Final Regulations under Section 409A: Implications for Equity Compensation Arrangements

As reported in two previous LawFlashes, the IRS has issued final regulations (Final Regulations) under section 409A of the Internal Revenue Code, as amended (the Code). The Final Regulations have an effective date of January 1, 2008, but may be applied earlier to any deferred compensation arrangement subject to section 409A. The key provisions of the Final Regulations as they relate to equity compensation vehicles, such as stock options, stock appreciation rights, restricted stock, restricted stock units, and phantom stock, are summarized below. All plans, agreements, and arrangements subject to section 409A must be reviewed and appropriately revised on or before December 31, 2007 to achieve compliance with section 409A. Every equity compensation plan or arrangement should be reviewed during 2007 to identify and, if applicable, resolve issues under section 409A.

Service Recipient Stock
In order for any stock right to be exempt from section 409A, the underlying stock must qualify as “service recipient stock.” In general, any class of common stock will qualify, whether or not that stock is publicly traded or subject to a transferability restriction or buyback right at fair market value. However, the regulations limit the types of preferences that a class of common stock can include and still qualify. Common stock with a preference limited to liquidation rights can qualify as service recipient stock, but common stock with other preferences (e.g., a preferential right to dividends) will not. Preferred stock cannot constitute service recipient stock under any circumstances.

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