409A FOR THE HOLIDAYS: Deferred Compensation Year-End Matters. December 8, 2009

Transcription

1 409A FOR THE HOLIDAYS: Deferred Compensation Year-End Matters Douglas J. Ellis Pittsburgh, PA Charles A. Grace Boston, MA December 8, 2009

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3 Speakers Douglas J. Ellis, Partner Pittsburgh Office Charles A. Grace, Partner Boston Office

4 Topics Quick Primer on 409A Deferred Compensation Reporting & Withholding Rules Correcting Non-Compliance End of Year Action Items 3

5 Quick Primer on 409A Deferred Compensation

6 Brave New World of Deferred Compensation 409A governs deferral, payment & funding of all deferred compensation Penalties for noncompliance Vested deferred compensation taxed immediately Additional 20% tax plus interest Taxes, interest & penalties can exceed compensation! Section 457A additional regulation of compensation to managers of offshore hedge funds 5

7 Broad Definition & Scope of 409A Legally binding right, even if subject to forfeiture or other conditions, to compensation that is or may be payable in a later year If compensation paid on vesting, it s current (not deferred) compensation Covers most service providers employees, directors, certain independent contractors 6

8 New Wine New Bottles Broad coverage SERPS, elective deferrals, employment agreements, severance pay, postemployment welfare or other benefits even equity compensation Exclusions for tax-qualified retirement plans, 457(b), SEPs, vacation leave & sick leave, disability pay, death benefits Grandfathered deferred compensation Earned and vested by 12/31/2004 Not materially modified after 10/3/2004 7

9 Many Ways to Fail Operational failure Document failure (no savings clauses) Failure can be infectious - violation in one plan with a $10,000 benefit will cause a violation in a separate but similar plan covering the same employee that has an accrued benefit of $1,000,000, even though the larger plan has been operated in compliance with 409A 8

10 Deferral & Payment Rules Hardwired under program terms Elective deferrals by employees subject to very specific deadlines Payment Triggers Fixed date or schedule Separation from service Death or disability Unforeseeable emergency Change in control 9

11 Reporting and Withholding Rules

12 Reporting Compliant Deferred Compensation Section 409A generally requires an employer to report annual deferrals under 409A plans Deferrals can be reported using new code Y in Box 12 of Form W-2 and in Box 15a of Form 1099 However, informational reporting of deferrals is currently suspended until final regulations are issued No change in reporting and withholding for deferred compensation for purposes of Social Security and Medicare 11

13 Reporting Noncompliant Deferred Compensation Noncompliant deferred compensation must be reported using new code Z in Box 12 of Form W-2 and in Box 15b of Form 1099 Reported for year in which the compensation becomes vested and no longer subject to a substantial risk of forfeiture, even if the compensation is not actually or constructively received The amount reported is reduced by the amount of any deferred compensation previously included in the employee s taxable income 12

14 Withholding Requirements Employers are required to withhold income taxes on noncompliant deferred compensation to employees which is reportable (i.e., vested deferred compensation) Withholding is at supplemental rates Under existing guidance, the additional 20% tax and interest penalties are not required to be withheld 13

15 Calculating the Amount to be Reported & Withheld Amount generally is calculated as of December 31 and includes any payments made to the employee during the year Amount is determined differently depending on the type of plan or arrangement: Account balance plans: total account balance, including deemed earnings/losses Nonaccount balance plans: present value of all amounts payable under the plan Options & stock appreciation rights: the difference between the fair market value of the underlying stock and the applicable exercise price (i.e., the spread) Severance and reimbursement arrangements and split-dollar life insurance plans have special rules for calculating 14

16 Subsequent Events If noncompliant deferred compensation is included in income prior to the date it is paid, it is not taxed again when it is actually paid Under the proposed regulations, if compensation that has already been included in income under 409A is forfeited (e.g., due to the employer s bankruptcy), the employee can deduct the amount forfeited, but the 20% tax and interest penalties cannot be recovered 15

