On June 10, the IRS issued a revenue ruling confirming that a nonstatutory stock option or stock-settled stock appreciation right (SSAR) that is exempt from Section 409A is also exempt from Section 457A.
As most readers will know, Section 457A is a special regime for certain “tax-indifferent” entities (entities such as corporations located in offshore tax havens or domestic partnerships substantially owned by tax-exempt organizations) that generally subjects such entities’ nonqualified deferred compensation arrangements to tax on vesting, rather than on payment as under Section 409A.
Previously, despite guidance in Notice 2009-8 exempting 409A-exempt stock options and SSARs from Section 457A, the IRS’s position had been in some doubt, given language in Section 457A that exempts 409A-exempt stock rights other than any “right to compensation based on the appreciation in value of a specified number of equity units of the service recipient.” It wasn’t entirely clear how the “other-than” language in the statute and the IRS’s guidance in Notice 2009-8 could be squared, since the “other than” language appears to refer to all stock appreciation rights. The revenue ruling addresses this apparent discrepancy by citing to legislative history indicating that the “other than” language was specifically not intended to apply to stock options, and holding that if stock options are exempt, SSARs should also be exempt, given the economic equivalence between net-settled stock options and SSARs.
Thus, the only difference in coverage of stock rights between Section 409A and Section 457A is with respect to stock appreciation rights that are or may be settled in cash (CSARs), which are subject to Section 457A but may still be exempt from Section 409A if certain conditions (FMV exercise price, etc.) are met.
Some may recall that the IRS originally intended to cover CSARs under Section 409A as well. Notice 2005-1 created an exemption only for SSARs of publicly traded companies, based on concern that CSARs or private company SSARs could resemble other nonqualified deferred compensation arrangements that were not exempt. Eventually, however, the IRS recongized that all SARs, public and private, cash and stock settled, were functionally equivalent and exempted them all in the final 409A regulations. Given they produce identical payouts, it’s still unclear as a policy matter why CSARs and SSARs should be treated differently under Section 457A, but the statutory language is what it is, and the revenue ruling does at least offer a welcome confirmation of the IRS’s guidance from 2009.