U.S. Income Portfolios ,U.S. Income Portfolios: Compensation Planning ,Portfolio 385-5th: Deferred Compensatio Table of Contents Worksheet 10 Commentary to Model Equity Compensation Plan Exempt from Section 409A U.S. Income Portfolios U.S. Income Portfolios: Compensation Planning Portfolio 385-5th: Deferred Compensation Arrangements Working Papers Worksheet 10 Commentary to Model Equity Compensation Plan Exempt from Section 409A By Steven H. Sholk, Esq. Steven H. Sholk, Esq. ([email protected]) is a Director in the Corporate Department of Gibbons P.C. and Chair of the Employee Benefits and Executive Compensation Group. Editor's Note: This is a February 2021 revision of a previous version of this insight. “In most English words and phrases there lurk uncertainties.” Robinson v. United States, 324 U.S. 282, 286 (1945). “Condemned to the use of words, we can never expect mathematical certainty from our language.” Grayned v. City of Rockford, 408 U.S. 104, 110 (1972). The ABC, Inc. Equity Compensation Plan (the “Model Plan”) is designed to satisfy the exemptions for equity compensation plans from Section 409A of the Internal Revenue Code of 1986, as amended (the “code”)1 found in the final Section 409A regulations (the “Final Regulations”).2 The Final Regulations provide exemptions for nonqualified stock options,3 incentive stock options,4 stock appreciation rights (“SARs”),5 and restricted stock.6 1 Section 409A was added to the code by the American Jobs Creation Act of 2004, Pub. L. No. 108- 375, §885, 118 Stat. 1418, 1634–F41. 2 Department of the Treasury, Internal Revenue Service, “Application of Section 409A to Nonqualified Deferred Compensation Plans, Final Regulations,” 72 F.R. 19,234 (April 17, 2007), and Department of the Treasury, Internal Revenue Service, “Application of Section 409A to Nonqualified Deferred Compensation Plans, Correction,” 72 F.R. 41,620 (July 31, 2007). 3 Treas. Reg. §1.409A-1(b)(5)(i)(A). 4 Treas. Reg. §1.409A-1(b)(5)(ii). 5 Treas. Reg. §1.409A-1(b)(5)(i)(B). 6 Treas. Reg. §1.409A-1(b)(6). Reprinted with permission from Bloomberg Law. February 2021. © 2021 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service // PAGE 2 U.S. Income Portfolios ,U.S. Income Portfolios: Compensation Planning ,Portfolio 385-5th: Deferred Compensatio Public Law 115-97, otherwise known as the Tax Cuts and Jobs Act of 2017, added Section 83(i) to the code to provide an exemption for deferral elections for stock issued under nonqualified stock options and restricted stock units (“RSUs”). The exemption applies to options and RSUs granted by eligible corporations to qualified employees, each as defined in Section 83(i).7 The exemption applies to stock attributable to options exercised, and RSUs settled, after December 31, 2017.8 7 I.R.C. §§83(i) and 409A(d)(7). 8 Section 13603(c)(2) of Public Law 115-97. The Model Plan contains the provisions that satisfy the requirements of the exemptions for nonqualified stock options, incentive stock options, SARs, and restricted stock. It also contains provisions that satisfy the requirements of the Final Regulations for nonqualified deferred compensation plans subject to Section 409A, but are not necessary to satisfy the requirements of these exemptions. Service recipients (e.g., employers) often use provisions that satisfy the requirements for nonqualified deferred compensation plans in their exempt equity compensation plans so that the equity compensation plans are consistent with the nonqualified deferred compensation plans that cover the same group of service providers (e.g., employees).9 In this manner, service recipients can achieve the elusive goal of having a compensation program that makes sense. 9 The Final Regulations define service recipient as the person for whom services are performed and with respect to whom the legally binding right to compensation arises, and all persons with whom such person would be considered a single employer under I.R.C. §414(b)-(c). Treas. Reg. §1.409A-1(g). The Final Regulations modify this definition for determining the service recipient employer on an employee's separation from service. Treas. Reg. §1.409A-1(h)(3). See discussion of this modification infra notes 385 to 393 and accompanying text. For convenience, this Article refers to a service recipient as the employer. The Final Regulations define service provider as an individual, corporation, subchapter S corporation, partnership, personal service corporation under I.R.C. §269A(b)(1), noncorporate entity that would be a personal service corporation if it were a corporation, qualified personal service corporation under I.R.C. §448(d)(2), and noncorporate entity that would be a qualified personal service corporation if it were a corporation, for any taxable year in which such individual, corporation, subchapter