On June 25, 2004, a notice of proposed rulemaking (REG-117307-04, 2004-2 C.B. 39) was published in the Federal Register (69 FR 35543). No requests for a public hearing were received, and no public hearing was held. The IRS received one written comment in response to the notice of proposed rulemaking. After consideration of the comment, the proposed regulation is adopted without change.

This Treasury decision adopts the language of the proposed regulation without change.

The IRS received one comment in response to the proposed regulation. The commentator requested further clarification regarding what constitutes an insurance company for federal income tax purposes. The IRS believes the issue of what constitutes an insurance company is outside the scope of this regulation, which solely relates to the application of the asset-use test to stock held by foreign insurance companies.

The commentator also expressed concern about the interaction of the proposed regulation with §1.864-5(a), which provides, generally, that foreign source income, such as a foreign-source dividend or gain, cannot constitute U.S. effectively connected income in circumstances in which a U.S.-source dividend or gain would not constitute U.S. effectively connected income. Accordingly, the commentator is concerned that the rule in the regulations will also expand the category of foreign-source dividends or gains that may constitute effectively connected income. That is true and the Treasury Department and the IRS believe this is the appropriate result.

The IRS invited comments whether the 10 percent threshold provided in the proposed regulation was an appropriate standard for determining whether stock is a portfolio investment. The commentator stated that it was possible for insurance companies to make a strategic investment in a corporation at a level below 10 percent of the vote or value of the corporation, such as by purchasing a special class of shares that conveyed the power to elect directors. The commentator recommended creating a rebuttable presumption of portfolio status.

We do not believe that treating the 10 percent threshold as a rebuttable presumption is appropriate. The 10 percent threshold provides a reasonable method for identifying portfolio stock held by a branch of a foreign life insurance company.

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because these regulations do not impose a collection of information on small entities, the provisions of the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. In §1.864-4, paragraph (c)(2)(iii)(b) is revised to read as follows:

This document contains proposed amendments to the Regulations on Procedure and Administration (26 CFR part 301) relating to the provision of notice under section 6320 of the Internal Revenue Code to taxpayers of a right to a CDP hearing (CDP Notice) after the IRS files a NFTL. Final regulations (T.D. 8979, 2002-1 C.B. 466) were published on January 18, 2002 in the Federal Register (67 FR 2558). The final regulations implemented certain changes made by section 3401 of the Internal Revenue Service Restructuring and Reform Act of 1998 (Public Law 105-206, 112 Stat. 685) (RRA 1998), including the addition of section 6320 to the Internal Revenue Code. The final regulations affected taxpayers against whose property or rights to property the IRS files a NFTL.

Section 3401 of RRA 1998 also added section 6330 to the Internal Revenue Code. That statute provides for notice to taxpayers of a right to a hearing before or, in limited cases, after levy. A number of the provisions in section 6330 concerning the conduct and judicial review of a CDP hearing are incorporated by reference in section 6320. On January 18, 2002, final regulations (T.D. 8980, 2002-1 C.B. 477) under section 6330 were published in the Federal Register (67 FR 2549) along with the final regulations under section 6320.

A taxpayer is entitled to one CDP hearing with respect to the tax and tax period covered by a CDP Notice concerning a levy or a CDP Notice concerning the filing of a NFTL. The IRS Office of Appeals (Appeals) has conducted over 92,000 CDP hearings and more than 30,000 equivalent hearings since sections 6320 and 6330 became effective for collection actions initiated on and after January 19, 1999.

In general, the experience of the past six years with CDP hearings has demonstrated that there is a need for changes to allow Appeals to effectively and fairly handle the cases of taxpayers who raise issues of substance. Appeals has instituted many improvements in its processing of CDP cases and has conducted extensive training in an effort to provide careful, but timely, review of CDP cases, which currently are filed at a rate of approximately 2,450 per month. The proposed regulations, if adopted as final regulations, will increase efficiency without compromising the quality and fairness of review.

In many CDP cases, significant time is spent merely identifying the issues. Although the Form 12153 used to request a CDP hearing requires a taxpayer to state a reason or reasons for disagreeing with the NFTL filing, many taxpayers either do not supply that information, or raise new issues during the CDP hearing process not identified on the hearing request. Delays result while taxpayers provide new supporting documentation and Appeals personnel reconsider prior conclusions in light of the new information. Cases of other taxpayers pending in Appeals are delayed because other work must be constantly rescheduled.

Cases are also delayed when taxpayers propose collection alternatives for which they are not eligible. The IRS does not consider offers in compromise or installment agreements from taxpayers who have failed to file required returns as of the date the offer or the proposed installment agreement is submitted. See Publication 594, “What You Should Know About the IRS Collection Process (Rev. 2-2004).” Similarly, the IRS will not consider an offer in compromise from an in-business taxpayer unless the taxpayer has timely filed all returns and timely made all Federal tax deposits for two consecutive quarters. See Form 656, “Offer in Compromise (Rev. 7-2004).” The resources of Appeals are ineffectively utilized arranging and conducting face-to-face conferences requested by non-compliant taxpayers whose only complaint is the rejection of an offer to compromise or installment agreement for which they are not eligible.

Frivolous cases also cause unnecessary delays. During fiscal year 2004, 5.4 percent of the 32,226 CDP and equivalent-hearing cases Appeals handled involved taxpayers who were non-filers or raised only frivolous issues. Cases raising frivolous issues, in particular, consume a disproportionately large amount of time, because Appeals personnel must often read lengthy, frivolous submissions in search of any substantive issue buried within. Delays also result when taxpayers use face-to-face conferences as a venue for frivolous oration and harassment of Appeals personnel.

The proposed regulations attempt to address these and other problems that have become apparent during the first six years of CDP practice. The proposed changes are aimed at creating a more focused procedure that will allow Appeals to continue to provide careful review of NFTL filings as the volume of cases increases.

A taxpayer must request a CDP hearing in writing. The current regulations require that a request for a CDP hearing include the taxpayer’s name, address, and daytime telephone number, and that the request be dated and signed by either the taxpayer or the taxpayer’s authorized representative. Section 301.6320-1(c)(2), Q&A-C1. A Form 12153, “Request for a Collection Due Process Hearing,” is included with the CDP Notice sent to the taxpayer pursuant to section 6320. The Form 12153 requests (1) the taxpayer’s name, address, daytime telephone number, and taxpayer identification number (SSN or EIN), (2) the type of tax involved, (3) the tax period at issue, (4) a statement that the taxpayer requests a hearing with Appeals concerning the filing of the NFTL, and (5) the reason or reasons why the taxpayer disagrees with the NFTL filing. Although taxpayers are encouraged to use a Form 12153 in requesting a CDP hearing, the current regulations do not require the use of Form 12153.

Section 301.6320-1(c)(2), A-C1, of the proposed regulations requires taxpayers to state their reasons for disagreement with the NFTL filing whether or not a Form 12153 is used to request a CDP hearing. In addition, a taxpayer who fails to sign a timely CDP hearing request because the request is made by a spouse or other unauthorized representative must affirm in writing that the request was originally submitted on the taxpayer’s behalf. Failure to provide the written affirmation within a reasonable time after a request from Appeals will result in the denial of a CDP hearing for that taxpayer.

A CDP hearing is to be conducted by an Appeals officer or employee who has had no “prior involvement” with respect to the tax for the tax periods to be covered by the hearing, unless the taxpayer waives this requirement. Section 301.6320-1(d)(2), A-D4 of the current regulations provides that “prior involvement” by an Appeals officer or employee includes participation or involvement in an Appeals hearing that the taxpayer may have had with respect to the tax and tax period shown on the CDP Notice, other than a CDP hearing held under either section 6320 or section 6330. It is important that “prior involvement” be construed in a manner that reasonably protects against predisposition but at the same time does not disqualify too broad a range of Appeals personnel. A broad standard of “prior involvement” would lead to uncertain application, could result in the disqualification of an entire Appeals office, many of which have small staffs, and could make it difficult to conduct the CDP hearing. Section 301.6320-1(d)(2), A-D4 of the proposed regulations provides that prior involvement exists only when the taxpayer, the tax liability and the tax period shown on the CDP Notice also were at issue in the prior non-CDP hearing or proceeding, and the Appeals officer or employee actually participated in the prior hearing or proceeding. Examples are provided in §301.6320-1(d)(3) of the proposed regulations. Section 301.6320-1(d)(2), A-D7, of the proposed regulations clarifies that a face-to-face conference is merely one aspect of a CDP hearing under section 6320 and is not by itself the entire CDP hearing.

A-D7 of the proposed regulations also provides that, in all cases, the Appeals officer or employee will review the taxpayer’s request for a CDP hearing, the case file, other written communications from the taxpayer, and any notes of oral communications with the taxpayer or the taxpayer’s representative. If no face-to-face or telephonic conference is held, review of those documents will constitute the CDP hearing for purposes of section 6320(b).

A-D7 of the proposed regulations further clarifies that when a business taxpayer is offered an opportunity for a face-to-face conference it will be held at the Appeals office closest to the taxpayer’s principal place of business. The current regulations have been misinterpreted by some taxpayers as requiring the IRS to hold a face-to-face conference at the taxpayer’s principal place of business. Q&A-D8 of the proposed regulations is new. It describes specific circumstances in which Appeals will not hold a face-to-face conference with the taxpayer or the taxpayer’s representative because a conference will serve no useful purpose. The experience of Appeals is that although most taxpayers request face-to-face conferences, they are sometimes difficult to schedule on a date and at a time that is convenient for the taxpayer. In some of these cases, taxpayers or their representatives have used the scheduling of a face-to-face conference as a tactic to delay the IRS’s collection efforts. In other cases, taxpayers have requested a face-to-face conference merely to raise frivolous arguments concerning the Federal tax system or to request collection alternatives for which they do not qualify. Q&A-D8 of the proposed regulations provides that a face-to-face conference need not be offered if the taxpayer or the taxpayer’s representative raises only frivolous arguments concerning the Federal tax system. See the IRS Internet site, www.irs.gov/pub/irs-utl/friv_tax.pdf, for examples of frivolous arguments. A face-to-face conference also will not be granted if the taxpayer proposes collection alternatives that would not be available to other taxpayers in similar circumstances. A face-to-face conference need not be granted if the taxpayer does not provide in the written request for a CDP hearing, as perfected, the required information set forth in A-C1(ii)(E) of paragraph (c)(2) of the proposed regulations.

