IRS audits signal focus on Section 409A compliance; Revenue Ruling makes certain nonqualified options and stock appreciation rights more attractive for offshore entities.

The IRS has begun its limited audit initiative of 50 large companies’ nonqualified deferred compensation (NQDC) arrangements, which is intended to evaluate whether these arrangements comply with Internal Revenue Code Section 409A (Section 409A). In another development concerning deferred compensation, the IRS released Revenue Ruling 2014-18, holding that stock-settled stock appreciation rights (SARs) and stock-settled options granted by certain offshore entities will not constitute NQDC for purposes of Internal Revenue Code Section 457A (Section 457A), suggesting that grants of these awards by entities subject to Section 457A should generally remain taxable upon exercise rather than vesting. This client alert describes the impact of these developments in additional detail.

Section 409A Audit Initiative -

The Section 409A compliance audit initiative, announced on May 9, targets participation in NQDC arrangements by the 10 most highly paid individuals at fewer than 50 large companies, each of which the IRS previously selected for employment tax audits. The audit focuses on three separate Section 409A compliance areas: (i) compliance with initial deferral election requirements, (ii) compliance with subsequent deferral election requirements, and (iii) and compliance with distributions of deferred compensation (including the “six-month delay” rule applicable to “specified employees” of public companies).