Deferred Compensation. Hot Topics in Executive and. Philadelphia, PA. Washington, DC. Atlanta, GA. Eleanor Banister King & Spalding

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1 Hot Topics in Executive and Deferred Compensation.., j...-.l a&.>.,,...."..,.,.....,;.r.,...;. - 't,, a*,?....,*... :<A,:.?:.:... Eleanor Banister King & Spalding Atlanta, GA Brian Dougherty Post & Schell PC Philadelphia, PA Martha 30 Wagner Venable LLP Washington, DC,.,..-.,., :'.,. -.+~~.P~;~,G;.L<~.~. ".. s r...i..->,*l..r.., -.., O Martha Jo Wagner, Eleanor Banister, and Brian Dougherty, 2007

2 Cover today? 409A. * Employment agreements * Signing bonuses. * Retention agreements * Involuntary severance pay exception. * Separation agreements. * Change-in-control agreements. * Reimbursement agreements.

3 9 409A covers. * Very broad coverage. * Any arrangement involving deferred compensation. * Legally binding right to compensation earned and vested in one year and paid in a later year.

4 409A may cover? * Employment agreements. * Signing bonuses. * Retention agreements. * Separation agreements. * Severance pay. * Change-in-control agreements.

5 409A may cover? * Reimbursement agreements. * Voluntary deferrals. * Company paid programs. * Equity compensation. * Indemnifications. * Non-taxable benefits. * Independent contractor agreements.

6 * Immediate taxation of vested amounts. * 20% federal excise tax on employee. * Plus additional excise tax (underpayment penalty + 1?40). * Possibly state excise taxes. Fail to comply with 409A?.... ~,,., ,,..

7 . ::>;>&-a.:+?;...~ >,w*?.*?:~ * Statutory effective date: January 1, * Good faith compliance and transition guidance from January 1, 2005 to December 31, * IRS Notice issued delays deadline for document compliance. -' ;..;;,, A effective when?..., -..*... ~,....,,.,..> *,..,...~,.,-, -.:..--&..,<+,;:*-.. E..*..:;. 4*>*--.. :A..*--4&;.@ "... 1,. ~,,,.; F,?,~~<;2~>%<<*r&>~*<,<+?akbc#*

8 + Final regulations effective January 1, 2008, and arrangements must be operationally compliant by that date. + Almost all the hard decisions still need to be made by the end of Written amendments to comply with final regulations currently due by December 31, A effective when... :,...-.,,, *?,L< ' 3,~......:.,<<.<. -..ll,.-, ":; >*..w.%&%*.&&+...- ;....,. ' *..-...,,.'.... '-. '.'..~~?~n~i~~;~~~@1~w%~ "m*u,:;-<.. '.. TX-,.:?,4d..,. ~.+>:caa.. ~,.:>....$

9 Employment Agreements. FEATURE Annual Salary Annual Bonus Long-term Bonus Equity Awards 409A? Exempt if paid by March 15 of next year Exempt if paid by March 15 of next year May be 409A May be 409A

10 Employment Agreements. FEATURE 409A? Vacation, Paid Sick Leave Exempt Reimbursements May be 409A Severance May be 409A.

11 Employment Agreements. FEATURE 409A? Continuation of Benefits May be 409A Indemnification Exempt Offsets for Service Provider Debt 409A unless diminimis

12 + 409A amounts must be paid on account of: Separation from service -- working 20 /0 or less of average level over last 36 months. Death. Disability A definition. Change in control A definition. Fixed time or schedule. + Note: Execution of release is not a 409A payment event. Employment Agreement.. ~.,..;,-,.re;..s*. x<-+.;-?.-.. : i*-*a,s;i:&.w.::h*-&*&~!.;2;i%.*+<!:.+ =;~+:%:,.,.. '......,.-,.1"..1".-.>..*-

13 Employment Agreements + Short term deferral (STD) is exempt from 409A. * STD must be paid by March 15 following year deferral is vested. Example: Bonus earned during 2007, paid by March 15,2008. If it could be paid on March 16, it is 409A. When in doubt, set a payment date in writing.

