ERISA Lawyer Blog

The IRS has issued Notice 2010-6, which contains procedures for voluntarily correcting many types of failures to comply with the document requirements that apply to nonqualified deferred compensation plans under Section 409A of the Internal Revenue Code. The Notice provides:

--clarification that certain language commonly included in plan documents will not
cause a document failure;

-- relief which permits correction of certain document failures without current income inclusion or additional taxes under Section 409A, so long as, in certain cases, the corrected plan provision does not affect the operation of the plan within
one year following the date of correction;

--relief limiting the amount currently includible in income and the additional taxes
under Section 409A for certain document failures, if correction of the failure affects the
operation of the plan within one year following the date of correction;

--relief permitting correction of certain document failures without current income
inclusion or additional taxes under § 409A, if the plan is generally the service recipient's
first plan of that type, and the failure is corrected within a limited period following the plan's adoption; and

--transition relief permitting corrections of certain document failures without
current income inclusion or additional taxes under Section 409A, if the document failure
is corrected by December 31, 2010, and any operational failures resulting from
the document failure are also corrected in accordance with IRS Notice 2008-113 by December 31, 2010.

The Notice also clarifies certain aspects of IRS Notice 2008-113, which addresses
various failures of nonqualified deferred compensation plans to comply with Section 409A in operation, including clarification of:

--the application of the subsequent year correction method to late payments of
amounts deferred; and

--the calculation of the amount that must be paid to the service provider as a
correction of a late or ealy payment of a deferred amount, if the payment
would have been made in property, such as shares of stock.

This item is of interest because it illustrates how issues involving section 409A can arise.

IRS Notice 2009-92 (the "Notice") provides guidance for a financial institution (a "TARP Recipient"), which has received financial assistance under the Troubled Asset Relief Program ("TARP"), on how to comply with section 409A of the Internal Revenue Code (the "Code") when amending its nonqualified deferred compensation plan to comply with an advisory opinion of the Office of the Special Master for TARP Executive Compensation (the "Special Master").

In October, 2008, the Treasury Department established TARP under the Emergency Economic Stabilization Act of 2008 ("EESA"). Under an interim final rule published by the Treasury Department on June 15, 2009, a TARP Recipient may request an advisory opinion from the Special Master as to whether a compensation structure is consistent with TARP, EESA, and the public interest. Also, the Special Master may render such an advisory opinion at his own initiative. The advisory opinion is not binding on the TARP Recipient who receives it, but the TARP Recipient may rely on the advisory opinion as to whether the covered compensation structure discussed in the opinion meets the consistency requirement.

An advisory opinion issued by the Special Master may indicate that changes to the time or form of payment of compensation under the TARP Recipient's nonqualified deferred compensation plan (the "Plan") are needed for the Plan to be consistent with TARP, EESA, and the public interest. The advisory opinion may also indicate that, to achieve such consistency, payment of compensation made under the Plan must be subject to
certainTARP-related conditions, for example, the prior repayment of some or all of
the financial assistance received by the TARP Recipient. However, the foregoing raises the problem that, to modify the Plan in the manner indicated in the advisory opinion, payments of compensation made under the Plan might have to be accelerated or delayed, causing the Plan to fail to meet the requirements of Code section 409A. The Notice addresses this problem.

The Notice applies when the advisory opinion is issued after September 30, 2009. Under the Notice, any changes made to the time or form of payment of compensation under a Tarp Recipient's Plan, as required by the advisory opinion, will not cause the Plan to fail to meet the requirements of section 409A, so long as a number of conditions are met. In general, these conditions are:

-- the advisory opinion is specifically addressed to that TARP Recipient and Plan;

--the TARP Recipient has fully disclosed to the Special Master the employees whose compensation will be affected by complying with the advisory opinion, and
any similarly situated employees;

-- the advisory opinion explicitly sets forth (1) a revised time and form of
payment for the compensation which complies with section 409A and/or (2) a condition on payment of compensation under the Plan that is directly related to the TARP financial assistance received by the TARP Recipient, or to the ability of the TARP Recipient to repay the TARP financial assistance;

-- the advisory opinion does not authorize the TARP Recipient or any recipient of compensation under the Plan to elect another time or form of payment of compensation due from the Plan, other than in a manner which complies with section 409A;

-- the TARP Recipient and any recipient of compensation under the Plan must enter into a written agreement containing the revised time and form of payment, and any applicable conditions on payment, not later than by the end of the compensation recipient's taxable year in which the advisory opinion is issued, or by the 15th day of the third month following the date on which the advisory opinion is issued, if later; and

-- the TARP Recipient and any recipient of compensation under the Plan
complies with the terms of the advisory opinion in all material respects.

IRS Revenue Ruling 2008-13 changed one of the exceptions to the $1million limit under Section 162(m) of the Internal Revenue Code (the "Code") on the deductibility of bonus pay by public companies, and generally requires that bonus plans be amended before the start of 2010 to reflect this change.