S corporation, partnership, or other entity accounts for gross income from the performance of services under the cash receipts and disbursements method of accounting. Treas. Reg. §1.409A-1(f)(1). For convenience, this Article refers to a service provider as the employee. The Final Regulations contain detailed rules for determining whether an independent contractor is a service provider subject to I.R.C. §409A. Treas. Reg. §1.409A-1(f)(2). On June 21, 2016, the Treasury Department and Internal Revenue Service issued proposed regulations that address provisions of the Final Regulations dealing with the exemptions for equity compensation plans, and the requirements for nonqualified deferred compensation plans subject to Section 409A (the “Proposed Regulations”).10 The Proposed Regulations are largely pro-taxpayer. 10 Department of the Treasury, Internal Revenue Service, “Application of Section 409A to Nonqualified Deferred Compensation Plans, Notice of Proposed Rulemaking,” 81 F.R. 40,569 (June 22, 2016). The Proposed Regulations are proposed to apply on or after the date on which they are published as final regulations in the Federal Register. For the period before this date, the Final Regulations and other applicable guidance will continue to apply, and taxpayers may rely on the Proposed Regulations before they are published as final regulations. Until the final regulations are published, the IRS will not assert positions that are contrary to the positions taken in the Proposed Regulations.11 11 Id. at Proposed Effective Dates, 81 F.R. at 40,577. THE PROMISED LAND OF EXEMPTION FROM SECTION 409A © 2021 The Bureau of National Affairs, Inc. All Rights Reserved. Terms of Service // PAGE 3 U.S. Income Portfolios ,U.S. Income Portfolios: Compensation Planning ,Portfolio 385-5th: Deferred Compensatio In the absence of an exemption from Section 409A, nonqualified deferred compensation plans can permit employees to exercise options and SARs only on one or more of the following six payment events and times:12 (1) separation from service; 13 (2) disability;14 (3) death;15 (4) at a specified time or pursuant to a fixed schedule;16 (5) a change-in-control;17 and (6) the occurrence of an unforeseeable emergency.18 12 Treas. Reg. §1.409A-3(b) (a plan of nonqualified deferred compensation may provide for payment upon the earliest or latest of more than one event or time, provided that each event or time is listed in Treas. Reg. §1.409A-3(a)(1)-(6)). 13 I.R.C. §409A(a)(2)(A)(i) (separation from service as determined by the Secretary is a permissible payment event); I.R.C. §409A(a)(2)(B)(i) (mandatory six month delay in payment to a specified employee on separation from service); Treas. Reg. §1.409A-1(h) (definition of separation from service); Treas. Reg. §1.409A-3(a)(1) (separation from service is a permissible payment event); Treas. Reg. §1.409A-3(i)(2) (mandatory six month delay in payment to a specified employee on separation from service). For the use of “termination of employment” as a permissible proxy for separation from service, see infra notes 474 to 478 and accompanying text. 14 I.R.C. §409A(a)(2)(A)(ii) and (C) (disability as defined in the statute is a permissible payment event); Treas. Reg. §1.409A-3(a)(2) and (i)(4) (disability as defined in the Final Regulations is a permissible payment event). 15 I.R.C. §409A(a)(2)(A)(iii) (death is a permissible payment event); Treas. Reg. §1.409A-3(a)(3) (same). 16 I.R.C. §409A(a)(2)(iv) (a specified time (or pursuant to a fixed schedule) specified under the plan at the date of deferral of the compensation is a permissible payment date); Treas. Reg. §1.409A-3(a)(4) and (i)(1) (a specified time or fixed schedule, as defined in the Final Regulations, is a permissible payment date). 17 I.R.C. §409A(a)(2)(A)(v) (to the extent provided by the Secretary, a change in the ownership or effective control of a corporation, or in the ownership of a substantial portion of the assets of a corporation, is a permissible payment event); Treas. Reg. §1.409A-3(a)(5) and (i)(5) (a change in the ownership or effective control of a corporation, or in the ownership of a substantial portion of the assets of a corporation, as these terms are defined in the Final Regulations, is a permissible payment event). 18 I.R.C. §409A(a)(2)(A)(vi) (occurrence of an unforeseeable emergency is a permissible payment event); Treas. Reg. §1.409A-3(a)(6) and (i)(3) (occurrence of an unforeseeable emergency, as defined in the Final Regulations, is a permissible payment event). The provision for payments to be made at a specified time or pursuant to a fixed schedule deprives the employee of the flexibility to choose when he or she can exercise options and SARs subject to Section 409A.

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