Annual Incentive Bonus

409A Guidelines on Payment of Annual Incentive Bonus

Fulcrum Partners Deferred Compensation News

From our friends at Winston & Strawn LLP, and attorney Michael S. Melbinger:

 

Payment of Annual Incentive Bonus by March 15

Now that the madness of Code Section 409A has subsided in the deepest, darkest corners of the mind and new generations are coming into the compensation and legal professions whose minds were not infected with the madness, I am beginning to get questions (calendar year companies) about why their plans and agreements provide for the payment of annual incentive bonuses by March 15 of the calendar year following the year the bonus is earned (or 2½ months after the end of the year). The short answer is: In order to qualify these payment amounts as short-term deferrals (and not deferred compensation) under Section 409A. Payments to an employee within 2½ months after the end of the year in which the payment amount is no longer subject to a substantial risk of forfeiture (vested) qualify as short-term deferrals.

But what happens if the company does not actually make the payment by March 15 (e.g., because performance results could not be finalized by then)? If the plan or agreement is well drafted or another special rule (described below) applies, a payment of annual incentive after March 15 will not violate 409A. If the plan or agreement providing for the annual incentive payment requires payment by March 15 following the year the bonus is earned, as long as the annual incentive payment is actually made before the end of the calendar year following the calendar year in which it was earned. Why? Because, although the payment was later than March 15, it still will be taxable to the recipient in the same calendar year. There is no deferral of income into a later tax year. Importantly, if the plan or agreement did not require payment of the annual incentive bonus by March 15 following the year in which it was earned, and the payment is actually made later than March 15, there would be a violation of 409A. The language in the plan or agreement makes all the difference.*

What about that other special rule, Mike? Well, it is not really a “special rule,” just a closer reading of the actual rule. Regulations under Section 409A provide that “the applicable 2 ½ month period is the period ending on the later of the 15th day of the third month following the end of the service provider’s first taxable year in which the right to the payment is no longer subject to a substantial risk of forfeiture…” Some plans and agreements require the employee/bonus recipient to remain employed until the day the annual incentive is actually paid. In these cases, the employee/service provider’s right to the payment subject to a substantial risk of forfeiture right up to the day of the payment. Thus, the 2 ½ month period does not expire until the calendar year after the year in which it was paid. (Other issues can arise with a requirement to remain employed until the date of payment, but that is a subject for a different blog.)

*If the plan or agreement does not explicitly provide for payment within 2½ months after the end of the year in which the amount was earned, but the company actually pays the amount within that period, there is no violation of 409A.

 

Securities offered through Valmark Securities, Inc. Member FINRASIPC, 130 Springside Drive, Akron, OH 44333-2431, Tel: 1-800-765-5201. Investment Advisory Services offered through Valmark Advisers, Inc., which is a SEC Registered Investment Advisor. Fulcrum Partners LLC is a separate entity from Valmark Securities, Inc. and Valmark Advisers, Inc.