In addition, a face-to-face conference will not be held at the location closest to the taxpayer’s residence or principal place of business if all Appeals officers or employees at that location are considered to have prior involvement as provided in A-D4. In this case, the taxpayer will be offered a hearing by telephone or correspondence, or some combination thereof. The taxpayer may be able to obtain a face-to-face conference at the Appeals office closest to the taxpayer’s residence or principal place of business under these circumstances if the taxpayer waives the requirement of section 6320(b)(3) concerning impartiality of the Appeals officer or employee. Appeals will offer the taxpayer a face-to-face conference at another Appeals office if in the exercise of its discretion Appeals would have offered the taxpayer a face-to-face conference at the original location.

With the foregoing exceptions, it is anticipated that a face-to-face conference will ordinarily be offered with respect to any relevant issues or collection alternatives for which the taxpayer qualifies.

Sections 301.6320-1(e)(1) and 301.6320-1(e)(3), A-E2 and A-E7 have been changed to more closely follow the language of section 6330(c)(2)(B), made applicable to section 6320 by section 6320(c). These changes are necessary because these regulations have been misinterpreted as defining the underlying tax liability that may be considered at the CDP hearing under section 6330(c)(2)(B) to be the tax liability listed on the CDP Notice. The intent of the existing regulations, which refer to tax liability on the CDP Notice, is that taxpayers may only challenge taxes or tax periods listed on the CDP Notice, not to supply a substantive definition of underlying tax liability. Section 301.6320-1(e)(3), A-E6 has been amended to clarify that taxpayers who receive CDP hearings can only qualify for collection alternatives available generally to taxpayers in similar circumstances.

The experience of the past six years has revealed that many taxpayers raise an issue with Appeals but fail to furnish any documentation or evidence with respect to the issue despite being given a reasonable period to do so. For example, a taxpayer may request an installment agreement, but when an Appeals officer or employee requests financial data necessary to determine eligibility for the installment agreement, the taxpayer may not comply with the request. Or a taxpayer may dispute liability for a tax period by claiming entitlement to deductions, but provide no substantiation for the deductions in response to requests from Appeals. Current §301.6320-1(f)(2), A-F5 provides that a taxpayer may not seek judicial review of an issue that he has not raised during the CDP hearing. A-F5 is revised to clarify that in order to obtain judicial review, a taxpayer must not only bring the issue to the attention of Appeals but must also submit, if requested, evidence with respect to that issue. Under revised A-F5, if the taxpayer does not provide Appeals any evidence with respect to the issue after being given a reasonable opportunity to submit such evidence, then he may not ask a court to consider the issue.

There has been some confusion about what documents Appeals should retain, and what notations the Appeals officer or employee conducting the hearing should make, in order to provide a judicially reviewable administrative record. A new Q&A-F6 has been added to specify the contents of the administrative record required for court review.

The IRS receives a number of tardy requests for CDP hearings. The changes to §301.6320-1(i)(2) explain how these requests will be treated. The proposed amendments to the regulations add a new Q&A-I1 to §301.6320-1(i)(2) to explain that a taxpayer must request an equivalent hearing in writing. A taxpayer may obtain an equivalent hearing if the 30-day period described in section 6320(a)(3) for requesting a CDP hearing has expired. Unlike an Appeals determination in a CDP hearing, the Appeals decision in an equivalent hearing is not reviewable in court. Under new Q&A-I1, the IRS is not required to treat a late-filed CDP request as a request for an equivalent hearing. Section 301.6320-1(c)(2), A-C7 has been amended to require that the taxpayer be notified of the right to an equivalent hearing in all cases in which a tardy request for a CDP hearing is received. It is expected that the IRS will either send the taxpayer a letter or orally inform the taxpayer that the CDP hearing request is untimely and ask if the taxpayer wishes to have an equivalent hearing. If the taxpayer elects to have an equivalent hearing, the IRS will treat the CDP hearing request as a request for an equivalent hearing without requiring the taxpayer to make an additional written request.

Current Q&A-I1 through I5 are renumbered Q&A-I2 through I6. The proposed regulations add Q&A-I7 to §301.6320-1(i)(2) to clarify that the period during which a taxpayer may obtain an equivalent hearing is not indefinite. The equivalent hearing procedure is not provided by statute but, consistent with the legislative history of RRA 1998, was adopted in order to accommodate taxpayers who failed timely to exercise their right to a CDP hearing. The equivalent hearing was meant to occur near the time a CDP hearing held pursuant to a timely request would have occurred, because it was meant to address the same matters that would have been addressed at a CDP hearing. The procedure was not meant to provide a hearing right that could be exercised months or years after the circumstances that precipitated the filing of the NFTL have passed. A hearing before Appeals at a later time may be obtained under the Collection Appeals Program. Therefore, proposed Q&A-I7 limits to one year the period during which a taxpayer may request an equivalent hearing. The period commences the day after the end of the five business day period following the filing of the NFTL, described in section 6320(a)(2).

Because the time for requesting an equivalent hearing will be limited, the proposed regulations add new Q&A-I8, Q&A-I9, Q&A-I10 and Q&A-I11 to §301.6320-1(i)(2) to provide the same rules governing mailing, delivery and determination of timeliness that apply to requests for CDP hearings. Unlike existing §301.6320-1(c)(2), A-C6, new A-I10 does not identify the officials to whom to send an equivalent hearing request if the CDP Notice does not specify where to send the request. Because the identity and the address of the person to whom the request should be sent may change in the future, taxpayers will be able to obtain more current information by calling the 1-800 number listed in A-I10. Section 301.6320-1(c)(2), A-C6 also has been revised in the proposed regulations to provide that taxpayers should call the 1-800 number to obtain the address to which the CDP hearing request should be sent.

The proposed regulations are effective the date 30 days after final regulations are published in the Federal Register with respect to requests for CDP hearings or equivalent hearings made on or after the date 30 days after final regulations are published in the Federal Register.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any electronic and written comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clarity of the proposed regulations and how they may be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for January 19, 2006, at 10 a.m. in the IRS Auditorium, Internal Revenue Building (7th Floor), 1111 Constitution Avenue, NW, Washington, DC. All visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having a visitor’s name placed on the building access list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT caption.

An outline of the topics to be discussed and the time to be devoted to each topic must be submitted by any person who wishes to present oral comments at the hearing. Outlines must be received by December 29, 2005.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving requests to speak has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1. The authority citation for part 301 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 301.6320-1 is proposed to be amended as follows:

1. Paragraph (c)(2) A-C1, Q&A-C6 and A-C7 are revised.

2. Paragraph (d)(2) A-D4 and A-D7 are revised.

3. Paragraph (d)(2) Q&A-D8 is added.

4. Paragraph (d)(3) is added.

5. Paragraph (e)(1) is revised.

6. Paragraph (e)(3) A-E2, A-E6 and A-E7 are revised.

7. Paragraph (f)(2) A-F5 is revised

8. Paragraph (f)(2) Q&A-F6 is added.

9. Paragraph (i)(2) Q&A-I1 through Q&A-I5 are renumbered Q&A-I2 through Q&A-I6, a new paragraph (i)(2) Q&A-I1 and new paragraphs Q&A-I7 through Q&A-I11 are added.

10. Paragraph (j) is revised.

This document contains proposed amendments to the Regulations on Procedure and Administration (26 CFR part 301) relating to the provision of notice under section 6330 of the Internal Revenue Code to taxpayers of a right to a CDP hearing (CDP Notice) before levy. Final regulations (T.D. 8980, 2002-1 C.B. 477) were published on January 18, 2002 in the Federal Register (67 FR 2549). The final regulations implemented certain changes made by section 3401 of the Internal Revenue Service Restructuring and Reform Act of 1998 (Public Law 105-206, 112 Stat. 685) (RRA 1998), including the addition of section 6330 to the Internal Revenue Code. The final regulations affected taxpayers against whose property or rights to property the IRS intends to levy.

Section 3401 of RRA 1998 also added section 6320 to the Internal Revenue Code. That statute provides for notice to taxpayers of a right to a hearing after the filing of a notice of Federal tax lien (NFTL). A number of the provisions in section 6330 concerning the conduct and judicial review of a CDP hearing are incorporated by reference in section 6320. On January 18, 2002, final regulations (T.D. 8979, 2002-1 C.B. 466) under section 6320 were published in the Federal Register (67 FR 2558) along with the final regulations under section 6330.

A taxpayer is entitled to one CDP hearing with respect to the tax and tax period covered by a CDP Notice concerning a levy or a CDP Notice concerning the filing of a NFTL. The IRS Office of Appeals (Appeals) has conducted over 92,000 CDP hearings and more than 30,000 equivalent hearings since sections 6320 and 6330 became effective for collection actions initiated on and after January 19, 1999.

In general, the experience of the past six years with CDP hearings has demonstrated that there is a need for changes to allow Appeals to effectively and fairly handle the cases of taxpayers who raise issues of substance. Appeals has instituted many improvements in its processing of CDP cases and has conducted extensive training in an effort to provide careful, but timely, review of CDP cases, which currently are filed at a rate of approximately 2,450 per month. The proposed regulations, if adopted as final regulations, will increase efficiency without compromising the quality and fairness of review.

In many CDP cases, significant time is spent merely identifying the issues. Although the Form 12153 used to request a CDP hearing requires a taxpayer to state a reason or reasons for disagreeing with the proposed levy, many taxpayers either do not supply that information, or raise new issues during the CDP hearing process not identified on the hearing request. Delays result while taxpayers provide new supporting documentation and Appeals personnel reconsider prior conclusions in light of the new information. Cases of other taxpayers pending in Appeals are delayed because other work must be constantly rescheduled.

