The IRS recently issued amendments of the final regulations under Code Section 409A (while I was out of the country on vacation). The IRS last issued regulations in 2007 and 2008. These amendments make a few changes and provide clarification in several important areas, as follows:
- The Stock Rights Exception. One common sense tweak made by the regulations is to clarify that stock awards made to prospective service providers still may qualify for the important “stock rights” exception to 409A. This would apply to a service provider who is reasonably anticipated to begin providing services within 12 months after the grant date, if the person actually begins providing services during that 12-month period (or the award lapses if services do not commence by the deadline). Note that a service provider may be an employee, non-employee director, or an entity.
- Payments upon Death. In another nod to practical realities, the regulations provide that a payment will be treated as being made upon death in satisfaction of Section 409A, if the payment is made no later than December 31 of the first year following the calendar year of death. The plan need not be specifically amended to incorporate this rule. The new regulations also make the following changes related to beneficiaries:
- The payment rule for amounts payable upon the death of an employee also applies in the case of the death of a beneficiary who has become entitled to a payment due to the employee’s death.
- The death, disability and unforeseeable emergency of a beneficiary who has become entitled to a payment due to an employee’s death may be added to the plan as a potentially earlier alternative payment event for amounts previously deferred.
- A schedule of payments that has already commenced prior to a beneficiary’s death, disability or unforeseeable emergency may be accelerated upon the beneficiary’s death, disability or unforeseeable emergency.
- Acceleration of Payment or Delay. The proposed regulations would permit the acceleration of deferred compensation if the acceleration is reasonably necessary to comply with a bona fide foreign ethics or conflicts of interest law, or with Federal debt collection laws. The regulations also extend to short-term deferrals the ability to delay payments that would otherwise violate Federal securities laws or other applicable laws.
- Separation Pay. The new regulations clarify the application of the separation pay exemption (that is, the ability to pay up to two times the 401(a)(17) limit within two years) to a service provider who was not providing services to the service recipient during the previous year.
- Restricted Stock Cannot be Distributed as a Substitute for Deferred Compensation. The new regulations clarify that an employer or plan cannot use unvested property (such as restricted shares) to satisfy a distribution obligation or deadline under a deferred compensation plan.
- Income Inclusion Rules. The new regulations clarifying that an unvested amount will be considered vested in any year in which there is a change in a time or form of payment provision not otherwise permitted. Previously, there was some thought that the so-called “income inclusion rules” IRS promulgated in 2008, would allow an employer/employee to change the time and form of payment of deferred amounts that had not yet unvested.
Although the new regulations are only proposed, employers, employees, and practitioners generally can rely on them immediately.