Corporate Finance Law Blog : Corporate Finance Lawyer & Attorney : Davis Wright Tremaine Law Firm

I was recently asked if a company had to obtain an independent, third party appraisal in order to grant stock options in compliance with Internal Revenue Code Section 409A, which generally requires that stock options be granted at fair market value or be subject to a 20% excise tax.  The answer is no, a third party appraisal is not required. 

"The final regulations adopt the provisions in the proposed regulations relating to the valuation of stock not readily tradable on an established securities market, subject to the modifications discussed in this section III.C.4.c. Accordingly, a valuation of stock based upon a reasonable application of a reasonable valuation method is treated as reflecting the fair market value of the stock. To meet this standard, it is not necessary that a taxpayer demonstrate that the value was determined by an independent appraiser. Where the taxpayer can otherwise demonstrate that the valuation was determined by the reasonable application of a reasonable valuation method, the standard will be met."

See the Final Regulations. That is not to say that an independent appraisal may not be advisable or worthwhile.  In fact, if done in the manner specified in the final regulations, a valuation will create a presumption that the valuation of the stock reflects the fair market value of the stock, which presumption is only rebuttable by a showing that the valuation is grossly unreasonably.

"The final regulations adopt a presumption in specified circumstances that, for purposes of section 409A, a valuation of stock reflects the fair market value of the stock, rebuttable only by a showing that the valuation is grossly unreasonable. The presumption applies where the valuation is based upon an independent appraisal, a generally applicable repurchase formula (applicable for both compensatory and noncompensatory purposes) that would be treated as fair market value under section 83, or, in the case of illiquid stock of a start-up corporation, a valuation by a qualified individual or individuals applied at a time that the corporation did not otherwise anticipate a change in control event or public offering of the stock."

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Credit to TaxProf Blog.

To read the story about the application of Section 409A to typical NFL player contracts, which appeared in The National Football Post, read here.

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 "Notice 2008-115 provides guidance to employers and payers on their reporting and wage withholding requirements for calendar year 2008 with respect to deferrals of compensation and amounts includible in gross income under section 409A of the Internal Revenue Code.  In addition, this notice provides guidance to service providers on their income tax reporting and tax payment requirements with respect to amounts includible in gross income under section 409A. 
  
Notice 2008-115 will appear in IRB 2008-52 , dated December 29, 2008."

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"SUMMARY: This document contains proposed regulations on the calculation of amounts includible in income under section 409A(a) and the additional taxes imposed by such section with respect to service providers participating in certain nonqualified deferred compensation plans. The regulations would affect such service providers and the service recipients for whom the service providers provide services. This document also provides a notice of public hearing on these proposed regulations."

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"Notice 2008-113 gives taxpayers the ability to correct certain operational failures to comply with section 409A of the Internal Revenue Code, or to limit the amount of additional taxes due to the failure to comply with section 409A. Section 409A provides rules governing the taxation of nonqualified deferred compensation plans. The notice expands upon and clarifies the program announced last year in Notice 2007-100, 2007-52 IRB 1243. Notice 2008-113 will appear in IRB 2008-51, dated December 22, 2008."  

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Published by DWT's Employee Benefits Group

As noted in prior DWT advisory bulletins, the IRS has repeatedly extended the deadline for amending plan documents to comply with Section 409A. Although most employers have already completed any needed plan amendments, or are well on their way to completion, there is still time (but just barely) for those who may have delayed taking action. In short, if you have put off your 409A compliance until the last minute, it is now the last minute.

For a summary of steps that should be taken, see our prior advisory bulletin. If you need assistance, contact one the attorneys below without delay. 

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Employers have until Dec. 31, 2008 to amend deferred compensation plans

By Holly Wylam, Stuart Harris, Jeff Belfiglio, Sarah Bhagwandin, Jason Froggatt, Greg Hitchcock and
Anne Northrup

In response to the requests of a nationwide coalition of law firms, the IRS has issued Notice 2007-86, which extends until Dec. 31, 2008 the deadline for complete compliance with Internal Revenue Code Section 409A. The Notice also reiterates issues that employers should consider in advance of the new deadline. This article outlines the effect of Notice 2007-86 and recommends how to prepare for the 2008 deadline.