Cases are also delayed when taxpayers propose collection alternatives for which they are not eligible. The IRS does not consider offers in compromise or installment agreements from taxpayers who have failed to file required returns as of the date the offer or the proposed installment agreement is submitted. See Publication 594, “What You Should Know About the IRS Collection Process (Rev. 2-2004).” Similarly, the IRS will not consider an offer in compromise from an in-business taxpayer unless the taxpayer has timely filed all returns and timely made all Federal tax deposits for two consecutive quarters. See Form 656, “Offer in Compromise (Rev. 7-2004).” The resources of Appeals are ineffectively utilized arranging and conducting face-to-face conferences requested by non-compliant taxpayers whose only complaint is the rejection of an offer to compromise or installment agreement for which they are not eligible.

Frivolous cases also cause unnecessary delays. During fiscal year 2004, 5.4 percent of the 32,226 CDP and equivalent-hearing cases Appeals handled involved taxpayers who were non-filers or raised only frivolous issues. Cases raising frivolous issues, in particular, consume a disproportionately large amount of time, because Appeals personnel must often read lengthy, frivolous submissions in search of any substantive issue buried within. Delays also result when taxpayers use face-to-face conferences as a venue for frivolous oration and harassment of Appeals personnel.

The proposed regulations attempt to address these and other problems that have become apparent during the first six years of CDP practice. The proposed changes are aimed at creating a more focused procedure that will allow Appeals to continue to provide careful review of proposed levies as the volume of cases increases.

A taxpayer must request a CDP hearing in writing. The current regulations require that a request for a CDP hearing include the taxpayer’s name, address, and daytime telephone number, and that the request be dated and signed by either the taxpayer or the taxpayer’s authorized representative. Section 301.6330-1(c)(2), Q&A-C1. A Form 12153, “Request for a Collection Due Process Hearing,” is included with the CDP Notice sent to the taxpayer pursuant to section 6330. The Form 12153 requests (1) the taxpayer’s name, address, daytime telephone number, and taxpayer identification number (SSN or EIN), (2) the type of tax involved, (3) the tax period at issue, (4) a statement that the taxpayer requests a hearing with Appeals concerning the proposed levy, and (5) the reason or reasons why the taxpayer disagrees with the proposed levy. Although taxpayers are encouraged to use a Form 12153 in requesting a CDP hearing, the current regulations do not require the use of Form 12153.

Section 301.6330-1(c)(2), A-C1, of the proposed regulations requires taxpayers to state their reasons for disagreement with the proposed levy whether or not a Form 12153 is used to request a CDP hearing. In addition, a taxpayer who fails to sign a timely CDP hearing request because the request is made by a spouse or other unauthorized representative must affirm in writing that the request was originally submitted on the taxpayer’s behalf. Failure to provide the written affirmation within a reasonable time after a request from Appeals will result in the denial of a CDP hearing for that taxpayer.

A CDP hearing is to be conducted by an Appeals officer or employee who has had no “prior involvement” with respect to the tax for the tax periods to be covered by the hearing, unless the taxpayer waives this requirement. Section 301.6330-1(d)(2), A-D4 of the current regulations provides that “prior involvement” by an Appeals officer or employee includes participation or involvement in an Appeals hearing that the taxpayer may have had with respect to the tax and tax period shown on the CDP Notice, other than a CDP hearing held under either section 6320 or section 6330. It is important that “prior involvement” be construed in a manner that reasonably protects against predisposition but at the same time does not disqualify too broad a range of Appeals personnel. A broad standard of “prior involvement” would lead to uncertain application, could result in the disqualification of an entire Appeals office, many of which have small staffs, and could make it difficult to conduct the CDP hearing. Section 301.6330-1(d)(2), A-D4 of the proposed regulations provides that prior involvement exists only when the taxpayer, the tax liability and the tax period shown on the CDP Notice also were at issue in the prior non-CDP hearing or proceeding, and the Appeals officer or employee actually participated in the prior hearing or proceeding. Examples are provided in §301.6330-1(d)(3) of the proposed regulations.

Section 301.6330-1(d)(2), A-D7, of the proposed regulations clarifies that a face-to-face conference is merely one aspect of a CDP hearing under section 6330 and is not by itself the entire CDP hearing.

A-D7 of the proposed regulations also provides that, in all cases, the Appeals officer or employee will review the taxpayer’s request for a CDP hearing, the case file, other written communications from the taxpayer, and any notes of oral communications with the taxpayer or the taxpayer’s representative. If no face-to-face or telephonic conference is held, review of those documents will constitute the CDP hearing for purposes of section 6330(b).

A-D7 of the proposed regulations further clarifies that when a business taxpayer is offered an opportunity for a face-to-face conference it will be held at the Appeals office closest to the taxpayer’s principal place of business. The current regulations have been misinterpreted by some taxpayers as requiring the IRS to hold a face-to-face conference at the taxpayer’s principal place of business.

Q&A-D8 of the proposed regulations is new. It describes specific circumstances in which Appeals will not hold a face-to-face conference with the taxpayer or the taxpayer’s representative because a conference will serve no useful purpose. The experience of Appeals is that although most taxpayers request face-to-face conferences, they are sometimes difficult to schedule on a date and at a time that is convenient for the taxpayer. In some of these cases, taxpayers or their representatives have used the scheduling of a face-to-face conference as a tactic to delay the IRS’s collection efforts. In other cases, taxpayers have requested a face-to-face conference merely to raise frivolous arguments concerning the Federal tax system or to request collection alternatives for which they do not qualify. Q&A-D8 of the proposed regulations provides that a face-to-face conference need not be offered if the taxpayer or the taxpayer’s representative raises only frivolous arguments concerning the Federal tax system. See the IRS Internet site, www.irs.gov/pub/irs-utl/friv_tax.pdf, for examples of frivolous arguments. A face-to-face conference also will not be granted if the taxpayer proposes collection alternatives that would not be available to other taxpayers in similar circumstances. A face-to-face conference need not be granted if the taxpayer does not provide in the written request for a CDP hearing, as perfected, the required information set forth in A-C1(ii)(E) of paragraph (c)(2) of the proposed regulations.

In addition, a face-to-face conference will not be held at the location closest to the taxpayer’s residence or principal place of business if all Appeals officers or employees at that location are considered to have prior involvement as provided in A-D4. In this case, the taxpayer will be offered a hearing by telephone or correspondence, or some combination thereof. The taxpayer may be able to obtain a face-to-face conference at the Appeals office closest to the taxpayer’s residence or principal place of business under these circumstances if the taxpayer waives the requirement of section 6330(b)(3) concerning impartiality of the Appeals officer or employee. Appeals will offer the taxpayer a face-to-face conference at another Appeals office if in the exercise of its discretion Appeals would have offered the taxpayer a face-to-face conference at the original location.

With the foregoing exceptions, it is anticipated that a face-to-face conference will ordinarily be offered with respect to any relevant issues or collection alternatives for which the taxpayer qualifies.

Sections 301.6330-1(e)(1) and 301.6330-1(e)(3), A-E2 and A-E7 have been changed to more closely follow the language of section 6330(c)(2)(B). These changes are necessary because these regulations have been misinterpreted as defining the underlying tax liability that may be considered at the CDP hearing under section 6330(c)(2)(B) to be the tax liability listed on the CDP Notice. The existing regulations, which refer to tax liability on the CDP Notice, were intended merely to make clear that taxpayers may only challenge taxes or tax periods listed on the CDP Notice, not to supply a substantive definition of underlying tax liability. Section 301.6330-1(e)(3), A-E6 has been amended to clarify that taxpayers who receive CDP hearings can only qualify for collection alternatives available generally to taxpayers in similar circumstances.

The experience of the past six years has revealed that many taxpayers raise an issue with Appeals but fail to furnish any documentation or evidence with respect to the issue despite being given a reasonable period to do so. For example, a taxpayer may request an installment agreement, but when an Appeals officer or employee requests financial data necessary to determine eligibility for the installment agreement, the taxpayer may not comply with the request. Or a taxpayer may dispute liability for a tax period by claiming entitlement to deductions, but provide no substantiation for the deductions in response to requests from Appeals. Current §301.6330-1(f)(2), A-F5 provides that a taxpayer may not seek judicial review of an issue that he has not raised during the CDP hearing. A-F5 is revised to clarify that in order to obtain judicial review, a taxpayer must not only bring the issue to the attention of Appeals but must also submit, if requested, evidence with respect to that issue. Under revised A-F5, if the taxpayer does not provide Appeals any evidence with respect to the issue after being given a reasonable opportunity to submit such evidence, then he may not ask a court to consider the issue.

There has been some confusion about what documents Appeals should retain, and what notations the Appeals officer or employee conducting the hearing should make, in order to provide a judicially reviewable administrative record. A new Q&A-F6 has been added to specify the contents of the administrative record required for court review.

The IRS receives a number of tardy requests for CDP hearings. The changes to §301.6330-1(i)(2) explain how these requests will be treated. The proposed amendments to the regulations add a new Q&A-I1 to §301.6330-1(i)(2) to explain that a taxpayer must request an equivalent hearing in writing. A taxpayer may obtain an equivalent hearing if the 30-day period described in section 6330(a)(3) for requesting a CDP hearing has expired. Unlike an Appeals determination in a CDP hearing, the Appeals decision in an equivalent hearing is not reviewable in court. Under new Q&A-I1, the IRS is not required to treat a late-filed CDP request as a request for an equivalent hearing. Section 301.6330-1(c)(2), A-C7 has been amended to require that the taxpayer be notified of the right to an equivalent hearing in all cases in which a tardy request for a CDP hearing is received. It is expected that the IRS will either send the taxpayer a letter or orally inform the taxpayer that the CDP hearing request is untimely and ask if the taxpayer wishes to have an equivalent hearing. If the taxpayer elects to have an equivalent hearing, the IRS will treat the CDP hearing request as a request for an equivalent hearing without requiring the taxpayer to make an additional written request.

