3551 / What factors are important in determining whether a Section 409A substantial risk of forfeiture exists if the individual has significant voting power in the entity paying the nonqualified deferred compensation?

The employee-shareholders’ relationship to the other shareholders and the extent of their control and potential control over the decision, and possible loss of control of the employee;

The position of the employee at the employer and the extent to which the employee-shareholder is subordinate to the other employees, especially other employee shareholders;

The relationship of the employee to the employer’s officers and directors (i.e., whether they are family);

The person or persons who would approve the employee’s discharge; and

The past actions of the employer in enforcing any restrictions on employees, especially employee-shareholders.¹

Of course, this means that majority or controlling shareholders in for-profit entities may find it difficult, if not impossible, to establish that there is a 409A SROF.² The failure to establish a 409A SROF in such situations apparently does not mean that a nonqualified deferred compensation plan cannot be created for such an employee-shareholder, or so it has been thought to date. This is because the 409A SROF definition is used for a special purpose under Section 409A, rather than to establish whether there is current taxation. Except in the case of 457(f) plans, based on its separate definition of substantial risk of forfeiture under the proposed regulations, the 409A definition is used to determine access to the short term deferral exception that allows the plan to entirely avoid compliance with the so-called 409A “detail” requirements. If a plan has no 409A SROF and cannot claim the short term deferral exception under the final 409A regulations, it must comply with all the form and operational requirements of Section 409A. Because Section 409A is additive income tax law, the plan would then also have to comply with the other applicable pre-409A IRC income tax sections (for example, Section 61/451 substantial limitation or risk of forfeiture requirements in the case of an unfunded deferred compensation plan) in order to achieve income tax deferral for the plan.

1. See generally Treas. Reg. § 1.409A-1(d).

2. It is less clear how these factors would be applied to 457(f) plans for employees in tax-exempt organizations that have no shareholders.