Write This Down … Participants Have to Follow the Plan’s Beneficiary Designation Procedures

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by Elizabeth Nedrow

The principles governing how ERISA plans determine a participant’s beneficiary haven’t changed much since the country singer George Strait sang “Write this down” in 1999. In short, the participant has to write it down … on the forms and following the procedures established by the plan.

Recently we’ve seen several examples of family members of deceased employees who are surprised by the plan’s record of who was designated as beneficiary. They have tried to argue that the deceased employee’s will should be allowed to designate a beneficiary, or that the plan should look to state laws regarding estates. However, the courts have clearly established that those extraneous sources do not affect the plan’s process. (Most famous are the U.S. Supreme Court’s 2001 Egelhoff decision, and its 2009 Kennedy v. DuPont decision.) Read more

What About Now? – 83(b) Tax Rules Applicable to Early Exercise of Stock Options

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by Bret F. Busacker

Some years ago, I published an article on the importance of understanding the tax rules applicable to equity grants, with a particular focus on being aware of the timing rules for filing an 83(b) election and the importance of making timely elections (available here).

A reader of that 83(b) article approached me recently looking for guidance on when an individual may make an 83(b) election with respect to a stock option.  The question was simple – do you make the 83(b) election within 30 days of the grant of the option or within 30 days of exercise of the option? Read more

Romeo Finds a Streetlight, Steps Out of the Shade, and Says Something Like, LLC Compensation, How About It?

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Tips for Structuring LLC Incentives

by John Ludlum

On a frequent question of how to structure incentives for LLC entities, we find that many of our clients decide to use profits interests for only a few key employees (making them partners subject to partnership taxation) and a cash-based bonus plan for the majority of the employees. The issue of being treated as a partner involves receiving K-1 income, not W-2, so there is no withholding and the partners must deal with self-employment taxes, quarterly estimated taxes, and items like employer contributions to health plan premiums are taxable. But profits interests can receive capital gains treatment. Read more

I’ll Be a Child of the Wind…At Least Until I Get a Retroactive 409A Valuation

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by John Ludlum

Most private companies are now well aware that the valuation methods under Code Section 409A are for the purpose of granting Section 409A exempt “stock rights” which include employee stock options with a requirement, among others, that the options be granted at no less than fair market value on the date of grant. It has become a best practice to obtain a valuation from an outside independent valuation firm as soon as the company has sufficient funds as doing so allows the company to obtain a regulatory presumption that the valuation is reasonable providing a more certain tax compliance position. This makes sense given the severe penalties applicable to a “discount option” under Section 409A.

However, we still see some companies struggle with the timing of a Section 409A valuation where the valuation is received by the company on one date but has an earlier effective date. For Section 409A, if options were granted in the period before the valuation was received but after the valuation effective date, and if these options have an exercise price lower than the valuation price, these options will be out of compliance with the Section 409A fair market value on the date of grant requirement. For this reason, we recommend that no awards are granted while a valuation is pending. Read more

Oh, Making Bad Decisions…or Not Really Considering the Long Game for Stock Options

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by John Ludlum

We often encounter questions relating to the fair market value of a private company for granting stock options where the company has experienced an event, such as receiving a signed term sheet, which almost certainly will result in a higher fair market value when the company had intended to grant options at an earlier price but had not gotten the grants completed.  Usually, the questions focus on when the company has to consider the business event and whether it would be possible to quickly make the awards at the price that was promised.  Almost always, this is short term thinking that could turn out to be long term expensive in a risky tax position. Read more

One Step Forward, Two Steps Back…Dreams of Perfect Equity Outcomes Can Affect Your Judgement

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Notes on stock options, restricted stock, private company valuations, Code Section 409A.

by John Ludlum

There are a number of well-known stories of equity compensation, often focusing on the tax outcomes for awards where fortunate optionees did everything right.  Some of these stories are actual outcomes, such as when ISOs that were issued early in a company’s history at a very low strike price, were then exercised and held for the required holding periods (two years from grant and one year from exercise), and finally were sold at a greatly appreciated price with the entire gain getting long term capital gains treatment.  While such great outcomes do happen, in most cases optionees don’t meet the holding periods because they don’t foresee the liquidity exit or don’t have the funds to exercise and the resulting disqualifying dispositions are subject to ordinary income rate taxation.  We note that even ordinary income rate taxes are a good thing because they apply to income, which is a good problem to have.  But the desire to optimize the tax treatment can lead some optionees to take risky business decisions like exercising options early with promissory notes or exercising options for shares in a company with an uncertain future. If an executive buys restricted stock with a full recourse promissory note and the value of the shares declines, considering that these promissory notes usually accelerate on termination of employment, the potential for debt forgiveness income if the executive leaves or the potential for company claims to recover the balance of the note can serve as unwanted retention incentives.   Read more

Trouble Ahead, Trouble Behind, and You Know Rule 701 Just Crossed My Mind

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By Benjamin Gibbons

This week we’re changing the station on the Benefits Dial to remind private companies who are granting securities to their employees of the importance of complying with Rule 701.  Rule 701 of the Securities Act of 1933 provides a federal securities registration exemption for privately-held companies who are granting securities (including stock options) through written compensatory benefit plans (such as omnibus equity incentive plans) to their employees and contractors (natural persons only).  Absent Rule 701, such securities would generally need to be registered with the Securities and Exchange Commission (SEC).

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In Our Shangri-La – Terms for Code Section 280G Golden Parachute Taxes in Employment Agreements

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by John Ludlum

Even in the current economic and business disruptions caused by COVID-19, we are still seeing key executive hiring go forward.  Executive employment agreements contain many tax terms, and while some are largely boilerplate (proper and helpful nevertheless), some tax provisions can have a major impact on how the executive is compensated under the agreement.  One such tax provision that often goes “under the radar” relates to the “golden parachute” tax under Code Section 280G.

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Relief . . . Just a Little Bit – IRS Notice 2020-23: Limited Extensions of Form 5500

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By Kevin Selzer and Lyn Domenick

In the midst of everything going on, we wanted to point out a few “under the radar” implications of IRS Notice 2020-23.  The Notice, issued on April 9th, provides that tax-related deadlines that fall between April 1, 2020 and July 14, 2020 (the “delay period”) are automatically extended to July 15, 2020. 

Delayed 5500s.  Most plan sponsors hoping for Form 5500 relief will have to wait for additional guidance since only a small group of plans have Form 5500 deadlines fall during the delay period.  For example, the regular Form 5500 due date for calendar year plans (July 31st) falls just outside of the delay period.  We note that the DOL has authority under the CARES Act to provide additional Form 5500 relief.

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I Come From Down in the Valley, Where the Options Are Now Underwater: Companies Look to Modify Incentives as Declining Markets Hurt Employee Stock Options

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by John Ludlum

This is the 3rd major economic upheaval we have had in 20 some years, and once again we have a climate of widespread business uncertainty, employment instability, and economic suffering.  Most of our clients have experienced a decline in company stock values, but we are expecting that as the uncertain business environment stabilizes, companies will start to consider changes to their equity awards to maintain incentives because many stock options are “underwater” where the exercise price is higher than the current fair market value.  There are several approaches that companies can use to either reprice or exchange underwater stock options, and each has advantages and disadvantages.

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