17 Correcting Non-Compliance

18 Notice : 409A Correction Program Incorporates, clarifies and expands on guidance in Notice Effective for years beginning on or after 1/1/09, but may be relied upon for years prior to 2009 Provides limited relief for operational failures only No relief for documentary failures at this time, but IRS is working on it and possible will be issued in December or early

19 Eligibility Part I Avoid recurring failures Relief not available to providers under examination No relief for exercise of stock right in violation of 409A Timely reporting of information about correction Relief only available for inadvertent and unintentional failures No relief if failure related to a tax avoidance transaction Repayments by service providers must be on gross amounts 18

20 Eligibility Part II Relief not available if employer experiences a substantial financial downturn, if downturn indicates significant risk that employer will be unable to pay deferred amounts when due Rules vary for insiders (officers, directors and 10% owners) 19

21 Type I Error And Correction In Same Year Error: Under-Deferral and Early Payment 20% deferral election of bonus, but only 10% actually deferred Amount payable in 2010 or later, but actually paid in 2009 Correction: Employee repays amount to employer in same year (or, if hardship and non-insider, over 24 month period following due date of employee s tax return for year of error) Interest required at short-term AFR (i) if payment exceeds 402(g) limit and employee is insider, or (ii) if repayment is later than year of error Adjustments for earnings/losses are permitted No impact on tax reporting 20

22 Type II Error And Correction In Same Year Error: Over-Deferral 20% deferral election, but 30% actually deferred Correction: Employer pays over-deferral to employee in same year Employer may (but not required to) pay interest on overdeferral Adjustments for earnings/losses are permitted, except that adjustments are mandatory for earnings (but not losses) with respect to insiders 21

23 Type III Error And Correction In Same Year Error: Failure in 6 month payment delay OR payment more than 30 days early (but in same year) Correction: Employee repays amount to employer in same year Must tack on additional days following repayment before subsequent payment Adjustments for losses (but not earnings) permitted 22

24 Type IV Error And Correction In Same Year Error: Grant of stock right otherwise exempt from 409A, except exercise price is set at below FMV Correction: Before exercise and not later than last day of year in which stock right is granted, reset exercise price to FMV as of date of grant 23

25 Type I Error And Correction In 1 st Year Following Error Error: Under-Deferral and Early Payment 20% deferral election of bonus, but only 10% actually deferred Amount payable in 2010 or later, but actually paid in 2009 Correction: Employee repays amount to employer in year following year of error (or, if hardship and non-insider, over 24 month period following due date of employee s tax return for year of error) Interest required at short-term AFR Erroneous payment included in income Repayment of erroneous payment (less interest) is deductible Adjustments for earnings/losses are permitted This relief is not available to insiders 24

26 Type II Error And Correction In 1 st Year Following Error Error: Over-Deferral and Failure to Pay 20% deferral election, but 30% actually deferred Amount payable in one year, but actually paid in later year Correction: Employer pays over-deferral to employee in year following year of error Employer may NOT pay interest Mandatory adjustments for earnings and permitted adjustments for losses This relief is not available to insiders 25

27 Type III Error and Correction In 1 st Year Following Error Error: Failure in 6 month payment delay OR payment more than 30 days early (but in same year) Correction: Employee repays amount to employer in year following year of error Must tack on additional days following repayment before subsequent payment Adjustments for losses (but not earnings) permitted Erroneous payment included in income in year of payment Deduction may or may not permissible for repayment depending on whether repayment and subsequent payment occur in different years This relief is not available to insiders 26

28 Type IV Error and Correction In 1 st Year Following Error Error: Grant of stock right otherwise exempt from 409A, except exercise price is set at below FMV Correction: Before exercise and not later than last day of the year following the year in which stock right is granted, reset exercise price to FMV as of date of grant This relief is not available to insiders 27

29 Special Transition Rule For Non-Insiders For any Type I, II or III operational failure applicable to a non-insider that occurred before 1/1/2008, 2009 will be treated as the taxable year next following the taxable year during which the failure occurred **** Special rule offers a free look back to 2005**** 28

