenses, outplacement expenses if:

• Time period limited to two years following separation year
• Medical benefits incurred and paid by SP otherwise deductible

under §213 are limited to COBRA coverage period

• Di minimis payment limit to §402(g)(1)(B) amount, if no exception
• Indemnification and insurance plans
• Legal settlements for FLSA
• Educational benefit plans for SP (and no other, i.e., not spouse or

dependents)

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DEFINITIONS

77

• Substantial risk of forfeiture (SROF) 1.409A-1(d)(1)
• Conditioned on the performance of future services or the occurrence of a

condition related to the purpose of the compensation, and

• The possibility of forfeiture is substantial and will be enforced.
• Performance-based compensation 1.409A-1(e)(1)
• Compensation is contingent on the satisfaction of pre-established
• rganizational or individual performance criteria relating to a

performance period of at least 12 consecutive months.

• Criteria must be established in writing within 90 days after

commencement of the relevant 12 month period.

• Compensation based on stock valuation increase is performance-based .
• Service provider (SP) 1.409A-1(f)(1)
• Includes an individual, corporation, S corporation, partnership personal

service corporation that reports on cash basis accounting

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DEFINITIONS (CONT.)

78

• Independent contractors are generally not SPs if SP:
• Not an employee or on board of directors
• Provides significant services to two or more SRs
• SP not related to SR
• Services are not “management services”
• Service recipient (SR) 1.409A-1(g)
• The person for whom the services are performed and with whom the

legally binding obligation arises

• Aggregation rules for SR apply - §§414(b) & (c) but “50%” for “80%”
• Separation from service (SFS) 1.409A-1(h)
• Death, disability, retirement or termination of employment
• Employment continues up to six months for military leave, sick leave or
• ther bona fide absence, unless there is a reasonable expectation or

return to employment.

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DEFINITIONS (CONT.)

79

• Termination of employment based on facts and circumstances
• Employer and employee agree that no further services to be provided

either as employee or independent contractor and services:

• Decrease to a 20% level pre-SFS presumes termination
• Services at 50% or more presumed not a SFS
• In a sale or disposition of “substantial” assets the SR (seller) and the

unrelated buyer may agree whether SPs being transferred to buyer have a SFS provided all SPs are treated consistently. Reg. 1.409-1(h)(4)

• Specified employee (SE) Reg. 1.409-1(i)
• A SP who is a “key employee” (KE) of a publicly traded corporation
• KE is defined in §416(i)(1)(A)(i), (ii) or (iii)
• Employee with > $130,000 ($165,000 in 2013 with COLA)
• 5% or more owner
• 1% owner with > $150,000 (no COLA)

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DEFINITIONS (CONT.)

80

• A SP is a SE if he/she is a KE on any Dec. 31 or at any time during the

preceding 12-month period and becomes an SE for the 12-month period commencing on the following April 1.

• There are special rules to identify SE in corporate acquisitions.
• Separation pay plan 1.409A-1(m)
• Any plan that provides for “separation pay” in whole or part upon SFS
• “Separation pay” is any deferral of compensation that will not be paid prior

to a SFS, whether voluntary or involuntary.

• Involuntary SFS Reg. 1.409A-1(n)
• SFS due to the independent exercise of the SR’s decision to terminate the SP
• ther than due to SP’s implicit or explicit request
• “Good reason” SFS is treated for all 409A as an involuntary SFS.
• “Material negative change to the service relationship, e.g. material

compensation reduction, duties, authority, location, etc.

• See safe harbor conditions in Reg. 1.409A-1(n)(2)(ii)(A)
• SFS must occur within a pre-determined period (2 years maximum)

upon initial existence of good reason.

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DEFERRAL ELECTIONS REG. 1.409A-2

81

• Deferral elections Reg. 1.409A-2(a)(below)
• General: Election to defer compensation by SP must be made by SP no

later than close of SP’s taxable year next preceding the service year (3).

• Initial year limited exception: Election to defer may be made before the

30th day after eligibility, if vesting of the deferred benefits requires 12 months of employment (7).

• Fiscal year compensation: Election to defer must be made on or before

SR’s immediately preceding fiscal year (6).

