Deferred Compensation Arrangements for Non-Profits: What I’ve Felt, What I’ve Known, Is Not Consistent with the Code

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by Benjamin Gibbons

Deferred compensation options for executives of tax-exempt entities are often misunderstood by those organizations who have not previously delved into them. Traditional tax-exempt organizations – think charities and non-profits – are subject not only to the deferred compensation rules of Section 409A of the tax code, but also Section 457 (though note that Section 457 does not apply to deferred compensation arrangements of churches). Section 457-subject organizations without deferred compensation experience are often under the impression that they are able to establish deferred compensation arrangements that are similar to those of for-profit entities, in that the right to deferred compensation can vest now and be taxed at a later date. When such organizations begin moving forward to put a deferred compensation arrangement place, they are often surprised to learn that Section 457 generally limits their ability do so.

The most analogous deferred compensation arrangement for tax-exempt executives compared to a traditional for-profit deferred compensation plan is what’s generally known as a Section 457(f) plan. While there are a number of differences between a Section 457(f) plan and a for-profit deferred compensation plan, the biggest is the timing of the taxation of the deferred compensation. A for-profit deferred compensation plan can be designed so that once the right to deferred compensation vests, it can be taxed (for income tax purposes) on the date that it is paid, which can be many years in the future. With a Section 457(f) plan, once the deferred compensation vests, it becomes immediately taxable, even if the plan provides for payment of the deferred compensation in a future year. Read more

I’ve Been Trying to Get Down to the Heart of the Matter – the Board Action

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by John Ludlum

If you ever want to see a benefits lawyer get nervous, start talking about corporate intent.  Yes, the company intended to grant options at an earlier and lower exercise price, and yes it may have made promises to the individuals who would receive the awards; everybody seems to be in agreement. But there may be inadequate documentation, or worse, none at all, and the tax implications have to be considered. The foundation for any equity grant will be corporate action, and the experienced perspective is that if there is doubt about the corporate action, it will be hard to defend.

The Incentive Stock Option (“ISO”) regulations and the Code Section 409A regulations (“Section 409A”) both provide guidance on when an equity grant is actually made for the purposes of those Code Sections. For ISOs, the “date or time when the granting corporation completes the corporate action” constituting an offer under the terms of a statutory option which is not considered complete until the maximum number of shares and the minimum price are fixed or determinable. For Section 409A, the date when the “granting corporation completes the corporate action” necessary to create a legally binding right to the option which is not complete until the date on which the maximum number of shares and the minimum exercise price are fixed or determinable, and the class of underlying stock and the identity of the service provider are designated. Obviously, the regulations have similarities, but the common and essential element is the requirement for a corporate action. Read more

With a Little Help From My Friends … New Clawback Rule Requires Coordination of Finance, Securities, HR, and Benefits Personnel

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by Elizabeth Nedrow

Many aspects of benefits and executive compensation require coordination between a company’s benefits, HR, finance and securities compliance personnel. One topic currently responsible for many such “all hands” planning sessions is the SEC’s new clawback rule. This rule has been a long time in the making, and the final compliance deadline of December 1, 2023 is now fast approaching.

In 2010, the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC and U.S. securities exchanges to require listed companies to implement clawback policies. After delays, proposed rules and other preliminary actions, in October 2022 the SEC issued its final rule (called “Rule 10D-1”) laying out the requirements for clawback policies. The NYSE and Nasdaq followed up by developing listing standards in line with Rule 10D-1. The SEC approved those listing standards on June 9, 2023. Public companies now have their marching orders – the rules are effective October 2, 2023 and listed companies must have clawback policies in place no later than December 1, 2023. Read more

Crazy Little Thing Called . . . Automatic Enrollment

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by Leslie Thomson

Secure Act 2.0 requires certain plans to automatically enroll participants once they become eligible to participate. Plans that were established prior to December 29, 2022 are exempt from this new requirement. Plans that are established after December 29, 2022 are subject to the automatic enrollment requirement but not until the 2025 plan year. Read more

Can’t Stop the AI*

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by Benjamin Gibbons

Today’s Benefits Dial post was written in part by a special guest author, ChatGPT. With all of the buzz surrounding AI chatbots, I decided to see how ChatGPT would do composing a blog post on a somewhat technical but fairly common executive compensation scenario. As discussed below, the results were not so good. Here is our guest author’s blog on the ability to make subsequent deferral elections in a nonqualified deferred compensation plan:

Making a Section 409A subsequent deferral election can be a complex process, but it is an important step for individuals who have previously deferred compensation under a nonqualified deferred compensation plan. The subsequent deferral election allows these individuals to change the timing of their future payments, providing greater flexibility and control over their income streams.

To make a subsequent deferral election under Section 409A, an individual must first meet certain eligibility requirements. Specifically, the individual must have originally deferred compensation under a nonqualified deferred compensation plan that complies with Section 409A, and the election must be made at least 12 months before the original payment date. Once eligibility is established, the individual must submit a written election to the plan administrator outlining the new deferral election terms.

