Do We Need To Register Employee If They Agree To Defer Compensation

Deferred bounty can be in many forms, and the rules and exceptions that apply to deferred compensation are far too numerous and complex to attempt to fully describe hither. What we can do, nonetheless, is:

identify what deferred bounty is, at its most fundamental level;
describe some of the most common forms of deferred compensation found in employment agreements;
discuss why it is of import to pay close attention to the rules and regulations surrounding deferred bounty; and
identify some of the most mutual mistakes and problems that ascend due to the inclusion of deferred bounty in an employment understanding.

Remember, the rules, definitions, and other items discussed here are general and summary in nature. If you are preparing, amending or reviewing an employment agreement that y'all believe may or should include elements of deferred compensation, you are strongly encouraged to consult with an experienced employee benefits lawyer.

Why Should I Care?

The rules regarding deferred compensation are contained in Department 409A of the Internal Revenue Code and the related regulations. Before we motion on to talk about what deferred compensation is, let's understand why we should fifty-fifty care. Section 409A regulates the payment of deferred bounty arrangements. The details of 409A are vast and circuitous, but for now allow'southward but recognize the penalties that issue if the rules of 409A are not followed. Beginning, all amounts payable under the deferred bounty organisation become immediately included in the taxable income of the employee in the year in which such amounts are no longer subject to a "substantial risk of forfeiture." This is true whether the amounts have actually been paid to the employee or not. And then, what is "substantial risk of forfeiture?" Honestly, I could write an entire series of blogs but on that topic solitary. Many applications of the rules under 409A hinge upon the creation and continued existence of adventure of forfeiture. For now, let's just agree that it means "the requirement of the employee to continue performing services for the employer." In addition to the immediate inclusion in income, the employee will face a twenty% excise taxation on all amounts under the deferred compensation arrangement, as well as applicable interest penalties. These are formidable penalties which any employer and employee volition certainly wish to avoid.

What is Deferred Bounty?

So, what exactly is deferred compensation? Merely put, information technology is any promise made by an employer to pay an amount to an employee in a subsequent year. I should point out that the actual definition does not use the terms "hope," "employer" or "employee," but nosotros will use them hither for simplicity. If y'all think most it, that is a very broad definition. Nearly ever aspect of an employee's compensation and benefits would seem to meet that definition. An employee's salary is a hope to pay that could result in payments made year after year. What about the amounts that an employer contributes each year to an employee's 401(k) plan that volition not exist paid out for many years to come; is that deferred bounty? What almost the typical severance language institute in an employment agreement? We could go on and on. The truth is that all of these ARE examples of deferred bounty, at least initially.

Exemptions to the Rules

This conclusion may seem a fiddling overwhelming. Fortunately, many of the typical aspects of compensation fall within designated exceptions to the deferred compensation rules. Among the exceptions are ordinary payroll, benefits paid under qualified retirement plans, the curt-term deferral exception, nigh welfare and fringe benefit plans, separation pay plans, and many stock plans. A give-and-take of caution here: the short-term deferral exception and separation pay plans are not what you lot might think they are, and in whatsoever event are quite complicated. It is safe to say that designing and operating an arrangement to fit within an exception to the 409A rules requires a great deal of experience and planning

Common Forms

Typically, the types of deferred bounty found in an employment agreement that are subject to 409A include:

signing bonuses paid over more than one year
severance payments
change of command benefits
bonus arrangements, whether incentive based or not
not-qualified plans that allow an employee to defer part of their bacon
sure equity-based arrangements
retention, or "gilded handcuff," plans

In reality, there are many forms and variations of deferred compensation plans. Sometimes the language in an employment agreement that creates deferred bounty is very long and detailed and easy to spot; other times information technology might exist just a few words innocently tucked in some obscure paragraph. As well, sometimes the deferred bounty plan or organisation does not really be within the employment agreement itself but is instead found in a divide plan certificate that is incorporated only past reference in the employment understanding. Even more problematic is when the language in an employment understanding creates deferred compensation in some grade when neither political party intended to do so. Often the near important step in dealing with deferred bounty is recognizing its being in the first place.

Complying with 409A

In one case you lot recognize that your employment understanding will include deferred bounty, what'due south next? Well, if the deferred compensation fits within an exception to 409A, then you are generally costless from the concern of complying with the regulations. Alternatively, if your deferred compensation arrangement does not fit within an exception, the design and operation must comply with all of the requirements of 409A. It is very important to note that employment agreements are often amended or rewritten over time. Be careful that futurity changes practice not change either the original exempt status of the deferred bounty or crusade an arrangement that is subject field to 409A to fall out of compliance in some way. There are many limitations regarding the power to make changes to an existing 409A covered organisation. We will discuss some of those next.

Oftentimes a client will inquire whether it is improve to design deferred compensation to fit within a 409A exception, or to just draft the language so that the organisation complies with 409A. The respond to that volition largely depend on the desired benefits to be provided. Some forms of benefits are tailor-made for the exceptions to 409A, others are nearly impossible to make exempt. It is normally not difficult to design a deferred compensation arrangement so that it initially complies with 409A. The bigger problem with a 409A plan is the long-term operation of the plan. People like to change their minds when information technology comes to coin, and 409A resists changes!

Irresolute the Agreement

2 of the key concepts under 409A are:

you cannot speed up the time or form of the payment of your deferred bounty
you lot cannot slow down, or delay, the time or form of the payment of your deferred compensation.

There are sure tailored exceptions to these basic rules, just ofttimes the rules regarding the exceptions simply will non apply or are in some fashion wholly impractical. For example, an employee is due to receive a lump sum bonus payment after v years of service. In year three, the employee wishes to delay the payment for two years and receive it in iii equal annual installment payments.

This is typical of the type of alter that clients request. In this case, it would not be possible to make the desired change. The rules regarding the modify in time and form of payment are rigid and would not allow this modification. If you made this change without knowing this, the employee could become subject field to the income inclusion, excise taxation, and interest penalties described to a higher place.

There are other noteworthy potential changes to consider every bit well. What if the employer experiences a change in its ownership? What if the employer wishes to terminate the deferred compensation portion of the employment agreement? What if the parties wish to combine the existing deferred compensation arrangement with a new and different organisation, or replace the existing organization with a new organization? These are important questions that do not usually have elementary answers. In that location are, of form, many more than potential deferred compensation speedbumps, touching on well-nigh every aspect of the creation, performance, modification, and ultimate payout of deferred compensation arrangements.

Next Steps

Information technology is hard to overstate the complexity of the 409A rules and the virtually infinite possibilities that tin can arise in designing and implementing an employment understanding that includes some form of deferred bounty. So, what should you practice?

Starting time, spend some time thinking about what yous wish to attain with your deferred compensation arrangement.
2nd, brand sure your organization is designed in a manner that best fits your needs while complying in one manner or another with the 409A rules.
Third, do non assume that y'all tin brand changes to your arrangement, no matter how subtle they appear, and make sure that any changes yous do make volition not violate the 409A rules.

Most chiefly, recognize that your employment agreement does or may contain elements of deferred compensation, and seek the advice of an experienced employee benefits lawyer.