Employment Contracts and Severance Agreements Should be Reviewed and May Need to be Amended by December 31 to Comply with Section 409A

by Saul Ewing Arnstein & Lehr LLP
Contact

Summary

Severance agreements and employment contracts with release of claims provisions may violate 409A of the Internal Revenue Code. Bad release provisions may be fixed, penalty-free, before December 31, 2012.

Most severance agreements provide for a review period (e.g., 21 or 45 days) and a revocation period (e.g., 7 days). Many employment contracts and other forms of deferred compensation condition payment on the execution of a release of claims, covenant not to compete or non-solicitation agreement. In 2010, the IRS issued a notice1 which provides that such a review and revocation period or the requirement of such execution may violate Code Section 409A because the employee can control the year in which payment is made. The IRS did, however, provide a method of correction2 which, if taken before the end of this year, will allow an employee to avoid adverse tax consequences.

The Problem

In employment or severance agreements subject to 409A where payment is triggered by a separation from service, payment must be made either on a fixed date or within a period not to exceed 90 days and the employee must not have the right to designate the year of payment.

Severance agreements under which employees have a review and revocation period may allow employees to control the year in which they receive payment. For example, if an employee terminates mid-December and has a 21-day review period and a 7-day revocation period, the employee could decide to sign the release in December or January of the next year. Similarly, if the severance agreement is offered in the context of a group reduction in force, which requires the execution of a release within 45 days of separation in order to receive payment, the employee could sign the release in one year or the next. An executive employment agreement that is negotiated up front might provide for payment following the execution of a release within 60 days of termination; again, the executive would have the ability to decide when to sign the release.

The Correction

The IRS provided a method for employers to correct agreements that run afoul of these rules. The employer must amend the agreements on or before December 31, 2012 to remove the ability of the employee to determine the year of payment. The method of correction depends on whether the agreement provides for payment within a designated period of time:

If the agreement provides for payment within a designated period of time following termination (e.g., within 60 days subject to the employee signing the release), the agreement must be amended to provide for either:

  • Payment on the last day of the designated period (e.g., 60th day following termination), or
  • Payment in the following year if the designated period ends in the following year (e.g., within 60 days following termination, but in all events payable in the second year).

If the agreement does not provide for payment within a designated period of time following termination, the agreement must be amended to provide either:

  • Payment on a fixed date either 60 or 90 days following a separation from service provided that the employee has executed the release; or
  • Payment during a period (not to exceed 90 days from the separation from service) with the condition that if the period ends in the following year, the payment will be made in the following year, regardless of when the release is executed.

Specific rules apply if payments were triggered between March 31, 2011 and December 31, 2012 that involve payment of penalties.

After December 31, 2012

Penalty-free (no dollar cost) correction will only be available if the payment event (e.g., termination) has not yet occurred and certain notification requirements are satisfied. Specifically, the employee must be provided notice of the correction and attach a statement to his or her tax return. There is no requirement for employer reporting under this correction.

Act Now

The time to act is now. To avoid the risk of potential penalties and avoid the need to comply with employee notification, employers should review all employment, change in control and severance agreements that condition payment on employee action, and amend them to correct faulty provisions.

Note

These provisions do not apply unless there is deferred compensation that is subject to 409A. If the agreement provides severance pay upon involuntary termination, the payment does not exceed two times the lesser of the employee’s annual compensation or Code Section 401(a)(17) limit ($250,000 in 2012), and payments are completed by the end of the second calendar year following the year in which the separation from service occurs, then Section 409A does not apply.

Please contact the authors with any questions regarding this development.

1. Notice 2010-6

2. Notice 2010-80

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Saul Ewing Arnstein & Lehr LLP | Attorney Advertising

Written by:

Saul Ewing Arnstein & Lehr LLP
Contact
more
less

Saul Ewing Arnstein & Lehr LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.