Does the fact that a taxpayer, by agreeing to defer receiving compensation in a year, earned the right to a 25% employer match in three years conditioned on the employee continuing to provide substantial services until that date mean the taxpayer now had a “substantial risk of forfeiture”? The question arises when looking at whether, under Reg. §1.409A-1(d)(1), this is an allowable deferral of income under IRC §409A.
In Chief Counsel Advice 201645012 the issue was considered.
Reg. §1.409A-1(d)(1) provides, in part:
An amount will not be considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the present value of the amount subject to a substantial risk of forfeiture (disregarding, in determining the present value, the risk of forfeiture) is materially greater than the present value of the amount the recipient otherwise could have elected to receive absent such risk of forfeiture.
In this case, the facts were outlined as follows:
On November 1, 2014, an employee entered into an agreement to defer $15,000 of the employee's salary that would otherwise have been paid during 2015, with payment of the deferred amount to be made as a lump-sum payment on January 1, 2018, but only if the employee continues to provide substantial future services until December 31, 2017. Under the agreement the employee's salary is reduced by $600 each biweekly pay period (so 26 x $600 or $15,600) and the employer credits matching amounts to the employee's deferred compensation account of 25% of each salary reduction (so 26 x ($600 / 4) or $3,900) for a total amount deferred of $19,500. The matching amounts are credited each time a salary reduction amount is credited, which is the time the salary reduction amount would otherwise be paid as salary.
So, did the IRS judge this 25% “sweetener” sufficient to create the substantial risk of forfeiture? Because, as was noted above, the general rule is that if you volunteer to not take salary today that doesn’t create a substantial risk of forfeiture unless you show you will get a “materially greater” amount, measured on a present value basis in the future.
In this case, the memo concludes this 25% addition with the 3-year delay does create a materially greater amount. As the memo notes:
Generally, under Treas. Reg. § 1.409A-1(d), the addition of a risk of forfeiture is disregarded. However, the addition of a substantial risk of forfeiture is respected if the present value of the amount subject to the substantial risk of forfeiture is "materially greater" than the present value of the amount the service provider otherwise could have elected to receive absent such risk of forfeiture. Under the facts here, the present value of the amount deferred by the employee is 25% greater than the amount the employee otherwise could have received absent the addition of the substantial risk of forfeiture. A 25% increase in the present value of the amount a service provider could have received absent the risk of forfeiture is a material increase. Accordingly, the combined deferred amount of 2015 salary ($15,600) plus the deferred amount of the employer's matching contribution ($3,900) is subject to a substantial risk of forfeiture for purposes of section 409A until December 31, 2017.