• Performance-based compensation: Election must be made at least 6

months before the end of the performance period (8).

• Contingent severance pay: Initial deferral election may be made at any

time prior to obtaining a legally binding right to payment.

• Sales commissions: Compensation for services is the SR taxable year in

which customer remits payment to SP (12).

• NOTE: Election includes (i) deferral election and (ii) time and form of

payment, if the plan does not specify them.

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DEFERRAL ELECTIONS (CONT.)

82

• Subsequent changes in time and form of payment Reg.409A-2(b)
• Includes any changes in (i) delay of payment or (ii) form of payment
• Plan must require:
• Election must occur at least 12 months before changes occur, and
• Payment must be deferred for at least 5 years from original payment

date.

• “Payment” means:
• Each separately identifiable payment
• Life annuity is treated as one single payment.
• Installment payments (series of substantively equal payments) are

treated as one single payment, unless plan provides otherwise.

• Rules apply to both participants and beneficiaries.
• Change in form of payment from series of payments to single payment is not

a prohibited acceleration, if there is compliance with “change” rules.

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RULES RELATING TO FUNDING IRC 409A(B)

83

• Offshore assets: Property set aside in a trust or other arrangement outside

the U.S. to pay deferred compensation is deemed transferred pursuant to §83 at the time of the transfer offshore §409A(b)(1).

• Whether or not assets are subject to claims of employer’s general

creditors

• Not applicable if substantially all the services are performed offshore
• Financial condition of employer: §409A(b)(2)
• Property is deemed transferred pursuant to §83 as of the earlier of:
• Date that the plan first provides assets will become restricted to

pay benefits with a change in the employer’s financial condition, or

• Date on which the assets are so restricted; and
• Regardless of whether assets are subject to claims of employer’s

general creditors.

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FUNDING (CONT.)

84

• Assets set aside during “restricted period” §409A(b)(3)
• “Transfer” defined: If during a “restricted period,”
• The employer restricts, reserves or sets aside assets for payment of

deferred compensation with which the employer sponsors a single- employer defined benefit pension plan (DBP), or

• Assets in a plan become restricted by the terms of the plan for a

“applicable covered employee,” Then the assets so restricted or reserved are treated as transferred, for purposes of §83.

• “Restricted period” defined:
• Period during which DBP is “at-risk” pursuant to IRC §430(i)
• Period during which employer is in bankruptcy, or
• 12-month period beginning 6 months before the DBP terminates if the

DBP is underfunded

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FUNDING (CONT.)

85

• “Applicable covered employee”: Defined in IRC 409A(b)(4)
• Covered employee of employer/plan sponsor, or
• Former covered employee who was a covered employee at the

time of SFS

• “Covered employee” is defined in §162(m)(3) or in §16(a) of

Securities Exchange Act of 1934.

• Aggregation: Controlled group rules apply under §414(b) and (c).
• Income/appreciation: Increases in value or earnings are treated as an

additional transfer of property. IRC §409A(b)(4)

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PERMISSIBLE PAYMENTS REG. 1.409A-3

86

• General rule: Deferred compensation may not be paid prior to (i) the occurrence
• f an event or (ii) at a time specified (event)
• “Event” defined:
• 1. SP’s SFS
• 2. SP’s disability
• 3. SP’s death
• 4. Time certain or a fixed schedule
• 5. Change in: (i) effective ownership (CIO) (ii) effective control (CIC) or (iii)

substantial portion of SR’s assets (CIA) (collectively, “change in control event” *CICE])

• 6. Unforeseeable emergency
• “Payment date” defined
• The date of the event or another specified date that is objectively

determinable and non-discretionary

• Payment can be on a fixed schedule after the event occurs that is
• bjectively determinable and non-discretionary, but only if:

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PERMISSIBLE PAYMENTS (CONT.)