Current Q&A-I1 through I5 are renumbered Q&A-I2 through I6. The proposed regulations add Q&A-I7 to §301.6330-1(i)(2) to clarify that the period during which a taxpayer may obtain an equivalent hearing is not indefinite. The equivalent hearing procedure is not provided by statute but, consistent with the legislative history of RRA 1998, was adopted in order to accommodate taxpayers who failed timely to exercise their right to a CDP hearing. The equivalent hearing was meant to occur near the time a CDP hearing held pursuant to a timely request would have occurred, because it was meant to address the same matters that would have been addressed at a CDP hearing. The procedure was not meant to provide a hearing right that could be exercised months or years after the circumstances that precipitated the proposed levy have passed. A hearing before Appeals at a later time may be obtained under the Collection Appeals Program. Therefore, proposed Q&A-I7 limits to one year the period during which a taxpayer may request an equivalent hearing. The period commences the day after the date of the CDP Notice issued under section 6330.

Because the time for requesting an equivalent hearing will be limited, the proposed regulations add new Q&A-I8, Q&A-I9, Q&A-I10 and Q&A-I11 to §301.6330-1(i)(2) to provide the same rules governing mailing, delivery and determination of timeliness that apply to requests for CDP hearings. Unlike existing §301.6330-1(c)(2), A-C6, new A-I10 does not identify the officials to whom to send an equivalent hearing request if the CDP Notice does not specify where to send the request. Because the identity and the address of the person to whom the request should be sent may change in the future, taxpayers will be able to obtain more current information by calling the 1-800 number listed in A-I10. Section 301.6330-1(c)(2), A-C6 also has been revised in the proposed regulations to provide that taxpayers should call the 1-800 number to obtain the address to which the CDP hearing request should be sent.

The proposed regulations are effective the date 30 days after final regulations are published in the Federal Register with respect to requests for CDP hearings or equivalent hearings made on or after the date 30 days after final regulations are published in the Federal Register.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any electronic and written comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clarity of the proposed regulations and how they may be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for January 19, 2006, at 10 a.m. in the IRS Auditorium, Internal Revenue Building (7th Floor), 1111 Constitution Avenue, NW, Washington, DC. All visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having a visitor’s name placed on the building access list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT caption.

An outline of the topics to be discussed and the time to be devoted to each topic must be submitted by any person who wishes to present oral comments at the hearing. Outlines must be received by December 29, 2005.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving requests to speak has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1. The authority citation for part 301 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 301.6330-1 is proposed to be amended as follows:

1. Paragraph (c)(2) A-C1, Q&A-C6 and A-C7 are revised.

2. Paragraph (d)(2) A-D4 and A-D7 are revised.

3. Paragraph (d)(2) Q&A-D8 is added.

4. Paragraph (d)(3) is added.

5. Paragraph (e)(1) is revised

6. Paragraph (e)(3) A-E2, A-E6 and A-E7 are revised.

7. Paragraph (f)(2) A-F5 is revised.

8. Paragraph (f)(2) Q&A-F6 is added.

9. Paragraph (i)(2) Q&A-I1 through Q&A-I5 are renumbered Q&A-I2 through Q&A-I6, a new paragraph (i)(2) Q&A-I1 and new paragraphs Q&A-I7 through Q&A-I11 are added.

10. Paragraph (j) is revised.

Section 409A was added to the Internal Revenue Code (Code) by section 885 of the American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418). Section 409A generally provides that unless certain requirements are met, amounts deferred under a nonqualified deferred compensation plan for all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Section 409A also includes rules applicable to certain trusts or similar arrangements associated with nonqualified deferred compensation, where such arrangements are located outside of the United States or are restricted to the provision of benefits in connection with a decline in the financial health of the sponsor.

On December 20, 2004, the IRS issued Notice 2005-1, 2005-2 I.R.B. 274 (published as modified on January 6, 2005), setting forth initial guidance with respect to the application of section 409A, and supplying transition guidance in accordance with the terms of the statute. Notice 2005-1 requested comments on all aspects of the application of section 409A, including certain specified topics. Numerous comments were submitted and all were considered by the Treasury Department and the IRS in formulating these regulations. In general, these regulations incorporate the guidance provided in Notice 2005-1 and provide substantial additional guidance. For a discussion of the continued applicability of Notice 2005-1, see the Effect on Other Documents section of this preamble.

These regulations are proposed to be generally applicable for taxable years beginning on or after January 1, 2007. As discussed, taxpayers may rely on these proposed regulations until the effective date of the final regulations.

These proposed regulations do not affect the applicability of other guidance issued with respect to section 409A, including Notice 2005-1, 2005-2 I.R.B. 274 (published as modified on January 6, 2005). However, upon the effective date of the final regulations, the Treasury Department and the IRS anticipate that Notice 2005-1 and certain other published guidance will become obsolete for periods after the effective date of the final regulations.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and Treasury Department request comments on the clarity of the proposed rules and how they can be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for January 25, 2006, beginning at 10 a.m. in the Auditorium of the Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written or electronic comments and an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and eight (8) copies) by January 4, 2006. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

(a) Nonqualified deferred compensation plan—(1) In general. Except as otherwise provided in this paragraph (a), the term nonqualified deferred compensation plan means any plan (within the meaning of paragraph (c) of this section) that provides for the deferral of compensation (within the meaning of paragraph (b) of this section).

(2) Qualified employer plans. The term nonqualified deferred compensation plan does not include—

(i) Any plan described in section 401(a) that includes a trust exempt from tax under section 501(a);

(ii) Any annuity plan described in section 403(a);

(iii) Any annuity contract described in section 403(b);

(iv) Any simplified employee pension (within the meaning of section 408(k));

(v) Any simple retirement account (within the meaning of section 408(p);

(vi) Any arrangement under which an active participant makes deductible contributions to a trust described in section 501(c)(18);

(vii) Any eligible deferred compensation plan (within the meaning of section 457(b)); and

(viii) Any plan described in section 415(m).

(3) Certain foreign plans—(i) Participation addressed by treaty. With respect to an individual for a taxable year, the term nonqualified deferred compensation plan does not include any scheme, trust or arrangement maintained with respect to such individual, where contributions made by or on behalf of such individual to such scheme, trust or arrangement are excludable by such individual for Federal income tax purposes pursuant to any bilateral income tax convention to which the United States is a party.

(ii) Participation by nonresident aliens and certain resident aliens. With respect to an alien individual for a taxable year during which such individual is a nonresident alien or a resident alien classified as a resident alien solely under section 7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)), the term nonqualified deferred compensation plan does not include any broad-based foreign retirement plan (within the meaning of paragraph (a)(3)(v) of this section) maintained by a person that is not a United States person.

(iii) Participation by U.S. citizens and lawful permanent residents. With respect to an individual for a given taxable year during which such individual is a U.S. citizen or a resident alien classified as a resident alien under section 7701(b)(1)(A)(i), and is not eligible to participate in a qualified employer plan described in paragraph (a)(2) of this section, the term nonqualified deferred compensation plan does not include a broad-based foreign retirement plan (within the meaning of paragraph (a)(3)(v) of this section) maintained by a service recipient that is not a United States person, but only with respect to nonelective deferrals of foreign earned income (as defined in section 911(b)(1)) and only to the extent that the amounts deferred under such plan in such taxable year do not exceed the applicable limits under section 415(b) and (c) that would be applicable if such plan were a plan subject to section 415 and the foreign earned income of such individual were treated as compensation for purposes of applying section 415(b) and (c).

(iv) Plans subject to a totalization agreement and similar plans. The term nonqualified deferred compensation plan does not include any social security system of a jurisdiction to the extent that benefits provided under or contributions made to the system are subject to an agreement entered into pursuant to section 233 of the Social Security Act with any foreign jurisdiction. In addition, the term nonqualified deferred compensation plan does not include a social security system of a foreign jurisdiction to the extent that benefits are provided under or contributions are made to a government-mandated plan as part of that foreign jurisdiction’s social security system.

(v) Broad-based retirement plan. For purposes of this paragraph (a)(3), the term broad-based retirement plan means a scheme, trust or arrangement that—

(A) Is written;

(B) In the case of an employer-maintained plan, is nondiscriminatory insofar as it (alone or in combination with other comparable plans) covers a wide range of employees, substantially all of whom are nonresident aliens or resident aliens classified as resident aliens solely under section 7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)), including rank and file employees, and actually provides significant benefits for the range of covered employees;

(C) In the case of an employer-maintained plan, contains provisions that generally limit the employees’ ability to use plan benefits for purposes other than retirement or restrict access to plan benefits prior to separation from service, such as restricting in-service distributions except in events similar to an unforeseeable emergency (as defined in §1.409A-3(g)(3)(i)) or hardship (as defined for purposes of section 401(k)(2)(B)(i)(IV)), and in all cases is subject to tax or plan provisions that discourage participants from using the assets for purposes other than retirement; and

(D) Provides for payment of a reasonable level of benefits at death, a stated age, or an event related to work status, and otherwise requires minimum distributions under rules designed to ensure that any death benefits provided to the participants’ survivors are merely incidental to the retirement benefits provided to the participants.

(vi) Participation by a nonresident alien — de minimis amounts. With respect to a nonresident alien, the term nonqualified deferred compensation plan does not include any foreign plan maintained by a service recipient that is not a United States person for a taxable year, to the extent that the amounts deferred under the foreign plan based upon the nonresident alien’s services performed in the United States (including compensation received due to services performed in the United States) do not exceed $10,000 in the taxable year.

(4) Section 457 plans. A nonqualified deferred compensation plan under section 457(f) may constitute a nonqualified deferred compensation plan for purposes of this paragraph (a). The rules of section 409A apply to nonqualified deferred compensation plans separately and in addition to any requirements applicable to such plans under section 457(f). In addition, nonelective deferred compensation of nonemployees described in section 457(e)(12) and a grandfathered plan or arrangement described in §1.457-2(k)(4) may constitute a nonqualified deferred compensation plan for purposes of this paragraph (a). The term nonqualified deferred compensation plan does not include a length of service award to a bona fide volunteer under section 457(e)(11)(A)(ii).

