Under Section 409A of the Internal Revenue Code, if deferred compensation is paid to a specified employee of a publicly traded company on account of separation from service, the commencement of the payment must be delayed for six months, except in the event of death. The Section 409A regulations set forth the requirements for determining which employees are considered specified employees for this purpose. In general, the list of specified employees is determined on an annual basis on the public company’s “specified employee identification date” (December 31, by default), and that designation takes effect on the next “specified employee effective date” (April 1, by default) and continues for 12 months (i.e., until March 31 of the following year, by default).
If a corporate transaction occurs during the applicable 12-month period for which the specified employee group has been set, the successor(s) are required to determine how specified employees will be identified following the transaction during a transition period. The following describes the transition rules applicable to several different types of corporate transactions.
Where two or more separate public companies become a single public company, the combined company’s next specified employee identification date and specified employee effective date following the corporate transaction are the specified employee identification date and specified employee effective date that the “acquiring service recipient” would have been required to use had the transaction not taken place.
- In the case of a merger, the acquiring service recipient is the service recipient that included the surviving corporation in its control group.
- In the case of a stock acquisition, the acquiring service recipient is the service recipient that included the corporation that acquired the relevant stock in its control group.
- In all other cases, the acquiring service recipient is determined on the basis of all of the facts and circumstances.
In the interim period between the transaction and the next specified employee effective date, the list of specified employees of the surviving public company consists of the 50 most highly compensated service providers appearing on the combined lists in effect as of the date of the transaction. Alternatively, the combined company may use any other reasonable method to determine its specified employees immediately after the transaction, provided that the alternative method is adopted not later than 90 days after the merger and applied prospectively from the date of adoption. This last part is important since there is a potential planning opportunity in connection with a transaction to adopt an alternative method effective as of the consummation of the change in control, but it would have to be adopted no later than immediately prior to the occurrence of the change in control.
Where a public company and a private company become a single public company, the combined company’s next specified employee identification date and specified employee effective date following the corporate transaction are the specified employee identification date and specified employee effective date that the public predecessor company would have been required to use had the transaction not taken place.
In the interim period between the transaction and the next specified employee effective date, the specified employees of the original company effective as of immediately before the transaction continue to be the specified employees of the combined company. Service providers of the private predecessor company will not become specified employees until the next specified employee effective date.
Note that where a transaction involving an originally public company results in no entity within the controlled group being public, the six-month delay no longer applies following the company becoming private, and no list of specified employees is necessary.
It is important that these rules be considered any time there is a corporate transaction, since individuals who may have been specified employees immediately prior to the transaction may no longer be specified employees immediately following the transaction. This is especially relevant for individuals whose employment terminates during the remainder of the applicable 12-month period as deferred compensation payments may not need to be delayed for six months.