30 Type I Error and Correction By End of 2 nd Year Following Error Error: Under-Deferral and Early Payment 20% deferral election of bonus, but only 10% actually deferred Amount payable in 2011 or later, but actually paid in 2009 Correction: Employee repays amount to employer by end of 2 nd year following year of error If insider, interest required at short-term AFR Erroneous payment included in income in year of payment Repayment of erroneous payment is NOT deductible Adjustments for earnings/losses are permitted Erroneous payment (and only the amount of such payment) is treated as income, including income under 409A on W-2, in Box 12, using Code Z Employee required to pay additional 20% tax, but not interest 29

31 Type II Error and Correction By End of 2 nd Year Following Error Error: Over-Deferral and Failure to Pay 20% deferral election, but 30% actually deferred Amount payable in one year, but actually paid in later year Correction: Employer pays over-deferral to employee by end of 2 nd year following error Employer may NOT pay interest Mandatory adjustments for earnings and permitted adjustments for losses W-2 must report payment as income, including income under 409A, for taxable year originally scheduled, in Box 12, using Code Z Employee must pay regular income tax, plus 20% tax (but no interest), for year of income inclusion 30

32 Type III Error and Correction By End of 2 nd Year Following Error Error: Failure in 6 month payment delay OR payment more than 30 days early (but in same year) Correction: Employee repays amount to employer by the end of the 2 nd year following error Must tack on additional days following repayment before subsequent payment Adjustments for losses (but not earnings) permitted Repayment of erroneous payment is NOT deductible Erroneous payment (and only the amount of such payment) is treated as income, including income under 409A on W-2, in Box 12, using Code Z Employee required to pay additional 20% tax, but not interest 31

33 Failure To Defer Limited Amounts Error: Under Deferral and Early Payment of 402(g) $$ limit 20% deferral election of bonus, but only 10% actually deferred Amount payable in 2010 or later, but actually paid earlier Failure in 6 month payment delay OR payment more than 30 days early (but in same year) Not corrected in same year Correction: Erroneous payment (and only the amount of such payment) is treated as income, including income under 409A on W-2, in Box 12, using Code Z Employee required to pay additional 20% tax, but not interest Employee must file tax return or amended tax return for applicable year on or before end of 2 nd year following year of payment 32

34 Excess Deferral of Limited Amounts Error: Over-Deferral or Failure to Pay 402(g) $$ limit 20% deferral election, but 30% actually deferred Amount payable in one year, but actually paid in later year Not corrected in same year Correction: Employer pays erroneous deferral before end of 2 nd year following year payment was originally scheduled Employer issues W-2 for year of payment, reporting income under 409A in Box 12, using Code Z Employee pays additional 20% tax for the year of payment, but not interest Earnings/losses may be added/subtracted (or disregarded) 33

35 Info/Reporting Req ts For Same Year Corrections Employer must attach to its federal tax return a statement with certain information about the affected employees, the applicable plans, the circumstances, etc. Employer must provide each affected employee a similar statement, but employees DO NOT need to file statements with their returns No statements required for tax returns or for affected employees with respect to corrections of stock right exercise prices 34

36 Info/Reporting Req ts For Other Corrections Employer must attach to its federal tax return a statement with certain information about the affected employees, the applicable plans, the circumstances, etc. Employer must provide each affected employee a similar statement, AND employees MUST attach the statements to their returns No statements required for tax returns or for affected employees with respect to corrections of stock right exercise prices 35

37 End of Year Action Items

38 Identify 409A Arrangements and Compliance Status Inventory all compensatory plans and arrangements with employees, directors, consultants and other independent contractors Review each plan and arrangement to determine if it includes any form of nonqualified deferred compensation Evaluate status of documentary and operational compliance 37

39 Non-Compliant 409A Arrangements Follow available correction methods to the extent applicable, notify affected participants Determine the extent of any non-compliant plan tax liabilities, including plan aggregation consequences and income inclusion calculations Coordinate with HR and payroll systems to ensure proper withholding and reporting 38

40 Questions? Douglas J. Ellis Charles A. Grace (412) (617)