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Friday, August 15, 2008

Favorable Results in the Olympics and Under Section 409A

Hey, did you see that "primal scream" shot (as David Hinckley of the NY Daily News referred to it) of Michael Phelps after that ridiculous relay win. If he gets the eight golds, they'll be showing that shot 4ever. And after the .01-second (!!!) win in the butterfly I just saw, I guess it looks like it's gonna happen. The butterfly win may actually be as amazing and exciting as any sports win I've ever seen . . . period.

And, speaking of favorable results (sorry, I couldn't think of a better segue) - I have noticed two areas in which Treasury seems to have specifically intended to confer favorable results under the 409A regulations, and yet some resist the largesse.

One is regarding slicing and dicing of severance, particularly to avoid application of the six-month delay rule. The Regulations set up what amounts to a rule that seeks to hypothesize whether a payment could ever be made outside of the S-TD period, and then takes the payment outside of S-TD from the get-go if there is even the possibility that the payment, absent a deferral election, is contemplated to be paid late.

So what of a stream of severance payments? If one is terminated on 12/31, only two-and-a-half months' of payments would be made within the S-TD period? Does that possibility doom all but two-and-a-half months' of payments to the Curse of Cap-A?

The answer seems a resounding "no." Under the Regulations as technically corrected, the focus is on whether vesting could occur too long before payment or, stated conversely, whether payment is contemplated to be deferred by too much after a possible vesting event. The focus is not on whether a payment stream might be other than the one that it is. Essentially, you test your stream of payments as it runs, not as it may run. Thus, if the termination is in fact early enough in the year, all of the payments could be S-TDs.

There's no real steel-trap proof of this reading of the Regulations, but (i) the Regulations as technically corrected are consistent with the reading, and (ii) there is at this point a good deal of anecdotal evidence that, after some internal dissension at Treasury on the point, the revisions made by the technicals were very specifically intended, at least in part, to confer the result described above. I would suggest that any imperfection in the language in conveying the result arises from the drafters' desire to retrofit corrective language into the final Regulation, and try to maximize the extent to which existing structure and language would be retained, so as to proceed consistently with the notion that the corrections were technical in nature.

Frankly, taking a step back, I don't believe that anyone will really pay cap-A taxes because the service recipient has followed a reasonable good-faith analysis believed in by some percentage of the practicing experts. The taxes will be paid when someone really messes up - misses a requirement, misadministers a plan, etc. - not because some analysis balanced on the head of a pin ultimately tips over. Heck, on so much of this stuff, Treasury and IRS people don't know the answers or, worse, disagree with each other. On this particular point, though, there seems clarity, and a uniform view that slicing and dicing is available to as much of the stream as is paid in the S-TD period based on the actual date of termination. Bolstering the foregoing is an affirmative change to the regulatory language that had to be intended to mean something and that is consistent with the intended result.

The other area I wanted to raise is the impact of a "bad" "good reason" definition. Some have suggested that the impact is to accelerate vesting so that affected benefits are vested from the get-go. But this misses the mark. If the condition at issue has a very low threshold but one still under the control of the service recipient, (i) I understand that the provision may well not amount to a constructive-termination provision and therefore arguably shouldn't be respected as such, but (ii) the service provider simply isn't vested, as the condition is within the control of the service recipient. If I say you have GR if I move your parking space over by one, you're just not vested. Rather, the significance is that, if the condition occurs, you'll be deemed to have vested at that time, rather than upon the ultimate termination. That's the practical effect - it's being involuntarily terminated that's the vesting event, and, under a "good" GR definition, the terminated is respected as an involuntary termination and so, until there's a termination, there's no involuntary termination. Where the purported GR termination is not respected as an involuntary termination, the triggering event is nothing more than a vesting event, and so you can vest in advance of the termination. And, bringing it full circle to the above discussion, since you could vest, not terminate, stay in service, later get fired and then get paid, you don't have an S-TD out of the gate, if your GR definition is not "good" (just like you wouldn't have one if you had a CiC walk right in a contract that does not expire in a timely fashion after the CiC). However, none of this is to say that you're vested before the triggering event transpires; that just doesn't make any sense. (One place where this analysis is highly relevant is regarding the ability to change the definition during transition. If a "bad" definition were itself accelerated vesting, you might have a problem.)

The problem is that the Regulation uses an "involuntary" convention to get to its destination, instead of a vesting analysis, and so the language doesn't scream (primal scream?) out the nuances. Also, there's a line in the preamble that seems to expand the significance of what it means to have "bad" GR, further potentially confusing the issue, but the expansiveness is not repeated in the regulatory language, nor should it have been. Thus, you're left with reasoning through to the correct result, rather than having it jump out at you.

Having said all that, I could imagine a "real bad" GR definition which accelerates vesting before the trigger occurs. If I say you can leave with GR if I'm ever once late with your coffee, I could see Treasury/IRS saying that the likelihood is so great you'll have GR that you should be considered vested out of the gate. But that's an extreme case, and not the kind of case that people are really talking about when talking about "bad" GR.

Well, it's back to the Olympics for me. They just rejected the Serbian protest of the Phelps butterfly win. Just like we shouldn't give away the favorable 409A approaches Treasury is trying to give us. (I know, I know, saying it won't make the segue so, but I'm tryin'.)


justsomeone said...

I tend to disagree with your conclusion that as long as the payment is made within 2 1/2 months it is ok, regardless of when vesting occurs. The ST deferral rule says that "a deferral of compensation does not occur if the plan ... does not provide for a deferred payment and [the payment is made within 2 1/2 months." It goes on to say that a "plan provides for a deferred payment if the plan provides that any payment will be made or completed on or after any date .. that will or may occur later than the end of the [2 1/2 month period]... regardless of whether an amount is actually paid... during the applicable 2 1/2 month period."
I read this to mean that if the payment could possibly be made after the 2 1/2 month period (e.g. terminated on 12/31 with a 12 month stream of severance) that only 2 1/2 months worth of severance is eligible for the ST deferral exception. If you have a different read of that, I'd be interested to understand it.

xtremErisa - said...

The key is in the changes made by the technical corrections to the regulations, 72 Fed. Reg. 41,620, and the focus (under Section 1.409A-1(b)(4)(i) and (i)(D) as it now reads) on the particular payment in question (presumably including the time of payment) rather than on the plan. The language may be something less than crystal clear due to the retrofitting that Treasury did to retain the character of the changes as technicals, but I am xtremely confident that that's the clear and considered intent. Both current and former Treasury officials have informally but consistently confirmed as much in presentations and telephone calls.