By way of background, Section 162(m)(1) of the Code provides that, in the case of any publicly held corporation, no deduction is allowed for the compensation of any "covered employee" (generally, the chief executive officer or one of the 3 other highest paid executive officers other than the chief financial officer), to the extent that the employee's compensation for the year in question exceeds $1,000,000. However, Section 162(m)(4)(C) of the Code and Section 1.162-27(e)(1) of the Treasury regulations provide that this limit does not apply to qualified performance-based compensation. Under the Treasury regulations, to be qualified performance-based compensation, several requirements must be satisfied. One such requirement is found in Treasury regulation Section 1.162-27(e)(2)(i), under which qualified performance-based compensation must be paid solely on account of the attainment of one or more preestablished, objective performance goals. Treasury regulation Section 1.162-27(e)(2)(v) states that compensation is not performance-based if the facts and circumstances indicate that the employee would receive all or part of the compensation regardless of whether the performance goal is attained. It further states that compensation does not fail to be qualified performance-based compensation merely because the plan in question allows the compensation to be payable upon the employee's death, disability, or change of control, although compensation actually paid on account of one of those events, prior to the attainment of the performance goal, would not be qualified performance-based compensation.

In Revenue Ruling 2008-13, the IRS considered the case in which a plan, agreement or contract (a "Plan") of a public company, under which compensation is paid to a covered employee, provides that the compensation will be paid (1) upon attainment of a performance goal or (2) without regard to whether the performance goal is attained, if (a) the covered employee's employment is involuntarily terminated by the employer without cause, or (b) the covered employee resigns from employment for good reason, or retires. The IRS ruled that compensation paid under this Plan is not qualified performance-based compensation, since it could be paid even if the performance goals are not met. The Ruling affirmed the IRS's position taken in a 2008 private letter ruling, which reversed the IRS's position in some earlier private letter rulings. This Ruling requires that any Plan of a public company, such as a bonus plan, which contains the language in (2) (or similar language) must be amended to remove such language, otherwise all compensation payable under the Plan to covered employees will be subject to the $1 million dollar limit on deductions under Section 162(m).

Fortunately, the IRS gave employers a period of time to make this amendment. Revenue Ruling 2008-13 stated that the Ruling will not be applied to disallow a deduction for any compensation which otherwise satisfies the requirements for being qualified performance-based compensation, and which is paid under a Plan that has language similar to that in (2) above, if either:

--the performance period (i.e., the period of service to which the performance goal applicable
to such compensation relates) for the compensation begins on or before January 1, 2009; or

--the compensation is paid pursuant to the terms of an employment contract as in effect on February 21, 2008, unless that contract has been renewed or extended after that date.

Thus, except for the case of an employment contract referred to above, the final performance period to which the Ruling will not apply is the performance period starting on January 1, 2009. If an employer's Plan has a calendar year performance period, it may still avoid the adverse effect of Revenue Ruling 2008-13 by amending its Plan to remove the proscribed language prior to the end of 2009.

In Chief Counsel Advice Memorandum 200935029 (8/28/2009), the IRS was reviewing a "salary advance program." Under this program, an employee would receive a salary advance, apparently as a loan. However, the employee was permitted to apply the amount otherwise due him or her, under a nonqualified deferred compensation plan (the "Plan") upon termination of employment, to offset and eliminate the loan balance.

The IRS said that the doctrine of constructive receipt applies to the "salary advances" to employees. Accordingly, an employee would be required to include the amount available as a salary advance in gross income in the earliest open tax year in which the advance was available (even if not taken), and this amount would be subject to income tax withholding at such time as a constructive payment.

The IRS continued by saying that, even if there was no constructive receipt, salary advances which an employee is expected to earn through future services are taxed as compensation, and are therefore included in gross income, at the time of receipt. The IRS conceded that an (unspecified) employment tax exception would apply to an employee, so that any advance would not be subject to employment tax. Further, if there is no constructive receipt, the salary advance program causes the Plan to violate IRC Section 409A, due to the permitted off-set feature described above. Apparently, the IRS felt that this offset, which is a pre-employment termination use of amounts deferred under the Plan, causes an acceleration of the payment of deferred compensation by the Plan, and this acceleration violates Section 409A.

I just received an email from my Congressman, Gary Ackerman, telling me that the House of Representatives has now passed the Corporate and Financial Institution Compensation Fairness Act, H.R. 3269. This Act would require that any public company with assets greater than $1 billion must hold an advisory shareholder vote on the compensation packages of the company's top executives at least once per year. It would also empower federal regulators to limit inappropriate or imprudently risky executive compensation packages. Acccording to the email, the Act is intended to help end the now all-too-familiar practice of executives taking excessive risk at the expense of their shareholders and, ultimately, the American taxpayer.

The IRS has issued interim final rules, under the Emergency Economic Stabilization Act of 2008, as amended ("EESA"), which provide guidance on the provisions of EESA pertaining to executive compensation and corporate governance, for financial institutions and other entities that receive financial assistance under the Troubled Asset Relief Program ("TARP").