The Notice is welcome news for legal practitioners and employers who have been struggling to identify all affected nonqualified deferred compensation plans and bring them into operational compliance with Code Section 409A by the end of 2007 (the prior deadline). As described in prior DWT advisories in June and September, Code Section 409A imposes a complex set of requirements on nonqualified deferred compensation plans. The new law also defined the term “nonqualified deferred compensation plan” very broadly to include programs ranging from stock option plans to bonus commitments in individual employment agreements. The penalty for noncompliance is steep: all vested amounts deferred under the “plan,” plus any earnings, become immediately includable in the participant’s taxable income, along with a 20 percent penalty tax. Continue reading...

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The IRS has issued interim guidance on reporting and wage withholding requirements for amounts includible in gross income under Section 409A in year 2007.  Notice 2007-89 will appear in IRB 2007-46, dated November 13, 2007.

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The IRS has issued Notice 2007-86, which provides additional transition relief under Section 409A.  Notice 2007-86 will appear in IRB 2007-46 on November 13, 2007.  In general, the additional relief extends until December 31, 2008, the previous transition relief that was scheduled to expire at the end of this year.

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96 law firms have written another letter to the IRS asking for more time on 409A compliance, even after the IRS responded favorably (at least in some respects) to the first request.

Again, this demonstrates the complexity of this area.  We are happy to assist you with compliance.

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By Stuart Harris

In newly issued Notice 2007-78 (see also the press release), the IRS sets Dec. 31, 2008 as the deadline for amending documents to comply with Section 409A; however, the extended deadline does not apply to a plan’s obligation to designate, in writing, the timing and form of payment of current benefits, which for existing deferred compensation amounts must be done no later than Dec. 31, 2007. Similarly, the Notice does not extend the requirement to operationally comply with the final 409A regulations beginning Jan. 1, 2008. Continue reading...

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Yesterday, September 10, 2007, the Treasury Department and the IRS announced that taxpayers will have until December 31, 2008, to bring their documents into compliance with the final regulations under Section 409A of the Internal Revenue Code.  Previously the deadline was December 31, 2007.  In Notice 2007-78, the Treasury and IRS also announced that they anticipate issuing guidance containing a limited voluntary compliance program that will permit the correction of certain unintentional, operational violations of Section 409A.  IRS Notice 2007-78 does not, however, extend the January 1, 2008, effective date of the final regulations.  We previously blogged about 92 large law firms requesting this exact relief.  Final Section 409A regulations were issued in April of this year.  

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Demonstrating the complexity of Section 409A compliance, 92 law firms sent the IRS a letter this week asking it to extend the deadline for amendment to deferred compensation plans to comply with Section 409A until December 31, 2008 (as opposed to the end of the current year).  The letter emphasizes that the failure to comply or the consequences of errors in compliance will result in significant tax liabilities to the individuals involved.  The letter also reiterates the ABA's request to develop a voluntary correction program for inadvertent Section 409A violations.

The final Section 409A regulations  are long (397 pages) and complex.  If you need help reviewing your compensation arrangements, we are happy to assist. 

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Demonstrating the depth and scope of the reach of Section 409A today, the IRS reassured teachers and other school employees that they need not worry about the draconian Section 409A consequences if they are paid over a 12 month period (as opposed to only during the school year). 

The concern was that "when teachers and other employees are given an annualization election – that is, they are allowed to choose between being paid only during the school year and being paid over a 12-month period – and they choose the 12-month period, they are deferring part of their income from one year to the next. For instance, a teacher who chooses to get paid over a 12-month period, running from August of one year through July of the next year, rather than over the August to May school year, falls under this law."

"The IRS clarified that the new rules do not require school districts to offer teachers an annualization election. Thus, school districts that have not been offering teachers this election are not required to start." 

You can access Frequently Asked Questions for more information.

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On April 11, 2007, the IRS issued the final Section 409A regulations.

The IRS issued preliminary guidance on Section 409A in Notice 2005-1 on January 10, 2005.  The final regulations for the most part supersede Notice 2005-1, but in some respect the final regulations refer you back to Notice 2005-1.

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