14 * Exempt as STD if entire bonus paid by March 15 following year hired. * Bonus that may be paid after STD deadline will be 409A. * 409A Fix: Written document + fixed payment dates. Payment date may be specific date or year. Signing Bonuses re: im+kt> :.. ~..:?,?;.,&>,:... *.,r, &.r:<!.~g.*>.-.i.; -.~;-$.~&..-:,..:+.>*:,i*.&.<%y'.,'.,., ;>%,<*A.*L-.A :z. - -.,.B[',.".. :;:.,,; --s>., -*.-.: :.>.,:

15 * Typically promises future payment or transfer of property for continued service until specified date or achievement of stated objective. * Deferral of compensation, depending on length of retention period. * Typically subject to substantial risk of forfeiture until service completed or objectives achieved. Retention Agreements ":; ,.:**,2-=,,,,...,,*,:.,-<,=+w..:i ~.e,%e.w~,~~,:~.s., L".MW.&+,A...?., " -,.,-*<,.,~:?+.=.F?s'$?s. 1- ->-.-;. t~&w~~.?~:~..;-s; ;~,*,-.-:, cdwd; &si: ;L~:++ ~,,.:, =::,.

16 * May qualify for short-term deferral exemption. Otherwise, payments must be scheduled to comply with 409A. * More complicated if reward is in the form of equity grant (e.g., stock options). Grant date and exercise price issues.. Retention Agreements..,,,.,,: :;-:.:...,wrsii~&$7&&&,,..... ; ~ 'z.>..? ,. ~'. i *%s~*%*+?. :h.%a;. :2:

17 Involuntary Severance Pay Exception ; * i.5.*ii3,p+-&w-jr~v. -, :,x.-*. )i * Severance paid due to involuntary termination is exempt from 409A. * Limited to 2 x lesser of: Annualized pay for preceding year or Annual qualified plan limit for year of separation ($225,000 for 2007). * Paid by 12/31 of 2nd year following separation.. ;.. ''Si)Hii~;Z&<.;;,..; c.2; ;,*.;.,*,..,~x~~~~~~i-.>~.i:~k"r..'~~"?~.,:> #., *- <,.,,...., *;,,.,

18 + Exemption does not apply to voluntary separation. + Exemption does not apply to "good reason" termination unless: Service recipient actions result in a material negative change in the employment relationship. Or good reason definition satisfies safe harbor. Involuntary Severance Pay Exception..... ~.... A-.<,... : :... :..... : --.2:?<.*~p&i: ,......,.:., '.. ~.;... :a.,. '. 7 q ~. e x. 9,.i*4usrcc....

19 + Good reason safe harbor requires: Material diminution in base pay. Material diminution in authority, duties or responsibilities of service provider or supervisor. Material diminution in budget for which service provider is responsible. Material change in work place location. Or material breach of agreement. Involuntary Severance Pay Exception.

20 + Additional good reason requirements: Separation occurs within 2 years of event. Service provider must give notice within 90 days of event. Service recipient must have at least 30 days to cure. Severance must be same as for involuntary separation. Involuntary Severance Pay Exception.

21 + Contracts may be amended during transition period. + BUT, substitution of safe harbor "good reason" in existing agreement problematic. Involuntary Severance Pay Exception., ~-~* 7.:.,-.... ~.. ',...,,,.k,.c ".,~..>..c.2.<.=*..*.,.~,. :.::~, ;;,;..:.. -.-,..m.?::';>,

22 + Increased flexibility to design benefits and structure payments for arrangements negotiated at time of separation. + 'Stacked" exemptions for: Certain welfare benefits. De minimis payments under 402(g) limit ($15,500 for 2007). Certain reimbursements for a limited period. And short-term deferrals and limited payments for involuntary separations and certain "good reason" separations.,.. -. :.... Separation Agreements.,...,....~ ,*T...-.,...**+.. : *I- i+..;...,,.? m.,,wa~~~&p.p.~~~cy?~.i;:~~~.,;~~~~:,-:~,~ +>.-.*-.,'.r,;;,.,.r?:. Cli-,..., :,..-..., r-,i

23 + 6-month delay for "key employees" of public companies. Applies to wholly owned U.S. subsidiaries of foreign parents traded on foreign stock exchange. 'Stacked" exemptions apply if payments structured properly. Can delay be avoided by characterization as payments on fixed schedule following vesting, rather than payments due to separation from service? :+*-, :.,.,..:....,, Separation Agreements ;. ~....,.,,.-...., =....,...~...:(:~..,,., ; >*:,.:.3, :,..' ~.~*~!,.~~~,~~.~~.~~~~:.>*~& ~*Y,,&~-.&:>;:~., r..wlp.ad:.,(<:.:(, "I*

