Analyzing Compensation Tax

Workflow

1. Classify each compensation element

   • Identify all deferred compensation arrangements subject to Section 409A (salary deferrals, SERPs, phantom equity, in-the-money options)
   • Distinguish exempt arrangements: short-term deferrals, separation pay exceptions, stock options granted at FMV with no additional deferral features
   • Categorize equity awards by type and applicable tax regime (IRC Section 83, 421/422 for ISOs, 409A if applicable)

2. Analyze Section 409A compliance

   • Verify that payment triggers qualify as permissible distribution events (separation from service, fixed date, change in control, disability, death, unforeseeable emergency)
   • Confirm six-month delay for specified employees of public companies upon separation from service
   • Check that plan terms prohibit acceleration of payments except for permitted exceptions [VERIFY against current Treasury Regulations Section 1.409A-3(j)(4)]
   • Review amendment and modification history for potential material modifications restarting the deferral analysis
   • Evaluate document correction opportunities under IRS Notice 2008-113 or subsequent correction programs [VERIFY current correction guidance]

3. Model Section 280G exposure (change-in-control scenarios)

   • Calculate each disqualified individual's base amount (average W-2/1099 compensation for five preceding tax years)
   • Identify all parachute payments: accelerated vesting, severance, non-compete payments, benefits continuation, and other contingent-on-change compensation
   • Apply the 3x base amount threshold — if aggregate parachute payments equal or exceed 3x the base amount, the excess over 1x is subject to 20% excise tax under Section 4999
   • Evaluate reasonable compensation exceptions for non-compete agreements and post-transaction services
   • For private companies, assess availability of shareholder approval safe harbor under Section 280G(b)(5) [VERIFY adequate disclosure requirements]
   • Model net-better-off vs. gross-up vs. hard-cap cutback approaches and quantify after-tax outcomes for each

4. Evaluate equity compensation tax treatment

   • ISOs: Confirm $100K annual vesting limit, holding period requirements (1 year from exercise, 2 years from grant), AMT preference item on exercise spread
   • NQSOs: Ordinary income at exercise on spread; confirm grant-date FMV to avoid 409A issues for private companies
   • Restricted stock / Section 83(b) elections: Evaluate timing benefits and risks of early election; note 30-day filing deadline
   • RSUs: Taxed as ordinary income at vesting/settlement; review settlement timing for 409A implications if settlement is deferred beyond vesting
   • Profits interests / carried interest: Confirm safe harbor under Rev. Proc. 93-27 (and Rev. Proc. 2001-43); assess Section 1061 three-year holding period for applicable partnership interests [VERIFY current legislative status]

5. Address international considerations

   • Identify taxable events in each jurisdiction for mobile employees or cross-border grants
   • Analyze treaty-based relief for double taxation on equity compensation income
   • Flag local filing and reporting obligations (e.g., UK share scheme reporting, Canadian stock option deduction changes) [VERIFY jurisdiction-specific rules]
   • Evaluate transfer pricing implications of intercompany cost-sharing for equity plans

Output

The analysis report should include:

• Executive summary: Key findings, aggregate tax exposure, and recommended actions
• Compensation element table: Each arrangement classified by type, IRC section, and compliance status (compliant / at risk / non-compliant)
• Section 409A compliance matrix: Plan-by-plan assessment of document terms against 409A requirements, with specific deficiency citations
• Section 280G exposure model: Per-individual parachute payment calculations, excise tax estimates, and comparison of mitigation approaches (cutback vs. gross-up vs. shareholder vote)
• Equity award tax summary: Per-award type tax treatment at grant, vest, exercise, and sale with applicable rates and holding period requirements
• Risk items and recommendations: Prioritized list of issues, correction opportunities, and structuring alternatives
• International tax overlay (if applicable): Jurisdiction-by-jurisdiction treatment and filing obligations

Quality Checks

• Verify that 280G base amount calculations use the correct five-year lookback period and include all required compensation elements (W-2 Box 1, not just base salary)
• Confirm Section 409A analysis distinguishes between grandfathered (pre-2005) and post-effective date arrangements
• Check that ISO analysis accounts for AMT implications, not just regular tax treatment
• Ensure equity valuations reference contemporaneous 409A valuations or other defensible FMV determinations
• Validate that recommended correction methods match current IRS correction programs and deadlines [VERIFY]
• Cross-check all statutory thresholds, tax rates, and penalty rates against current law — flag any amounts that may have been adjusted for inflation or legislative change [VERIFY]
• Confirm international analysis reflects current treaty provisions and local law, not outdated guidance [VERIFY]