(5) Certain welfare benefits. The term nonqualified deferred compensation plan does not include any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. For these purposes, the term disability pay has the same meaning as provided in §31.3121(v)(2)-1(b)(4)(iv)(C) of this chapter, and the term death benefit plan refers to a plan providing death benefits as defined in §31.3121(v)(2)-1(b)(4)(iv)(C) of this chapter. The term nonqualified deferred compensation plan also does not include any Archer Medical Savings Account as described in section 220, any Health Savings Account as described in section 223, or any other medical reimbursement arrangement, including a health reimbursement arrangement, that satisfies the requirements of section 105 and section 106.

(b) Deferral of compensation—(1) In general. Except as otherwise provided in paragraphs (b)(3) through (b)(9) of this section, a plan provides for the deferral of compensation if, under the terms of the plan and the relevant facts and circumstances, the service provider has a legally binding right during a taxable year to compensation that has not been actually or constructively received and included in gross income, and that, pursuant to the terms of the plan, is payable to (or on behalf of) the service provider in a later year. A service provider does not have a legally binding right to compensation if that compensation may be reduced unilaterally or eliminated by the service recipient or other person after the services creating the right to the compensation have been performed. However, if the facts and circumstances indicate that the discretion to reduce or eliminate the compensation is available or exercisable only upon a condition, or the discretion to reduce or eliminate the compensation lacks substantive significance, a service provider will be considered to have a legally binding right to the compensation. Whether the negative discretion lacks substantive significance depends on the facts and circumstances of the particular arrangement. However, where the service provider to whom the compensation may be paid has effective control of the person retaining the discretion to reduce or eliminate the compensation, or has effective control over any portion of the compensation of the person retaining the discretion to reduce or eliminate the compensation, or is a member of the family (as defined in section 267(c)(4) applied as if the family of an individual includes the spouse of any member of the family) of the person retaining the discretion to reduce or eliminate the compensation, the discretion to reduce or eliminate the compensation will not be treated as having substantive significance. For this purpose, compensation is not considered subject to unilateral reduction or elimination merely because it may be reduced or eliminated by operation of the objective terms of the plan, such as the application of an objective provision creating a substantial risk of forfeiture. Similarly, a service provider does not fail to have a legally binding right to compensation merely because the amount of compensation is determined under a formula that provides for benefits to be offset by benefits provided under a plan that is qualified under section 401(a), or because benefits are reduced due to actual or notional investment losses, or in a final average pay plan, subsequent decreases in compensation.

(2) Earnings. References to the deferral of compensation include references to earnings. When the right to earnings is specified under the terms of the arrangement, the legally binding right to earnings arises at the time of the deferral of the compensation to which the earnings relate. However, a plan may provide that the right to the earnings is treated separately from the right to the underlying compensation. For example, provided that the rules of section 409A are otherwise met, a plan may provide that earnings will be paid at a separate time or in a separate form from the payment of the underlying compensation. For the application of the deferral election rules to current payments of earnings and dividend equivalents, see §1.409A-2(a)(13).

(3) Compensation payable pursuant to the service recipient’s customary payment timing arrangement. A deferral of compensation does not occur solely because compensation is paid after the last day of the service provider’s taxable year pursuant to the timing arrangement under which the service recipient normally compensates service providers for services performed during a payroll period described in section 3401(b), or with respect to a non-employee service provider, a period not longer than the payroll period described in section 3401(b) or if no such payroll period exists, a period not longer than the earlier of the normal timing arrangement under which the service provider normally compensates non-employee service providers or 30 days after the end of the service provider’s taxable year.

(4) Short-term deferrals—(i) In general. A deferral of compensation does not occur if, absent an election by the service provider (including an election under §1.409A-2(a)(3)) to otherwise defer the payment of the compensation to a later period, an amount of compensation is actually or constructively received by the service provider by the later of the 15^th day of the third month following the service provider’s first taxable year in which the amount is no longer subject to a substantial risk of forfeiture or the 15^th day of the third month following the end of the service recipient’s first taxable year in which the amount is no longer subject to a substantial risk of forfeiture. In addition, the arrangement must not otherwise defer the payment to a later period. For example, an arrangement that deferred a payment until 5 years after the lapsing of a condition that constituted a substantial risk of forfeiture would constitute a deferral of compensation even if the amount were actually paid on the date the substantial risk of forfeiture lapsed. For these purposes, an amount that is never subject to a substantial risk of forfeiture is considered to be no longer subject to a substantial risk of forfeiture on the first date the service provider has a legally binding right to the amount. For example, an employer with a calendar year taxable year who on November 1, 2008, awards a bonus so that the employee is considered to have a legally binding right to the payment as of November 1, 2008, will not be considered to have provided for a deferral of compensation if, absent an election to otherwise defer the payment, the amount is paid or made available to the employee on or before March 15, 2009. An employer with a taxable year ending August 31 who on November 1, 2008, awards a bonus so that the employee is considered to have a legally binding right to the payment as of November 1, 2008, will not be considered to have provided for a deferral of compensation if, absent an election to otherwise defer the payment, the amount is paid or made available to the employee on or before November 15, 2009.

(ii) Delayed payments due to unforeseeable events. A payment that otherwise qualifies as a short-term deferral under paragraph (b)(4)(i) of this section but is made after the 15^th day of the third month following the end of the relevant taxable year (the applicable 2¹/₂ month period) may continue to qualify as a short-term deferral if the taxpayer establishes that it was administratively impracticable to make the payment by the end of the applicable 2¹/₂ month period or that making the payment by the end of the applicable 2¹/₂ month period would have jeopardized the solvency of the service recipient, and, as of the date upon which the legally binding right to the compensation arose, such impracticability or insolvency was unforeseeable, and also the payment is made as soon as reasonably practicable. For example, an amount that would otherwise qualify as a short-term deferral except that the payment is made after the applicable 2¹/₂ month period may continue to qualify as a short-term deferral under this paragraph (b)(4) to the extent that the delay is caused either because the funds of the service recipient were not sufficient to make the payment before the end of the applicable 2¹/₂ month period without jeopardizing the solvency of the service recipient, or because it was not reasonably possible to determine by the end of the applicable 2¹/₂ month period whether payment of such amount was to be made, and the circumstance causing the delay was unforeseeable as of the date upon which the legally binding right to the compensation arose. Thus, the amount will not continue to qualify as a short-term deferral to the extent it was foreseeable, as of date upon which the legally binding right to the compensation arose, that the amount would not be paid within the applicable 2¹/₂ month period. For purposes of this paragraph (b)(4)(ii), an action or failure to act of the service provider or a person under the service provider’s control, such as a failure to provide necessary information or documentation, is not an unforeseeable event.

(5) Stock options, stock appreciation rights and other equity-based compensation—(i) Stock rights—(A) Nonstatutory stock options not providing for the deferral of compensation. An option to purchase service recipient stock does not provide for a deferral of compensation if—

(1) The amount required to purchase stock under the option (the exercise price) may never be less than the fair market value of the underlying stock (disregarding lapse restrictions as defined in §1.83-3(i)) on the date the option is granted and the number of shares subject to the option is fixed on the original date of grant of the option;

(2) The transfer or exercise of the option is subject to taxation under section 83 and §1.83-7; and

(3) The option does not include any feature for the deferral of compensation other than the deferral of recognition of income until the later of exercise or disposition of the option under §1.83-7, or the time the stock acquired pursuant to the exercise of the option first becomes substantially vested (as defined in §1.83-3(b)).

(B) Stock appreciation rights not providing for the deferral of compensation. A right to compensation equal to the appreciation in value of a specified number of shares of stock of the service recipient occurring between the date of grant and the date of exercise of such right (a stock appreciation right) does not provide for a deferral of compensation if—

(1) Compensation payable under the stock appreciation right cannot be greater than the difference between the fair market value of the stock (disregarding lapse restrictions as defined in §1.83-3(i)) on the date of grant of the stock appreciation right and the fair market value of the stock (disregarding lapse restrictions as defined in §1.83-3(i)) on the date the stock appreciation right is exercised, with respect to a number of shares fixed on or before the date of grant of the right;

(2) The stock appreciation right exercise price may never be less than the fair market value of the underlying stock (disregarding lapse restrictions as defined in §1.83-3(i)) on the date the right is granted; and

(3) The stock appreciation right does not include any feature for the deferral of compensation other than the deferral of recognition of income until the exercise of the stock appreciation right.

(C) Stock rights that may provide for the deferral of compensation. An option to purchase stock other than service recipient stock, or a stock appreciation right with respect to stock other than service recipient stock, generally will provide for the deferral of compensation within the meaning of this paragraph (b). If under the terms of an option to purchase service recipient stock (other than an incentive stock option described in section 422 or a stock option granted under an employee stock purchase plan described in section 423), the amount required to purchase the stock is or could become less than the fair market value of the stock (disregarding lapse restrictions as defined in §1.83-3(i)) on the date of grant, the grant of the option may provide for the deferral of compensation within the meaning of this paragraph (b). If under the terms of a stock appreciation right with respect to service recipient stock, the compensation payable under the stock appreciation right is or could be any amount greater than, with respect to a predetermined number of shares, the difference between the stock value (disregarding lapse restrictions as defined in §1.83-3(i)) on the date of grant of the stock appreciation right and the stock value (disregarding lapse restrictions as defined in §1.83-3(i)) on the date the stock appreciation right is exercised, the grant of the stock appreciation right may provide for a deferral of compensation within the meaning of this paragraph (b).

