LeBron James, the Miami Heat and Section 409A of the Internal Revenue Code
After an hour long television special last Thursday night, the "Decision" was announced on national television. LeBron James told the basketball world that he is taking his talents to South Beach and will play for the Miami Heat, joining superstars Dwayne Wade and Chris Bosh. The Miami Heat will be paying James over $100 Million over a 6 year period. As with many highly paid athletes and corporate executives, some of the compensation to be received by James may be deferred. Quite frankly, none of us at this time really know what the exact payment terms and schedule of payments were agreed to.
The deferral of compensation generally provides an advantageous tax result by delaying the taxation of such amounts. But to achieve this advantageous result, the requirements of Section 409A must be satisfied assuming, of course, that there is no income trigger resulting from application of the economic benefit or constructive receipt doctrines.
As the ink dries on James’ new employment agreement, as well as those of Dwayne Wade and Chris Bosh, the Miami Heat and James’ attorneys will have inevitably contemplated and believed, in good faith, to have satisfied the requirements contained in the statute and in the accompanying regulations. .
Section 409A enacted by Congress as part of the American Jobs Creation Act of 2004. The somewhat "over the top" provision was what Congress felt was necessary to respond to corporate excess and perceived abuses of Enron, WorldCom, and others. Also targeted were off shore deferred compensation arrangments.
Section 409A generally provides that if, at any time during a taxable year, a nonqualified deferred compensation plan such as an employment agreement fails, in form or in operation to meet certain requirements, then all compensation deferred under the plan for that taxable year, and all preceding taxable years, will be immediately included in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. To add insult to injury, in addition to the immediate taxation of the deferred compensation, when compensation is required to be included in gross income under Section 409A, an additional tax of 20% and interest, will be imposed on the amount included by the employee.
The application of Section 409A is surprisingly broad so as to include any delayed payment of compensation such as sign-on bonuses and certain severance benefits and payments. For example, if James is entitled to a sign-on bonus of $10 million from the Miami Heat that is paid over five years and James’ employment agreement does not comply with the requirements of Section 409A, then James in year 1 would receive $2 million in actual compensation but be responsible for payment of overover $5 million in taxes. James would most likely be unhappy with this result.
Earlier this year the IRS issued a notice which allows nonqualified deferred compensation plans to be corrected for certain Section 409A document failures with reduced current income inclusion and additional taxes. Fortunately, as part of the notice, the IRS provided a transition period so that the employee may avoid both income inclusion and additional taxes if the Section 409A document failures are corrected before December 31, 2010.
Section 409A essentially requires nonqualified deferred compensation plans to comply with three design and operational requirements to avoid immediate inclusion and additional taxation. First, the plan may not allow any deferred compensation to be distributed earlier than the occurrence of certain permissible distribution events such as a separation from service, disability, death, a time or a fixed schedule specified under the plan, a change in control, or an unforeseeable emergency. Second, except as otherwise provided, the plan may not permit the acceleration of the time or form of the payment of the deferred compensation. Finally, elections to defer compensation must be made within certain time periods that are set forth under the Section and its related regulations.
While I doubt LeBron focused on the Section 409A requirements in coming to terms with the Heat, I am fairly certain his tax advisors were "right there" making sure the plan and payout requirements were satisfied for any deferrals agreed upon or timing for severance payments in the event of a termination.