87

• Payment period begins and ends within one taxable year of SP,
• r
• Payment period is not more than 90 days, and SP does not have

right to designate taxable year of payment (not applicable to Event #4). Reg. 1.409A-3(b)

• Only one time and form of payment may be designated upon an

event, i.e., cannot have one form if event occurs on Monday and a different form if occurs on a different day. Reg. 1.409A-3(c)

• Exception for SFS upon a CIC if SFS is not more than 2 years after

CIC

• Exception for SFS other than CIC, e.g., with cause, voluntary, etc.
• Payment on a “specified date” (all six Events) is deemed to be made

timely:

• At a later date in the SP’s taxable year, or
• On or before the 15th day of the third month following SP’s

taxable year, provided the SP has no discretion over payment.

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PERMISSIBLE PAYMENTS (CONT.)

88

• Disputes and refusals to pay Reg. 1.409A-3(g)
• SP must accept portion of payment from SR unless further waiver.
• Notice must be provided by SP to SR within 90 days of due date.
• SP must take “enforcement action” within 180 day.
• Specified date or fixed schedule Reg. 1.409A-3(i)(1)
• Must be non-discretionary and objectively determinable at time of deferral
• Can be determined due to an objective, non-discretionary formula, e.g.

when 50% of an account receivable is paid to SR

• Can be payable in a specific taxable year of SP
• If payable within a specified period, it cannot overlap SP taxable years,
• Payments can be limited or curtailed by an objective, non-discretionary

formula not within the control of SP or SR.

• Expense reimbursements Reg. 1.409A-3(i)(1)(iv)
• Plan must objectively define types of expenses and specify the period.
• Cannot affect reimbursements in any other taxable year of SP

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PERMISSIBLE PAYMENTS (CONT.)

89

• Payment must be made before the end of the taxable year following

incurrence of the expense.

• Tax gross-up payments Reg. 1.409A-3(i)(1)(v)
• Typically used with §280G excess parachute payments and non-compliant

409A plans

• Payment must be no later than end of SP taxable year following taxable

year in which SP remits taxes.

• Specified employees Reg. 1.409A-3(i)(2)
• A “specified employee” is a “key employee” as defined in §416(i)(1)(A).
• Officer with compensation over $130,000 ($165,000

w/COLA)

• 5%-or-more-owner employee
• 1% owner with compensation over $150,000 (no COLA)
• Payment may not be made before 6 months from SFS or upon death, if

earlier.

• Payments that would have been made but delayed may be paid on the

first day of the 7th month following SFS.

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PERMISSIBLE PAYMENTS (CONT.)

90

• Unforeseeable emergency defined: Reg. 1.409A-3(i)(3)
• Severe financial hardship to SP, SP’s spouse, beneficiary or

dependent resulting from illness or accident

• Loss of SP’s property due to casualty
• Imminent foreclosure or eviction
• Funeral expenses of spouse
• Other extraordinary and unforeseeable circumstances outside of SP’s

control

• Not:
• College tuition
• Home purchase
• Relief through reimbursement or insurance, cessation of deferrals
• Amounts needed to satisfy emergency need may include taxes.

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PERMISSIBLE PAYMENTS (CONT.)

91

• Disability defined: Reg. 1.409A-3(i)(3)
• SP is unable to engage in any substantial gainful activity by reason of

any medically determinable physical or mental impairment that can be expected to last for a continuous period of at least 12 months, or

• SP has medically determinable physical or mental impairment that

can be expected to result in death.

• CIO, CIC or CIA (collectively CICE) Reg. 1.409A-3(i)(5)
• CICE must relate to SR, entity liable for deferred compensation

payment or the entity owning >50% of the SR.

• Payment must be transaction-based compensation that is payable to

SP at the same time, terms and conditions as the SR, or else its shareholders will be treated as paid at designated date or schedule.

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PERMISSIBLE PAYMENTS (CONT.)

92

• CIO Reg. 1.409A-3(i)(v)
• Defined: The date on which one or more persons “acting as a group”

acquire ownership of >50% of total FMV or total voting power of stock

• Acquisition by existing >50% shareholder of additional stock is not a CIO.
• Persons are “acting as a group” if they are part of the same merger,

consolidation or purchase of stock transaction; or own stock in any such acquiring entity.

• CIC Reg. 1.409A-3(i)(vi)
• Defined: Notwithstanding that there may not have occurred a CIO,
• The date on which one or more persons “acting as a group”

acquire during any 12-month period ownership of >30% of total voting power of stock, or

• The date a majority of the board of directors is replaced during a

12-month period who have not approved by the prior board of directors.

