Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
FALLACIES OF PRESUMPTION: UNPACKING THE IMPACT OF THE SECTION 409A PROPOSED REGULATIONS ON STOCK APPRECIATION RIGHTS ISSUED BY PRIVATELY-HELD COMPANIES
Vanessa A. Scott
Legislative Counsel and Corporate Secretary, The ERISA Industry Committee, Washington, D.C.; Duke University, A.B. 1993; Vanderbilt University School of Law, J.D. 1997; Georgetown Law Center, LL.M. 2006. The author thanks Peter I. Elinsky for his guidance and assistance with this article. The views expressed herein are solely those of the author, and not the ERISA Industry Committee or its members.
For decades, nonqualified deferred compensation plans were subject to limited government regulation. However, in the last five years these plans have received considerable scrutiny from both Congress and the Department of Treasury (Treasury). This scrutiny culminated in the passage of section 409A, the first comprehensive Code provision to regulate nonqualified deferred compensation plans. Under the initial administrative guidance issued pursuant to the statute, certain forms of equity compensation received different treatment under section 409A. In particular, private-company stock appreciation rights (SARs), which are equity appreciation rights in employer stock, were made subject to the new rules, while certain public-company SARs and stock options were exempted. Attempts were made to correct this inequity in the proposed regulations published in October 2005; however, the morass of rules, restrictions, and caveats related to the valuation of private-company stock under the proposed regulations still make SARs an unattractive deferred compensation tool for privately-held companies.
This paper begins with a brief review of the history of nonqualified deferred compensation and related law, including the passage into law of new section 409A through the American Jobs Creation Act of 2004. 1 Next, the paper specifically examines the treatment of SARs under section 409A’s regulatory history, under the statute itself, and in the initial guidance on section 409A issued by Treasury in December 2004. Finally, the paper reviews the treatment of SARs under the October 2005 proposed regulations and the practical effects of the proposed regulations on privately-held company SARs. This review reveals that when the only viable presumed-reasonable method for valuing privately-held company stock under the proposed section 409A regulations is applied in light of current law regarding formula prices and nonlapse restrictions, private-company SARs are still severely, and perhaps fatally, disadvantaged when compared to SARs issued by public companies.