Overview of Specific Exceptions Available for International Service

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Overview of Specific Exceptions Available for
International Service

• Jonathan F. LewisDebevoise Plimpton LLP

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Introduction

1. Categories of participants
2. Exceptions available to both expats and
   nonresident aliens working in the U.S.
3. Exceptions only available to expats
4. Exceptions only available to nonresident aliens
   working in the U.S.
5. Common situations to watch out for

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1. Categories of participants

• Section 409A only applies to individuals subject
  to U.S. taxation
• Category 1 Expatriates U.S. citizens and
  green card holders on assignment outside of the
  U.S.
• Category 2 Resident aliens (other than green
  card holders) and nonresident aliens on
  assignment inside the U.S.
• Particularly problematic where individuals are
  subject to U.S. taxation on benefits earned under
  their home country benefit plans.
• The focus is on these individuals accruing
  benefits under non-U.S. plans that are deemed to
  be nonqualified deferred compensation plan under
  Section 409A

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2. Exceptions available to both Category 1 and
Category 2

• Tax Treaty Exceptions
• Contributions and accruals under a plan are
  excluded from Section 409A if they are excluded
  from U.S. federal income tax pursuant to a tax
  treaty typically applies to broad-based
  tax-qualified plans and similar non-U.S. plans
• Compensation credited under a plan is excluded
  from Section 409A if the compensation would have
  been excluded from U.S. federal income tax
  pursuant to a tax treaty if paid to the employee
• It appears that these items must be excludable
  from income (as opposed to taxable in a future
  year)

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2. Exceptions available to both Category 1 and
Category 2 (contd)

• Exception for Broad-Based Non-U.S. Retirement
  Plans
• Contributions and accruals under a
  non-discriminatory, broad-based retirement plan
  may be excluded from Section 409A applies to
• nonresident aliens working in the U.S. and
• resident aliens classified as such only under the
  substantial presence text of Section 7701 of the
  Code
• The exception is also available to U.S. residents
  and green card holders, but additional
  limitations apply, including that
• The individual cannot be eligible to participate
  in a U.S. plan
• The exception only applies to nonelective
  deferrals of specified foreign income

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2. Exceptions available to both Category 1 and
Category 2 (contd)

• What is a broad-based non-U.S. retirement plan?
• Must have written rules
• Must cover a wide range of employees,
  substantially all of whom are nonresident aliens,
  resident aliens who satisfy the substantial
  presence test (and are not green card holders) or
  residents of U.S. possessions
• Must provide significant benefits for a
  substantial majority of participants (alone or in
  combination with other plans)
• Must be nondiscriminatory
• Legal or tax restrictions must discourage
  pre-retirement distributions
• There is very little published guidance on how to
  interpret these requirements (in particular the
  nondiscrimination requirement and the
  pre-retirement distribution requirement)

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2. Exceptions available to both Category 1 and
Category 2 (contd)

• Tax Equalization Agreements
• Payments under tax equalization agreements are
  excluded from Section 409A if the payments are
  made by the later of
• the second year beginning after the year in which
  the employees U.S. tax return relating to the
  compensation subject to equalization is filed
  (including extensions) and
• the second taxable year beginning after the
  latest taxable year in which the employees
  non-U.S. tax return or payment is required to be
  filed or made relating to the compensation
  subject to equalization
• In the event of an audit or litigation over the
  amount of taxable income, equalization payments
  may be delayed until the completion of the audit
  or litigation

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2. Exceptions available to both Category 1 and
Category 2 (contd)

• Plans Subject to Totalization Agreements and
  Non-U.S. Social Security
• Plans are excluded from Section 409A if (1) they
  are mandated by a foreign government and (2)
  contributions or benefits are subject to a
  totalization agreement
• The U.S. has totalization agreements with 21
  countries, including most European nations
• Non-U.S. social security benefits are also
  excluded from Section 409A

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2. Exceptions available to both Category 1 and
Category 2 (contd)

• Foreign Separation Pay Plans
• Separation pay required to be paid under non-U.S
  law is not subject to Section 409A (but only to
  the extent relating to non-U.S. income)
• May be payable on a voluntary or involuntary
  termination
• Earnings
• To the extent that compensation is not subject to
  Section 409A, then earnings on that amount
  generally will also not be subject to Section
  409A

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3. Exceptions only available to Category 1

• Compensation Excludable under Sections 911, 931
  or 933
• If an amount accrued under a deferred
  compensation plan would have been excluded from
  income if actually paid to an expat under these
  sections of the Internal Revenue Code, then the
  accrual will be excluded from Section 409A
• Section 911 is a limited exclusion for
  foreign-earned income by U.S. persons for
  services outside of the U.S.
• Sections 931 and 933 exclude certain income
  earned in U.S. territories and possessions

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4. Exceptions only available to Category 2

• Compensation Excludable under Section 872
• Amounts accrued under non-U.S. plans which would
  not have been U.S. source income or related to
  conducting a trade or business in the U.S. if
  paid to the employee are excluded from Section
  409A

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4. Exceptions only available to Category 2
(contd)

• Limited Deferrals
• Amounts accrued under non-U.S. plans by
  nonresident aliens working in the U.S. are
  excluded from Section 409A if they do not exceed
  a specified dollar amount (15,500 in 2008)
• Substantially all participants must be
  nonresident aliens who are not green card holders
• As a practical matter, this exception will
  normally apply only to nonresident aliens working
  in the U.S. for a limited number of days

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5. Common situations to watch out for

• Plans funded by offshore trusts
• Section 409 generally prohibits the funding of
  benefits in trusts located outside of the United
  States
• To the extent that the benefits of a U.S.
  taxpayer are funded in an offshore trust, there
  is an exception from Section 409A, but the
  services to which the deferred compensation
  relates must have been performed in that
  jurisdiction
• The short-term deferral exception may also apply
  to the extent these benefits are taxable on
  vesting

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5. Common situations to watch out for (contd)

• Garden leave an individual who is on garden
  leave may have a separation from service
  earlier than his or her designated termination
  date
• Guarantees where a new employee is provided
  with a compensation guarantee and the employer
  has the right to satisfy the guarantee in
  currently taxable income (e.g., cash in shares)
  or non-taxable income (e.g., phantom units or
  restricted stock), Section 409A issues may arise