(D) Feature for the deferral of compensation. To the extent a stock right grants the recipient a right other than to receive cash or stock on the date of exercise and such additional rights allow for the deferral of compensation, the entire arrangement (including the underlying stock right) provides for the deferral of compensation. For purposes of this paragraph (b)(5)(i), neither the right to receive substantially nonvested stock (as defined in §1.83-3(b)) upon the exercise of a stock right, nor the right to pay the exercise price with previously acquired shares, constitutes a feature for the deferral of compensation.

(E) Rights to dividends declared. For purposes of this paragraph (b)(5)(i), the right to receive, upon the exercise of a stock right, an amount equal to all or part of the dividends declared and paid on the number of shares underlying the stock right between the date of grant and the date of exercise of the stock right constitutes an offset to the exercise price of the stock option or an increase in the amount payable under the stock appreciation right (generally causing such stock rights to be subject to section 409A), unless the right to the dividends declared and paid on the number of shares underlying the stock right is explicitly set forth as a separate arrangement. If set forth as a separate arrangement, the arrangement may provide for deferred compensation for purposes of section 409A. However, the existence of a separate arrangement to receive such an amount that complies with the requirements of section 409A would not cause a stock right to fail to satisfy the requirements of the exclusion from the definition of deferred compensation provided in paragraphs (b)(5)(i)(A) and (B) of this section.

(ii) Statutory stock options. The grant of an incentive stock option as described in section 422, or the grant of an option under an employee stock purchase plan described in section 423 (including the grant of an option with an exercise price discounted in accordance with section 423(b)(6) and the accompanying regulations), does not constitute a deferral of compensation. However, this paragraph (b)(5)(ii) does not apply to a modification, extension, or renewal of a statutory option that is treated as the grant of a new option that is not a statutory option. See §1.424-1(e). In such event, the option is treated as if it were a nonstatutory stock option at the date of the original grant, so that the modification, extension or renewal of the stock option that caused the stock option to be treated as the grant of a new option under §1.424-1(e) is treated as causing the option to be treated as the grant of a new option for purposes of this paragraph (b)(5) only if such modification, extension or renewal of the stock option would have been treated as resulting in the grant of a new option under paragraph (b)(5)(v) of this section.

(iii) Stock of the service recipient—(A) In general. Except as otherwise provided in paragraphs (b)(5)(iii)(B) and (C) of this section, for purposes of this section, stock of the service recipient means stock that, as of the date of grant, is common stock of a corporation that is a service recipient (including any member of a group of corporations or other entities treated as a single service recipient) that is readily tradable on an established securities market, or if none, that class of common stock of such corporation having the greatest aggregate value of common stock issued and outstanding of such corporation, or common stock with substantially similar rights to stock of such class (disregarding any difference in voting rights). However, under no circumstances does stock of the service recipient include stock that is preferred as to liquidation or dividend rights or that includes or is subject to a mandatory repurchase obligation or a put or call right that is not a lapse restriction as defined in §1.83-3(i) and is based on a measure other than the fair market value (disregarding lapse restrictions as defined in §1.83-3(i)) of the equity interest in the corporation represented by the stock.

(B) American depositary receipts. For purposes of this section, an American depositary receipt or American depositary share may constitute service recipient stock, to the extent that the stock traded on a foreign securities market to which the American depositary receipt or American depositary share relates qualifies as service recipient stock.

(C) Mutual company units. For purposes of this section, mutual company units may constitute service recipient stock. For this purpose, the term mutual company unit means a fixed percentage of the overall value of a non-stock mutual company. For purposes of determining the value of the mutual company unit, the unit may be valued in accordance with the rules set forth in paragraph (b)(5)(iv)(B) of this section governing valuation of service recipient stock the shares of which are not traded on an established securities market, applied as if the mutual company were a stock corporation with one class of common stock and the number of shares of such stock determined according to the fixed percentage. For example, an appreciation right based on the appreciation of 10 mutual company units, where each unit is defined as 1 percent of the overall value of the mutual company, would be valued as if the appreciation right were based upon 10 shares of a corporation with 100 shares of common stock and no other class of stock, whose shares are not readily tradable on an established securities market.

(D) Definition of service recipient—(1) In general. For purposes of this paragraph (b)(5)(iii), the term service recipient generally has the same meaning as provided in paragraph (g) of this section, provided that a stock right, or the plan or arrangement under which the stock right is granted, may specify that in applying section 1563(a)(1), (2) and (3) for purposes of determining a controlled group of corporations under section 414(b), the language “at least 50 percent” is used instead of “at least 80 percent” each place it appears in section 1563(a)(1), (2) and (3), and in applying §1.414(c)-2 for purposes of determining trades or businesses (whether or not incorporated) that are under common control for purposes of section 414(c), the language “at least 50 percent” is used instead of “at least 80 percent” each place it appears in §1.414(c)-2. In addition, where the use of such stock with respect to the grant of a stock right to such service provider is based upon legitimate business criteria, the term service recipient has the same meaning as provided in paragraph (g) of this section, provided that the stock right, or the plan or arrangement under which the stock right is granted, may specify that in applying sections 1563(a)(1), (2) and (3) for purposes of determining a controlled group of corporations under section 414(b), the language “at least 20 percent” is used instead of “at least 80 percent” at each place it appears in sections 1563(a)(1), (2) and (3), and in applying §1.414(c)-2 for purposes of determining trades or businesses (whether or not incorporated) that are under common control for purposes of section 414(c), the language “at least 20 percent” is used instead of “at least 80 percent” at each place it appears in §1.414(c)-2. For example, stock of a corporation participating in a joint venture involving an operating business, used with respect to stock rights granted to employees of the joint venture who are former employees of such corporation, generally will constitute use of such stock based upon legitimate business criteria, and therefore could constitute service recipient stock with respect to such employees if the corporation owns at least 20 percent of the joint venture and the other requirements of this paragraph (b)(5)(iii) are met. A designation by a service recipient to use the 50 percent or 20 percent thresholds described in this paragraph (b)(5)(iii)(D) must be applied consistently as to all compensatory stock rights for purposes of this paragraph (b)(5)(iii), and any designation of a different permissible ownership threshold percentage may not be made effective until 12 months after the adoption of such change.

(2) Investment vehicles. Notwithstanding the provisions of paragraph (b)(5)(iii)(D)(1) of this section, except as to a service provider providing services directly to such corporation, for purposes of this paragraph (b)(5) the term service recipient does not include any corporation whose primary purpose is to serve as an investment vehicle with respect to the corporation’s interest in entities other than the service recipient.

(3) Substitutions and assumptions by reason of a corporate transaction. If the requirements of paragraph (b)(5)(v)(D) of this section are met such that the substitution of a new stock right pursuant to a corporate transaction for an outstanding stock right, or the assumption of an outstanding stock right pursuant to a corporate transaction, would not be treated as the grant of a new stock right or a change in the form of payment for purposes of section 409A, the stock underlying the stock right that is substituted or assumed will be treated as service recipient stock for purposes of applying this paragraph (b)(5) to the replacement stock rights. For example, where by reason of a spinoff transaction under which a subsidiary corporation is spun off from a distributing corporation, a distributing corporation employee’s stock option to purchase distributing corporation stock is replaced with a stock option to purchase distributing corporation stock and a stock option to purchase the spun off subsidiary corporation’s stock, and where such substitution is not treated as a modification of the original stock option pursuant to paragraph (b)(5)(v)(D) of this section, both the distributing corporation stock and the subsidiary corporation stock are treated as service recipient stock for purposes of applying this paragraph (b)(5) to the replacement stock options.

(E) Stock rights granted on or before December 31, 2004. Notwithstanding the requirements of paragraph (b)(5)(iii)(A) of this section, any class of common stock of the service recipient with respect to which stock rights were granted to service providers on or before December 31, 2004, is treated as service recipient stock for purposes of this paragraph (b)(5)(iii), but only with respect to stock rights granted on or before December 31, 2004.

(iv) Determination of the fair market value of service recipient stock—(A) Stock readily tradable on an established securities market. For purposes of (b)(5)(i) of this section, in the case of service recipient stock that is readily tradable on an established securities market, the fair market value of the stock may be determined based upon the last sale before or the first sale after the grant, the closing price on the trading day before or the trading day of the grant, or any other reasonable basis using actual transactions in such stock as reported by such market and consistently applied. The determination of fair market value also may be based upon an average selling price during a specified period that is within 30 days before or 30 days after the grant, provided that the commitment to grant the stock right based on such valuation method must be irrevocable before the beginning of the specified period, and such valuation method must be used consistently for grants of stock rights under the same and substantially similar programs.

(B) Stock not readily tradable on an established securities market—(1) In general. For purposes of paragraph (b)(5)(i) of this section, in the case of service recipient stock that is not readily tradable on an established securities market, the fair market value of the stock as of a valuation date means a value determined by the reasonable application of a reasonable valuation method. The determination of whether a valuation method is reasonable, or whether an application of a valuation method is reasonable, is made based on the facts and circumstances as of the valuation date. Factors to be considered under a reasonable valuation method include, as applicable, the value of tangible and intangible assets of the corporation, the present value of future cash-flows of the corporation, the market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substantially similar to those engaged in by the corporation whose stock is to be valued, the value of which can be readily determined through objective means (such as through trading prices on an established securities market or an amount paid in an arm’s length private transaction), and other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material economic effect on the service recipient, its stockholders or its creditors. The use of a valuation method is not reasonable if such valuation method does not take into consideration in applying its methodology, all available information material to the value of the corporation. Similarly, the use of a value previously calculated under a valuation method is not reasonable as of a later date if such calculation fails to reflect information available after the date of the calculation that may materially affect the value of the corporation (for example, the resolution of material litigation or the issuance of a patent) or the value was calculated with respect to a date that is more than 12 months earlier than the date for which the valuation is being used. The service recipient’s consistent use of a valuation method to determine the value of its stock or assets for other purposes, including for purposes unrelated to compensation of service providers, is also a factor supporting the reasonableness of such valuation method.

