EB Buzz: Why Do We Have to Worry About 409A, Our Incentive Plan Always Pays Out on Vesting?
If an incentive award, such as an RSU, is structured such that it is paid out within two-and-a-half months following the year the service and performance criteria are met (when the award vests), the award will often qualify under Section 409A's "short-term deferral rule" and therefore remain exempt from the onerous requirements of Section 409A. One of the most common issues that we see in our practice, however, is employers who fail to take into account the Section 409A impact of providing accelerated vesting upon an employee's retirement. If an award accelerates vesting on retirement, the award could be considered vested for Section 409A purposes before completion of the general service or performance criteria. Why is that? The award will be considered vested at the time the retirement eligible executive could voluntarily walk out the door and still receive payment. Thus, if an award is granted to an executive who is "retirement eligible" at the time of grant, the award would be vested at that time.
What does that mean? Unless the award is paid out within two-and-a-half months following the year the executive becomes retirement eligible, the award will provide deferred compensation! In addition, FICA taxes could apply earlier than anticipated, since FICA often applies to deferred compensation at the time of vesting. An incentive award of property, such as restricted stock, that allows accelerated vesting on retirement could also trigger income taxation when the individual becomes "retirement eligible." If your incentive plan contains accelerated vesting on retirement, careful scrutiny is required.
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