EMPLOYEE BENEFITS ALERT DEFERRED COMPENSATION UNDER 409A: JUNE - PDF document

WWW.KENNEDYCOVINGTON.COM EMPLOYEE BENEFITS ALERT DEFERRED COMPENSATION UNDER 409A: JUNE 2007 Focus on Issues: Equity-Based Compensation Equity-based compensation refers to grants of stock rights (which are This bulletin is published as a service to nonqualified stock options and SARs), statutory stock options and clients and others interested in restricted stock to employees, directors, consultants or other service employee benefits issues. The providers, including similar equity-based incentives issued by information provided herein is general partnerships. Equity-based compensation may be exempt from 409A in nature and should not be relied upon coverage if certain exemption criteria are satisfied. If all such criteria as legal advice as to specific factual are not satisfied, equity-based compensation will be subject to the situations. If you have any questions or general principles and limitations set forth in the 409A rules and require assistance in evaluating or summarized in our previous Alerts. Also, modification of stock rights modifying existing plans, please contact after grant could bring otherwise exempt stock rights within the scope one of the members of the Employee of 409A. Benefits Practice Group. Consequently, plans, arrangements and related practices regarding Employee Benefits Practice Group equity-based compensation should be promptly examined to determine if they currently comply with, or are otherwise exempt from, 409A. If James E. Earle 704.331.7530 not, then they should be reviewed to determine if they can be revised Sally W. Higgins 704.331.7510 to avoid penalties potentially triggered by 409A violations. Allyson B. Lavins 704.331.7573 Reminder - Transition Relief: The 409A rules provide a variety of Kiran H. Mehta 704.331.7437 planning opportunities, including the ability to change the timing of Lee West Movius (Chair) 704.331.7435 various payments, that are only available if implemented during the transition period that ends on December 31, 2007. John Nestico 704.331.7529 Raleigh A. Shoemaker 704.331.7457 Glossary : Please refer to the attached glossary for key terms and Mary Turk-Meena 704.331.7590 concepts used in this and subsequent Alerts on 409A. Michel P. Vanesse 704.331.7464 The final 409A regulations require full operational Lynne S. Wakefield 704.331.7578 compliance and documentation by December 31, 2007. Caroline E. Wainright 704.331.7483 Emily Zimmer 704.331.7405 Founded in 1957, Kennedy Covington is one of the largest law firms in the Carolinas with offices Kennedy Covington in Charlotte, Raleigh, Research Triangle Park, Columbia and Rock Hill. Our more than 200 Hearst Tower, 47th Floor attorneys use their diverse experience and knowledge to counsel clients in varied industries 214 North Tryon Street such as banking and finance, real estate, technology and manufacturing. At Kennedy Charlotte, NC 28202 Covington, we give more than a legal opinion; we provide a business perspective.

Exemption for Stock Rights · Stock rights generally are exempt from 409A if: - the option or SAR is not in-the-money at grant; - the option or SAR is only exercisable for or with respect to "service recipient stock"; and - the option or SAR does not include any feature to defer compensation beyond the date on which the option or SAR is exercised or, if later, the date on which the acquired stock becomes substantially vested. · For purposes of determining whether a stock right is in-the-money at grant, the 409A rules provide guidance for valuing the underlying stock. Taxpayers should carefully document the valuation method used in determining the exercise price of stock rights . The permissible valuation methods depend on whether the stock is readily tradable on an established securities market. - For stock readily tradable on an established securities market, the 409A rules generally use the trading price of the stock over certain time periods to determine fair market value. - For stock not readily tradable, the 409A rules provide that fair market value is a "value determined by reasonable application of a reasonable valuation method." The 409A rules also provide presumptions in favor of the taxpayer if certain valuation methods are used to value the stock. · Generally, stock is treated as "service recipient stock" only if such stock (i) is treated as common stock for purposes of Code Section 305, (ii) does not include any distribution preferences other than in liquidation, and (iii) is not subject to certain mandatory repurchase obligations, puts or calls at other than fair market value. Any grants of stock rights with respect to any stock other than traditional common stock should be closely evaluated. · Stock rights that are not exempt from 409A must comply with 409A to avoid the penalties summarized in our previous Alerts. Stock rights generally will not comply with 409A unless the time at which such stock rights can be exercised is limited to permissible distribution events under 409A. · Caution should be exercised in modifying the terms of any existing stock rights . A modification that may provide the holder with a direct or indirect reduction in exercise price is generally treated as the grant of a new stock right . Such new grant will then have to be retested using the above criteria to determine if such stock right is exempt from 409A. Extending the time during which a stock right can be exercised may cause such stock right to be treated as having an impermissible deferral feature. · 409A imposes strict limitations on substituting stock rights of one corporation for stock rights of another corporation in connection with corporate acquisition and other transactions. · Until further IRS guidance is provided, the principles applicable to stock rights described above apply to equivalent rights with respect to partnership interests. Exemption for Statutory Stock Options · Generally, incentive stock options and options granted under a tax-qualified employee stock purchase plan are excluded from 409A. · The exemption for statutory stock options does not apply to a modification, extension or renewal of a statutory stock option treated as the grant of a new option that is not a statutory stock option. Exemption for Restricted Stock · Grants of restricted stock generally are excluded from 409A. · However, restricted stock "units," phantom stock and other forms of deferred delivery of shares may provide for a deferral of compensation under 409A. These types of plans should be closely reviewed. · Until further IRS guidance is provided, a partnership's issuance of a capital or profits interest should also qualify for exemption from 409A. Page 2