Employees, particularly executives, look closely at the full benefits package they are offered upon employment. Benefits, both health and retirement plans, are often major factors in choosing between different job offers for top tier candidates. Employers are expected to operate these plans in a reasonable fashion, and when they don’t they often find themselves subject to lawsuits alleging breach of fiduciary duty.

409A Excise Taxes

Section 409A of the Internal Revenue Code regulates nonqualified deferred compensation (NQDC) or compensation earned in one year and paid in a subsequent year. Deferred compensation may include deferred pay that is not qualified under ERISA (i.e., a pension or 401(k) plan). It includess plans for executives that allow for compensation deferral in excess of those allowed under qualified plans. Section 409A imposes a 20% excise tax when certain operational rules of the provision are violated.

The rules that this NQDC must comply with include timing rules around deferrals and distributions, as well as exceptions for certain common types of NQDC. Section 409A covers not only cash distributions, but also equity payments and other types of income that are made in the years after they are earned. Failure to follow the detailed rules of 409A means employees, in this case executives, are subject to the excise tax. In essence, if the employer fails to comply with the regulations, the burden falls on the employee.

Wilson v. Safelite Group, Inc.

A recent case argued in the Sixth Circuit concerned the President and CEO of Safelite Group, Inc. Dan Wilson elected to defer over $9 million in compensation and the IRS determined that some of these elections did not comply with 409A and were therefore subject to the 20% tax. In the complaint, Wilson alleges that because of these defects, in addition to lost investment gains he owed the IRS over $2.6 million in taxes. Wilson brought the action seeking damages on the basis of breach of contract and negligent misrepresentation. He alleged that Safelite’s failure to comply with Section 409A was a breach of contract and that Safelite was negligent in representing to him that his elections were made correctly.

Safelite argued that Wilson’s state law claims were preempted by ERISA since they pertained to an employee benefit pension plan. The district court granted Safelite’s motion for summary judgment on this point and the circuit court affirmed. If Wilson had pursued the claims under ERISA and claimed breach of fiduciary duty, he would have first been required to prove that the plan in question was not a “top-hat” plan, a plan designed to defer compensation only for a select group of managers. Top-hat plans are specifically carved out from ERISA fiduciary obligation provisions. Had Wilson succeeded in his claims, his previous employer, Safelite, would have been responsible for returning to him his losses due to the 20% excise tax.