It is important to note that making a subsequent deferral election is not a decision to be taken lightly. There may be significant tax consequences associated with a change in payment timing, and it is important to consult with a tax professional before making any changes to a nonqualified deferred compensation plan. In addition, the plan document may contain specific rules and procedures for making a subsequent deferral election, and failure to follow these rules could result in adverse tax consequences.

In summary, a subsequent deferral election under Section 409A can provide valuable flexibility for individuals who have previously deferred compensation under a nonqualified deferred compensation plan. However, it is important to carefully consider the tax implications and procedural requirements before making any changes to a plan. For more information on making a subsequent deferral election, consult with a benefits attorney or tax professional.

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Like a Vision She Dances Across the Porch As the Radio Plays… Thinking About Equity Practices In the Good Old Days

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Changes and trends in private company equity incentive plan terms over time

by John Ludlum

A client who remembered equity plans from Silicon Valley in years past asked about what has changed in private company equity plans over time. This can be a big topic, with some changes driven by securities compliance considerations, some by accounting (for those of us who remember when options were “free” of compensation expense in the days before SFAS 123R now ASC 718), and some by tax rule changes (what did any of us do before Code Section 409A?). Read more

It Doesn’t Have To Be That Way: Negotiating Good Service Provider Agreements Is More Important than Ever

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by Bret F. Busacker

It may be an understatement to say that compliance with benefit plan laws and regulations is becoming increasingly more complicated. In my experience, the COVID era has brought about some of the widest-sweeping changes on the burden of administering benefit plans in some time.

There has been major evolution around service provider fee disclosure, DOL reporting and disclosure on mental health parity and disclosure of plan costs, new claims procedure rights, expanded expectations around Cyber Security protections, and expansion of the use of ESG and crypto currency (and on-again, off-again regulatory efforts). Read more

Even if We’re Just Dancin’ in the Dark… We Should Still Understand the Equity Repurchase Rights

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by John Ludlum

It is common for employees and executives of technology companies to receive a significant portion of their compensation in equity. For executives, the equity often represents the majority of the financial upside of the relationship. Years ago, business practices were more relaxed in Silicon Valley and other technology-favorable business environments with terms like single trigger vesting acceleration baked into equity plans for a change of control, and equity repurchase rights for the company were often quite limited.

Times have changed. While it is fair to say that sometimes terms like single trigger change of control acceleration resulted in unfair windfalls for employees who received equity awards shortly before a change of control, especially during economic cycles where valuations were volatile (rapid value increases for the common stock of private companies seem to go in cycles), there are now several considerations for executives to think about in connection with the likely value of their equity in an employment opportunity. Read more

Oh Won’t You Stay…Until the Bonus is Paid

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by Brenda Berg

A new interpretation by the Colorado Department of Labor and Employment (CDLE) could have significant tax impacts under Internal Revenue Code Section 409A (409A). Many bonus and incentive programs require that the intended recipient remain employed with the employer through the date of payment. If the employee quits before the payment date, the employee is not entitled to receive the bonus. In fact, many bonuses are granted specifically in order to retain the employee.

In Interpretative Notice and Formal Opinion (INFO) #17, the CDLE interprets the Colorado Wage Act as prohibiting an employer from requiring the employee be employed on a certain date in order to receive a bonus, if all other conditions to receive the bonus have been met. See my colleague’s article here for more discussion about the new guidance in general.

If the CDLE interpretation is applied to retention bonuses, the bonuses might not, in fact, be forfeitable if the employee quits before the payment date. Since these bonuses are typically designed to be exempt from 409A tax rules under the “short term deferral” exception which requires there to be a “substantial risk of forfeiture,” this could mean that there is no longer a substantial risk of forfeiture. The amount could be considered deferred compensation that is subject to 409A – and all of 409A’s restrictions and an extra 20% tax for any violation. Earlier “vesting” and disregard of “substantial risk of forfeiture” could have other tax and accounting impacts as well, including the timing of federal/state income taxation and FICA taxation, and which taxable year is allocated the company deduction under the “all-events test” for liabilities. Read more

You Can’t Touch That: Permitting Cashouts of PTO May Create Tax Traps for Employees and Employers

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by Bret F. Busacker

As we approach year end, employers should give some thought to reviewing their PTO policies for the coming year. One of the most common tax traps that we see is employers offering employees the right to cash out their PTO.

“It’s their PTO, and if they have accumulated a large balance, then we want to encourage them to get the large PTO accrual off the books,” is a common explanation we hear from employers.

Not so fast. Giving an employee a choice between current cash and rolling over PTO hours accelerates the taxation of the employee’s PTO hours (even if the employee never elects to cash them out). Many employers are surprised to learn that an obscure IRS rule known as “constructive receipt” generally requires an employer to treat PTO as taxable wages at the earliest time the employee is able to elect to cash out the PTO. Read more