24 + Tax exempt employers: IRS proposal to harmonize 457(f) and 409A definitions of "severance pay" and "substantial risk of forfeiture." Much executive severance pay will be subject to 457(f) and taxable immediately on separation at full present value. Separation Agreements ~..,.,.,~ ~....*. ~.,> *~,:-...?.:w:w,-*~s,..d<::::.".",z~+>: AS.?'>...,..,..,, :.,-...i&+&z. '..>.,.,....., ; : '.....,,......,.. ~?3?*."?,.., &*". :.>?-: -'--~.-.:~- 4?&,<%<,r;;;&,&....,,.c.*!..-. -,

25 ~. * A "change in control" is a 409A distribution event. Change in ownership. Person attains more than 5O0/0 of vote or value. Change in effective control. Person attains more than 30% of vote. Change in majority of board in 12-month period. Change in ownership of substantial assets. 3rd party acquires more than 40% of value. Change-in-Control Agreements..,.. :. - ;,,,<,,.,,,,.?.,,,,, '..*. s *,a. ~.'.:.>.-&,*'. '.:,z&&.&&-%-:. <, a~<~~w~~~!~;~:imnr.-~..i.r:.~~.i?."...,..,.:f*++-.&.-...,... ~..,..., ~... >..;y. m,&.

26 + Change-in-Control distribution not subject to 6-month delay. + BUT distribution on separation following change-in-control is subject to 6-month delay. Payment tied to separation is subject to 6-month. 'Single trigger" vs. "double trigger". Change-in-Control.~ Agreements.....,...-.'*.<,,,+,..-...,'.+:;.; :., :,.,...,.... :... ~.. :,. cy?&*:*

27 + Only one form and time of payment for each 409A amount and 409A event. Example: Severance may be paid in installments upon separation from service or lump sum at death. + Alternative forms/times permitted under limited circumstances, including change-in-control. Example: Severance before change-in-control paid in installments; severance after change-in-control paid in lump sum..... Change-in-Control Agreements...., ><?...,.,,,,,,, >.:, '..,,... L;;<,.,.,,..,.;, :*.,., :..., - -.>;...I;..,.,:,a I-%C;*,?s 2; -,.,,:.>... ;,.,.-&;-:'. -9**.,:,... :...,...,,.,. :., $,<<~7>>.*$,. Y:*.'%:*.*.72?~4.*.:,~. l:.r.qw*;!??:+>:?z&+,&;: v*<&*-<s*.,: -,;A,,;.,.-*,.- :,,,

28 ...., A generally applies only to reimbursements to former employees. + Exemption for non-taxable reimbursements and taxable reimbursements for certain expenses for limited period. Outplacement, moving and deductible business expenses incurred by end of 2" year and paid by end of 3" year after year of separation. Discriminatory self-insured health care: COBRA coverage period. Reimbursement Agreements....-.,.~~.<,< -2- G:,*:.*$,.::T.;*>A::~%? ~. ~,... ~., a,.. ~.:,,.,..,. :.. ~ ~.. : I....: 7.~,%%.-,ihnrr"6a,~ \.-,,.., ~ ~ - ~. ~ w ~. & ~ ~,, ~., $ ~ * ~ ~ ~ ~ ~ x ~ *

29 .?,...< Reimbursement Agreements, ,,.,,.,,.....,. A"+.-. 'i-..-..,., -.,... ~..,,,. ~; &As&. 5*1~.. _..,.::.>- r...;*.-:x;jr*ll..,,* :.;::*A:,...~. -.:-. -. ;. :.:.w&l,s-."% i,.,.-*v,-q.r-cr..,.,..-,. ~ + Reimbursements that are not exempt (e.g., extend beyond limited period permitted for exem P tion) can and must be structured to comp y with 409A. + Payments in one ear cannot affect amount available for reim KI ursement in another year. + Must be paid by end of year following year expenses incurred. + Special rule for tax gross-ups. &Tt,:p..;.:6::<,$;: ~.. 4,.'&***. :.,.(,,., + Must be paid by end of year following Y ear taxes paid or tax controversy otherwise reso ved.

30 Questions? Eleanor Banister King & Spalding Atlanta, GA Brian Doug herty Post & Schell PC Philadelphia, PA Martha Jo Wagner Venable LLP Washington, DC