The interim final rules include the following limits, provisions and requirements which generally apply to all TARP recipients (subject to certain exceptions for TARP recipients that do not hold outstanding obligations):

-- limits on compensation which encourage the senior executive officer ("SEO") to take unnecessary and excessive risks that threaten the value of the TARP recipient;

-- provisions for the recovery of any bonus, retention award, or incentive compensation paid to a SEO or the next twenty most highly compensated employees based on materially inaccurate statements of earnings, revenues, gains or other criteria;

-- a prohibition on making any golden parachute payment to a SEO or any of the next five most highly compensated employees;

--a prohibition on the payment or accrual of any bonus, retention award or incentive compensation to a SEO or certain highly compensated employees (subject to certain exceptions for payments made in the form of restricted stock);

--a prohibition on employee compensation plans that would encourage manipulation of earnings reported by the TARP recipient to enhance an employee's compensation;

-- the establishment of a compensation committee of independent directors to meet semi-annually to review employee compensation plans and the risks posed by these plans to the TARP recipient;

--the adoption of an excessive or luxury expenditures policy;

--the disclosure of perquisites offered to a SEO and certain highly compensated employees;

--a disclosure related to compensation consultant engagements;

--a prohibition on tax gross-ups to a SEO and certain highly compensated employees;

--rules on compliance with federal securities law regarding the submission of a non-binding resolution on SEO compensation to shareholders;

--the establishment of certain reporting and recordkeeping requirements regarding the foregoing compensation and corporate governance standards; and

--the establishment of the Office of the Special Master for TARP Executive Compensation, to address the application of the foregoing limits, provisions and requirements.

The interim final rules are effective as of June 15, 2009, except as they apply to certain statutory provisions with an earlier effective date, as explained in the preamble accompanying the rules. They replace certain earlier IRS guidance on EESA rules applying to TARP recipients (i.e., interim final rules issued in October, 2008, Notice 2008-PSSFI and Notice 2008-TAAP), as of the dates set forth in the rules and the accompanying preamble. The interim final rules and preamble are here.

A press release, dated June 11, 2009, contains a statement by Gene Sperling, Counselor to the Secretary of the Treasury, which outlines the Treasury Department's thoughts on how executive compensation should be improved to avoid further adverse effects on the economy. The statement was made at a hearing of the U.S. House of Representatives Committee on compensation practices.

The statement indicated that one contributing factor to the current economic crisis has been excessive risk taking, which is attributable to compensation practices at financial institutions that encourage short-term gains to be realized with little regard to the potential economic damage that could be caused. What is most important for the economy now is understanding how compensation practices contributed to the economic crisis, and what steps can be taken to ensure that these practices do not cause excessive risk-taking in the future.

The statement noted that Treasury Secretary Geithner has laid out a set of principles for moving forward with compensation reforms. The goal of these principles is to help ensure that there is a much closer alignment between compensation, sound risk management and long-term value creation for firms and the economy as a whole. These principles are the following:

--compensation plans should properly measure and reward performance

--compensation should be structured in line with the time horizon of risks;

--compensation practices should be aligned with sound risk management;

--golden parachutes and supplemental retirement packages should be reviewed and rewritten to align the interests of executives and shareholders; and

--transparency and accountability to shareholders should be promoted in setting compensation.

The statement discusses each principle in some detail. The press release containing the statement may be found here.

In Notice 2009-49, the IRS states that a transaction under the Troubled Asset Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 ("EESA"), which involves the acquisition by the Treasury Department of stock or another type of equity in a financial institution or other entity, is not an event with respect to which a payment can be made under a nonqualified deferred compensation plan ("NQDCP) under Section 409A of the Internal Revenue Code and the underlying Treasury regulations. The Notice clarifies that, for purposes of those regulations, this type of transaction-a "TARP Transaction"- is not a change in ownership or effective control, or a change in the ownership of a substantial portion of the assets of the corporation, and therefore is not a permissible Section 409A payment event.

Accordingly, a NQDCP will fail to satisfy the requirements of Section 409A if it makes a payment on account of a TARP Transaction, and will not fail to satisfy those requirements merely because it fails to make a payment on account of a TARP Transaction. Further, a NQDCP will not fail to satisfy any requirement of Section 409A or the underlying regulations (e.g., the written plan requirement) merely because it fails to explicitly provide that a TARP Transaction will not trigger a payment, without regard to whether the plan incorporates the definition of a change in control event by reference to the regulations or sets forth a definition of a change in control event that is otherwise compliant.

The IRS intends to amend the regulations under Section 409A to incorporate the guidance set out in Notice 2009-49. The Notice and the amended regulations will apply to TARP transactions occurring on or after June 4, 2009. The Notice is here.

The author of this blog is Stanley D. Baum. Stanley is an attorney in New York. He concentrates in ERISA, employee benefits, executive compensation and employment law. Stanley encourages the readers to submit comments and questions to him by using the contact form on the right side of the blog.