Whether you are an employer or employee, we can prepare and negotiate your employment agreements, non-competition agreements, and retention agreements. Careful attention needs to be paid to the drafting of provisions that set forth the duties of the employee, the grounds for termination (by the employer for cause, by the employer or employee without cause, and by the employee for good reason), the amount of the severance payments to be paid to the employee, and the scope of any non-competition and non-solicitation restrictions.
When preparing any employment agreement, it is important to ensure that the agreement's provisions comply with the complex restrictions of Sections 280G, 4999 and 409A of the Internal Revenue Code. A lack of compliance can cause adverse tax consequences for both the employee and the employer.
Sections 280G and 4999 - IRS Golden Parachute Payment Penalties. Under Sections 280G and 4999 of the Internal Revenue Code, there are tax penalties to both the employer and the employee if severance compensation is paid out to the employee in an amount that is greater than or equal to three times an employee's base pay amount (averaged over a five year period of time). Subject to certain exemptions, if severance compensation is greater than or equal to three times the base pay, there will be an "excess parachute payment" in an amount equal (i) the severance compensation payment minus (ii) the employee's base pay amount. The employee must pay an excise tax equal to 20% of the excess parachute payment. The employer loses its income tax deduction for the amount of the excess parachute payment.
Section 409A - Restrictions on Severance Compensation. Under complex iRS regulations promulgated under Section 409A of the Internal Revenue Code, if the IRS, in an audit, determines that an employee has received deferred compensation that is not in compliance with certain restrictions, the IRS can subject the employee to immediate tax recognition for the amount of the deferred compensation and require payment of a 20% excise tax and interest. An employer is also subject to potential IRS penalties for failing to report properly the compensation of its employees. Under certain circumstances, severance pay can be deemed to be deferred compensation subject to the tax penalties of Section 409A. A right to severance compensation vests under Section 409A when it is no longer subject to a "substantial risk of forfeiture." There are two frequently utilized exemptions for severance arrangements from the tax penalties of Section 409A: (i) the "2x2" exemption and (ii) the "short term deferral" exemption.
Under the "2x2" exemption, a severance arrangement can be exempt from the tax penalties of Section 409A if, among other things, the employee receives — within two years after any involuntary separation from service — severance compensation that is up to the lesser of (i) two times the employee's base salary at the end of the year before the year of termination or (ii) $550,000 (as of 2018).
Under the "short-term deferral" exemption (also known as the "2 1/2 month" exemption), a severance arrangement can be exempt from the tax penalties of Section 409A if, among other things, the employee receives severance compensation payments for an involuntary separation from service on or before the 15th day of the third month following the end of the employee’s or employer's tax year (whichever is later) in which the right to the payment vests.
This website provides general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to retain an attorney for advice on specific legal issues.