As a result, nearly every compensation arrangement must be examined to determine if it is potentially subject to Section 409A. Rather, Section 409A applies to both private and public companies and to nearly all service providers, including executives and other employees, nonemployee directors, and most independent contractors. In addition, and unlike some other sections of the Internal Revenue Code, Section 409A is not limited to public companies or certain high-ranking or highly paid executives. Section 409A covers not only traditional deferred compensation arrangements involving the deferral of salaries and bonuses, but also many employment, change in control, and severance arrangements, awards of phantom stock, deferred shares and restricted stock units, and bonus payments. This happens because Section 409A applies to a wide variety of arrangements that may not be thought of as providing for deferred compensation. One reason for many inadvertent violations of Section 409A is the failure to identify that the arrangement at issue is subject to its requirements. The following sets forth some of the main Section 409A compliance issues frequently encountered in practice. This makes it even more critical that companies and their advisors place extra emphasis on developing procedures for identifying potential Section 409A risks and ensuring compliance with Section 409A rules, to avoid the taxes and penalties that can result from even innocent mistakes. While many companies have gained significant familiarity with Section 409A over the past 10 years, the 2014 announcement by the Internal Revenue Service that it has begun auditing Section 409A arrangements has put enhanced pressure on the need to ensure that all arrangements are in compliance with Section 409A. Violations of Section 409A, whether documentary or operational, can result in significant monetary penalties for the employees and executives who are parties to these arrangements. Section 409A contains a comprehensive set of requirements that govern the broadly defined universe of so-called nonqualified deferred compensation arrangements. This article highlights some of the key pitfalls and other traps for the unwary that can cause unintentional failures and result in unintended consequences and penalties under these two sections.
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#IRC 409A CODE#
Two sections of the Internal Revenue Code that continue to challenge both companies and their advisors in creating compensation arrangements are Section 409A, which governs the treatment of nonqualified deferred compensation arrangements, and Section 162(m), which limits the annual compensation deduction that a public company may take with respect to certain of its executive officers. These arrangements must be structured and maintained in a way that not only meets the company’s desired business needs, but also complies with the complex and often counterintuitive rules contained in various applicable sections of the Internal Revenue Code. The early part of the year is a time during which many companies and their compensation committees, management teams, and outside advisors are focused on both developing new compensation arrangements and reviewing existing compensation arrangements for executives and other employees. Diversity and Inclusion in the Profession.Recent Developments in Business and Corporate Litigation.Business Regulation & Regulated Industries.Business Litigation & Dispute Resolution.Our 409(A)/fair value analyses have been thoroughly reviewed by the Big Four accounting firms, and have complied with each accounting firms’ audit testing regimen. Such valuations are also accepted by all major audit firms for fair value financial reporting purposes under FASB ASC 718 and 505-50.
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Since 2005, Cogent Valuation has performed over 500 common stock valuations to establish the fair market value of common stock in connection with the issuance of compensatory stock options. This led to the establishment of Cogent Valuation as one of the preeminent appraisal firms in this rapidly emerging area of valuation. Immediately after publication of the proposed regulations, Cogent Valuation worked with the leading employee benefits attorneys and advisors to educate companies and their equity sponsors about the implications of the proposed regulations. The proposed regulations shifted the burden of proof to the IRS to demonstrate that the option exercise price is below the fair market value of the common stock when a company obtains an independent appraisal. In 2005, the IRS issued proposed regulations under IRC Section 409(A) that, for tax purposes, regulates the treatment of “nonqualified deferred compensation” including the issuance of compensatory stock options.