(2) Presumption of reasonableness. For purposes of this paragraph (b)(5)(iv)(B), the consistent use of any of the following methods of valuation is presumed to result in a reasonable valuation, provided that the Commissioner may rebut such a presumption upon a showing that either the valuation method or the application of such method was grossly unreasonable:

(i) A valuation of a class of stock determined by an independent appraisal that meets the requirements of section 401(a)(28)(C) and the regulations thereunder as of a date that is no more than 12 months before the relevant transaction to which the valuation is applied (for example, the grant date of a stock option).

(ii) A valuation based upon a formula that, if used as part of a nonlapse restriction (as defined in §1.83-3(h)) with respect to the stock, would be considered to be the fair market value of the stock pursuant to §1.83-5, provided that such stock is valued in the same manner for purposes of any nonlapse restriction applicable to the transfer of any shares of such class of stock (or substantially similar class of stock), and all noncompensatory purposes requiring the valuation of such stock, including regulatory filings, loan covenants, issuances to and repurchases of stock from persons other than service providers, and other third-party arrangements, and such valuation method is used consistently for all such purposes, and provided further that this paragraph (b)(5)(iv)(B)(2)(ii) does not apply with respect to stock subject to a stock right payable in stock, where the stock acquired pursuant to the exercise of the stock right is transferable other than through the operation of a nonlapse restriction.

(iii) A valuation, made reasonably and in good faith and evidenced by a written report that takes into account the relevant factors described in paragraph (b)(5)(iv)(B)(1) of this section, of an illiquid stock of a start-up corporation. For this purpose, an illiquid stock of a start-up corporation is service recipient stock of a service recipient corporation that has no trade or business that it or any predecessor to it has conducted for a period of 10 years or more and has no class of equity securities that are traded on an established securities market (as defined in paragraph (k) of this section), where such stock is not subject to any put or call right or obligation of the service recipient or other person to purchase such stock (other than a right of first refusal upon an offer to purchase by a third party that is unrelated to the service recipient or service provider and other than a right or obligation that constitutes a lapse restriction as defined in §1.83-3(i)), and provided that this paragraph (b)(5)(iv)(B)(2)(iii) does not apply to the valuation of any stock if the service recipient or service provider may reasonably anticipate, as of the time the valuation is applied, that the service recipient will undergo a change in control event as described in §1.409A-3(g)(5)(v) or §1.409A-3(g)(5)(vii) or make a public offering of securities within the 12 months following the event to which the valuation is applied (for example, the grant of a stock option or exercise of a stock appreciation right). For purposes of this paragraph (b)(5)(iv)(B)(2)(iii), a valuation will not be treated as made reasonably and in good faith unless the valuation is performed by a person or persons with significant knowledge and experience or training in performing similar valuations.

(3) Consistent use of a method. For purposes of paragraph (b)(5)(iv)(B)(2) of this section, the consistent use of a valuation method means the consistent use of the method for all equity-based compensation arrangements, including with respect to stock rights, for purposes of determining the exercise price, and with respect to stock appreciation rights not paid in stock, for purposes of determining the payment at the date of exercise, and for stock appreciation rights or stock options paid in stock subject to a put or call right providing for the potential repurchase by the service recipient, or other obligation of the service recipient or other person to purchase such stock, for purposes of determining the payment at the date of the purchase of such stock. Notwithstanding the foregoing, a service recipient may change the method prospectively for purposes of new grants of equity-based compensation, including stock rights. In addition, where after the date of grant, but before the date of exercise, of the stock right, the service recipient stock to which the stock right relates becomes readily tradable on an established securities market, the service recipient must use the valuation method set forth in paragraph (b)(5)(iv)(A) of this section for purposes of determining the payment at the date of exercise or the purchase of the stock, as applicable.

(v) Modifications, extensions, renewals, substitutions and assumptions of stock rights—(A) Treatment of modified stock right as a new grant. Any modification of the terms of a stock right, other than an extension or renewal of the stock right, is considered the granting of a new stock right. The new stock right may or may not constitute a deferral of compensation under paragraph (b)(5)(i) of this section, determined at the date of grant of the new stock right. Where a stock right is extended or renewed, the stock right is treated as having had an additional deferral feature from the date of grant.

(B) Modification in general. The term modification means any change in the terms of the stock right (or change in the terms of the arrangement pursuant to which the stock right was granted or in the terms of any other agreement governing the stock right) that may provide the holder of the stock right with a direct or indirect reduction in the exercise price of the stock right, or an additional deferral feature, or an extension or renewal of the stock right, regardless of whether the holder in fact benefits from the change in terms. In contrast, a change in the terms of the stock right shortening the period during which the stock right is exercisable is not a modification. It is not a modification to add a feature providing the ability to tender previously acquired stock for the stock purchasable under the stock right, or to withhold or have withheld shares of stock to facilitate the payment of employment taxes or required withholding taxes resulting from the exercise of the stock right. In addition, it is not a modification for the grantor to exercise discretion specifically reserved under a stock right with respect to the transferability of the stock right.

(C) Extensions and renewals. An extension of a stock right refers to the granting to the holder of an additional period of time within which to exercise the stock right beyond the time originally prescribed, provided that it is not an extension if the exercise period of the stock right is extended to a date no later than the later of the 15^th day of the third month following the date at which, or December 31 of the calendar year in which, the stock right would otherwise have expired if the stock right had not been extended, based on the terms of the stock right at the original grant date. For example, an option granted January 1, 2011, that expires upon the earlier of January 1, 2021, or 30 days after separation from service will not be considered to be modified if, upon the holder’s separation from service on July 1, 2015, the term is extended to December 31, 2015. Notwithstanding the foregoing, it is not an extension of a stock right if the expiration of the stock right is tolled while the stock right is unexercisable because an exercise of the stock right would violate applicable securities laws, provided that the period during which the stock right may be exercised is not extended more than 30 days after the exercise of the stock right first would no longer violate applicable securities laws. A renewal of a stock right is the granting by the corporation of the same rights or privileges contained in the original stock right on the same terms and conditions.

(D) Substitutions and assumptions of stock rights by reason of a corporate transaction. If the requirements of §1.424-1 would be met if the stock right were a statutory option, the substitution of a new stock right pursuant to a corporate transaction for an outstanding stock right or the assumption of an outstanding stock right pursuant to a corporate transaction will not be treated as the grant of a new stock right or a change in the form of payment for purposes of section 409A. For purposes of the preceding sentence, the requirement of §1.424-1(a)(5)(iii) will be deemed to be satisfied if the ratio of the exercise price to the fair market value of the shares subject to the stock right immediately after the substitution or assumption is not greater than the ratio of the exercise price to the fair market value of the shares subject to the stock right immediately before the substitution or assumption. In the case of a transaction described in section 355 in which the stock of the distributing corporation and the stock distributed in the transaction are both readily tradable on an established securities market immediately after the transaction, for purposes of this paragraph (b)(5)(v), the requirements of §1.424-1(a)(5) may be satisfied by using market quotations for the stock of the distributing corporation and the stock distributed in the transaction as of a predetermined date not more than 60 days after the transaction or based on an average of such market prices over a predetermined period of not more than 30 days ending not later than 60 days after the transaction.

(E) Acceleration of date when exercisable. If a stock right is not immediately exercisable in full, a change in the terms of the right to accelerate the time at which the stock right (or any portion thereof) may be exercised is not a modification for purposes of this section. With respect to a stock right subject to section 409A, however, such an acceleration may constitute an impermissible acceleration of a payment date under §1.409A-3(h). Additionally, no modification occurs if a provision accelerating the time when a stock right may first be exercised is removed before the year in which it would otherwise be triggered.

(F) Discretionary added benefits. If a change to a stock right provides, either by its terms or in substance, that the holder may receive an additional benefit under the stock right at the future discretion of the grantor, and the addition of such benefit would constitute a modification, then the addition of such discretion is a modification at the time that the stock right is changed to provide such discretion.

(G) Change in underlying stock increasing value. A change in the terms of the stock subject to a stock right that increases the value of the stock is a modification of such stock right, except to the extent that a new stock right is substituted for such stock right by reason of the change in the terms of the stock in accordance with paragraph (b)(5)(v)(D) of this section.

(H) Change in the number of shares purchasable. If a stock right is amended solely to increase the number of shares subject to the stock right, the increase is not considered a modification of the stock right but is treated as the grant of a new additional stock right to which the additional shares are subject. Notwithstanding the previous sentence, if the exercise price and number of shares subject to a stock right are proportionally adjusted to reflect a stock split (including a reverse stock split) or stock dividend, and the only effect of the stock split or stock dividend is to increase (or decrease) on a pro rata basis the number of shares owned by each shareholder of the class of stock subject to the stock right, then the stock right is not modified if it is proportionally adjusted to reflect the stock split or stock dividend and the aggregate exercise price of the stock right is not less than the aggregate exercise price before the stock split or stock dividend.

(I) Rescission of changes. Any change to the terms of a stock right (or change in the terms of the plan pursuant to which the stock right was granted or in the terms of any other agreement governing the right) that would inadvertently result in treatment as a modification under paragraph (b)(5)(v)(A) of this section is not considered a modification of the stock right to the extent the change in the terms of the stock right is rescinded by the earlier of the date the stock right is exercised or the last day of the calendar year during which such change occurred. Thus, for example, if the terms of a stock right are changed on March 1 to extend the exercise period and the change is rescinded on November 1, then if the stock right is not exercised before the change is rescinded, the stock right is not considered modified under paragraph (b)(5)(v)(A) of this section.

(J) Successive modifications. The rules of this paragraph (b)(5)(v) apply as well to successive modifications, including successive extensions or renewals.

(6) Restricted Property—(i) In general. If a service provider receives property from, or pursuant to, a plan maintained by a service recipient, there is no deferral of compensation merely because the value of the property is not includible in income in the year of receipt by reason of the property being substantially nonvested (as defined in §1.83-3(b)), or is includible in income solely due to a valid election under section 83(b). For purposes of this paragraph (b)(6)(i), a transfer of property includes the transfer of a beneficial interest in a trust or annuity plan, or a transfer to or from a trust or under an annuity plan, to the extent such a transfer is subject to section 83, section 402(b) or section 403(c).