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PERMISSIBLE PAYMENTS (CONT.)

93

• Acquisition by existing >50% shareholder of additional stock is

not a CIC.

• Persons are “acting as a group” if they are part of the same

merger, consolidation or purchase of stock transaction; or own stock in any such acquiring entity.

• CIA 1.409A-3(i)(vii)
• Defined: The date on which one or more persons “acting as a

group” acquires or has acquired during a 12-month period

• wnership of >40% of total FMV of all the assets
• No CIA if the transfer of assets is to a controlled entity, to a

>50% shareholder or in exchange of a shareholder’s stock

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PERMISSIBLE PAYMENTS (CONT.)

94

• No payment acceleration is permitted by plan Reg. 1.409A-3(j)(1)
• A plan may not permit an acceleration of payments.
• If a participant dies, payments may be accelerated and paid in a lump sum.
• Waiver of SROF by SR is not an acceleration.
• Beneficiaries of participants are subject to same rules.
• Exceptions:
• SP may not have discretion to accelerate.
• Exceptions need not be listed in plan
• Domestic relations orders
• Compliance with ethics agreement in federal government
• Compliance with ethics or conflict of interest laws
• §457(f) plan, but only to the extent to pay taxes
• Limited cash-outs if in plan permitted SR to make distribution to

terminate plan not in excess of §402(g)(2)(B)

• Payment of employment taxes for NQDCAs under §3121

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PERMISSIBLE PAYMENTS (CONT.)

95

• Cancellation of deferrals following hardship distribution
• Plan terminations and liquidations; distribution permitted if:

▫ SR liquidates, and plan liquidates within 12 months. ▫ SR termination of plan within 30 days preceding or 12 months following CICE, provided that all plans are terminated ▫ SR termination of plan provided: (i) not proximate to a downturn in financial health of SR, (ii) all plans are terminated; (iii) no payments are made within 12 months

• f decision/action; (iv) all payments are made within 24

months; and, (v) SR does not adopt a new plan within 3 years

• Payment of state, local or foreign taxes
• Cancelation of deferral election due to disability of SP
• Bona fide dispute settlement between SP and SR

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PERMISSIBLE PAYMENTS (CONT.)

96

• Linkage to qualified employer plans Reg. 1.409A-3(j)(5)
• Decreases in amounts deferred to plan due to the amount

determined by formula in a qualified plan are not an acceleration.

• Changes in elections under cafeteria plan do not result in an

accelerated payment under a plan.

Slide Intentionally Left Blank

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APPLICATION OF 409A AND EFFECTIVE DATES REG. 1.409A-6

98

• Effective date: §409A applies to amounts deferred in taxable years beginning after
• Dec. 31, 2004 and amounts deferred prior to Jan. 1, 2005, if the plan is materially

modified after Oct. 3, 2004.

• Amounts are considered deferred prior to Jan. 1, 2005 only if the benefits were

not subject to a SROF at that date.

• Benefits that were not substantially vested as of Dec. 31, 2004 are treated as

being deferred on and after Jan. 1, 2005.

• Material modifications: A modification is material if a benefit or right existing as of
• Oct. 3, 2004, is materially enhanced or a new material benefit or right is added that

affects amounts earned and vested before Jan. 1, 2005. Reg. 1.409A-3(a)(4)(i)

• Examples:
• Addition of a provision permitting distribution in SP discretion if a 20%

forfeiture occurs

• SR exercises discretion to accelerate vesting prior to Jan. 1, 2005.

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409A APPLICATION (CONT.)

99

• Amendment of a plan to bring it into 409A compliance is not a

material modification. Reg. 1.409A-6(a)(4)(i)

• Adoption of a new plan after Oct. 3, 2004 and prior to Jan. 1, 2005 is a

material modification of a plan.

• Suspension or termination of a plan is not a material modification if

permitted by the terms of the plan. Reg. 1.409A-6(a)(4)(iii) NOTE: This regulation was effective for taxable years beginning or after Jan. 1, 2008.