(ii) Promises to transfer property. A plan under which a service provider obtains a legally binding right to receive property (whether or not the property will be substantially nonvested (as defined in §1.83-3(b)) at the time of grant) in a future year may provide for the deferral of compensation and, accordingly, may constitute a nonqualified deferred compensation plan. The vesting of substantially nonvested property subject to section 83 may be treated as a payment for purposes of section 409A, including for purposes of applying the short-term deferral rules under paragraph (b)(4) of this section. Accordingly, where the promise to transfer the substantially nonvested property and the right to retain the substantially nonvested property are both subject to a substantial risk of forfeiture (as defined under paragraph (d) of this section), the arrangement generally would constitute a short-term deferral under paragraph (b)(4) of this section because the payment would occur simultaneously with the vesting of the right to the property. For example, where an employee participates in a two-year bonus program such that, if the employee continues in employment for two years, the employee is entitled to either the immediate payment of a $10,000 cash bonus or the grant of restricted stock with a $15,000 fair market value subject to a vesting requirement of three additional years of service, the arrangement generally would constitute a short-term deferral under paragraph (b)(4) of this section because under either alternative the payment would be received within the short-term deferral period.

(7) Arrangements between partnerships and partners. [Reserved.]

(8) Certain foreign arrangements—(i) Arrangements with respect to compensation covered by treaty or other international agreement. An arrangement with a service provider does not provide for a deferral of compensation for purposes of this paragraph (b) to the extent that the compensation under the arrangement would have been excluded from gross income for Federal income tax purposes under the provisions of any bilateral income tax convention or other bilateral or multilateral agreement to which the United States is a party if the compensation had been paid to the service provider at the time that the legally binding right to the compensation first arose or, if later, the time that the legally binding right was no longer subject to a substantial risk of forfeiture.

(ii) Arrangements with respect to certain other compensation. An arrangement with a service provider does not provide for a deferral of compensation for purposes of this paragraph (b) to the extent that compensation under the arrangement would not have been includible in gross income for Federal tax purposes if it had been paid to the service provider at the time that the legally binding right to the compensation first arose or, if later, the time that the legally binding right was no longer subject to a substantial risk of forfeiture, due to one of the following—

(A) The service provider was a nonresident alien at such time and the compensation would not have been includible in gross income under section 872;

(B) The service provider was a qualified individual (as defined in section 911(d)(1)) at such time and the compensation would have been foreign earned income within the meaning of section 911(b)(1) if paid at such time, and the compensation would have been foreign earned income within the meaning of section 911(b)(1) that is less than the difference between the maximum exclusion amount under section 911(b)(2)(D) for such taxable year and the amount of foreign earned income actually excludible from gross income by such qualified individual for such taxable year under section 911(a)(1);

(C) The compensation would have been excludible from gross income under section 893; or

(D) The compensation would have been excludible from gross income under section 931 or section 933.

(iii) Tax equalization arrangements. Compensation paid under a tax equalization arrangement does not provide for a deferral of compensation, provided that any payment made under such arrangement is paid no later than the end of the second calendar year beginning after the calendar year in which the service provider’s U.S. Federal income tax return is required to be filed (including extension) for the year to which the tax equalization payment relates. For purposes of this paragraph (b)(8)(iii), the term tax equalization arrangement refers to an arrangement that provides payments intended to compensate the service provider for the excess of the taxes actually imposed by a foreign jurisdiction on the compensation paid (other than the compensation under the tax equalization agreement) by the service recipient to the service provider over the taxes that would be imposed if the compensation were subject solely to United States Federal income tax, and provided that the payments made under such arrangement may not exceed such excess and the amount necessary to compensate for the additional taxes on the amounts paid under the arrangement.

(iv) Additional foreign arrangements. An arrangement with a service provider does not provide for a deferral of compensation for purposes of this paragraph (b) to the extent designated by the Commissioner in revenue procedures, notices, or other guidance published in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter).

(v) Earnings. Earnings on compensation excluded from the definition of deferral of compensation pursuant to this paragraph (b)(8) are also not treated as a deferred compensation. However, amounts that would be recharacterized as deferred compensation under §31.3121(v)(2)-1(d)(2)(iii)(B) of this chapter (nonaccount balance plans), §31.3121(v)(2)-1(d)(2)(iii)(A) of this chapter (account balance plans), or similar principles with respect to plans that are neither nonaccount balance plans nor account balance plans, will not be treated as earnings for purposes of this paragraph (b)(8)(v).

(9) Separation pay arrangements—(i) In general. An arrangement that otherwise provides for a deferral of compensation under this paragraph (b) does not fail to provide a deferral of compensation merely because the right to payment of the compensation is conditioned upon a separation from service. However, see paragraphs (b)(9)(ii), (iii) and (iv) of this section for separation pay arrangements that do not provide for the deferral of compensation. Notwithstanding any other provision of this paragraph (b)(9), any payment or benefit, or entitlement to a payment or benefit, that acts as a substitute for, or replacement of, amounts deferred by the service recipient under a separate nonqualified deferred compensation plan constitutes a payment or a deferral of compensation under the separate nonqualified deferred compensation plan, and does not constitute a payment or deferral of compensation under a separation pay arrangement.

(ii) Collectively bargained separation pay arrangements. A separation pay arrangement does not provide for a deferral of compensation if the arrangement is a collectively bargained separation pay arrangement that provides for separation pay upon an actual involuntary separation from service or pursuant to a window program. Only the portion of the separation pay arrangement attributable to employees covered by a collective bargaining agreement is considered to be provided under a collectively bargained separation pay arrangement. A collectively bargained separation pay arrangement is a separation pay arrangement that meets the following conditions:

(A) The separation pay arrangement is contained within an agreement that the Secretary of Labor determines to be a collective bargaining agreement.

(B) The separation pay provided by the collective bargaining agreement was the subject of arms-length negotiations between employee representatives and one or more employers, and the agreement between employee representatives and one or more employers satisfies section 7701(a)(46).

(C) The circumstances surrounding the agreement evidence good faith bargaining between adverse parties over the separation pay to be provided under the agreement.

(iii) Separation pay plans due to involuntary separation from service or participation in a window program. A separation pay plan that is not described in paragraph (b)(9)(ii) of this section and that provides for separation pay upon an actual involuntary separation from service or pursuant to a window program does not provide for a deferral of compensation if the plan provides that—

(A) The separation pay (other than amounts described in paragraph (b)(9)(iv) of this section) may not exceed two times the lesser of—

(1) The sum of the service provider’s annual compensation (as defined in §1.415-2(d)) for services provided to the service recipient as an employee and the service provider’s net earnings from self-employment (as defined in section 1402(a)) for services provided to the service recipient as an independent contractor, each for the calendar year preceding the calendar year in which the service provider has a separation from service from such service recipient; or

(2) The maximum amount that may be taken into account under a qualified plan pursuant to section 401(a)(17) for such year; and

(B) The separation pay must be paid no later than December 31 of the second calendar year following the calendar year in which occurs the separation from service.

(iv) Reimbursements and certain other separation payments—(A) In general. To the extent a separation pay arrangement entitles a service provider to payment by the service recipient for a limited period of time of reimbursements that are otherwise excludible from gross income, of reimbursements for expenses that the service provider can deduct under section 162 or section 167 as business expenses incurred in connection with the performance of services (ignoring any applicable limitation based on adjusted gross income), or of reasonable outplacement expenses and reasonable moving expenses actually incurred by the service provider and directly related to the termination of services for the service recipient, such arrangement does not provide for a deferral of compensation. To the extent a separation pay arrangement (including an arrangement involving payments due to a voluntary separation from service) entitles a service provider to reimbursement by the service recipient for a limited period of time of payments of medical expenses incurred and paid by the service provider but not reimbursed and allowable as a deduction under section 213 (disregarding the requirement of section 213(a) that the deduction is available only to the extent that such expenses exceed 7.5 percent of adjusted gross income), such arrangement does not provide for a deferral of compensation.

(B) In-kind benefits and direct service recipient payments. A service provider’s entitlement to in-kind benefits from the service recipient, or a payment by the service recipient directly to the person providing the goods or services to the service provider, will also be treated as not providing for a deferral of compensation for purposes of this paragraph (b), if a right to reimbursement by the service recipient for a payment for such benefits, goods or services by the service provider would not be treated as providing for a deferral of compensation under this paragraph (b)(9)(iv).

(C) De minimis payments. In addition, if not otherwise excluded, to the extent a separation pay arrangement entitles a service provider to reimbursements or other payments or benefits that do not exceed $5,000 in the aggregate, such arrangement does not provide for a deferral of compensation.

(D) Limited period of time. For purposes of paragraphs (b)(9)(iv)(A) and (B), a limited period of time refers to both the period during which applicable expenses may be incurred, and the period during which reimbursements must be paid, and may not extend beyond the December 31 of the second calendar year following the calendar year in which the separation from service occurred.

(v) Window programs — definition. The term window program refers to a program established by the service recipient to provide for separation pay in connection with a separation from service, for a limited period of time (no greater than one year), to service providers who separate from service during that period or to service providers who separate from service during that period under specified circumstances. A program will not be considered a window program if a service recipient establishes a pattern of repeatedly providing for similar separation pay in similar situations for substantially consecutive, limited periods of time. Whether the recurrence of these programs constitutes a pattern is determined based on the facts and circumstances. Although no one factor is determinative, relevant factors include whether the benefits are on account of a specific business event or condition, the degree to which the separation pay relates to the event or condition, and whether the event or condition is temporary or discrete or is a permanent aspect of the employer’s business.

(c) Plan—(1) In general. The term plan includes any agreement, method or arrangement, including an agreement, method or arrangement that applies to one person or individual. A plan may be adopted unilaterally by the service recipient or may be negotiated or agreed to by the service recipient and one or more service providers or service provider representatives. An agreement, method or arrangement may constitute a plan regardless of whether it is an employee benefit plan under section 3(3) of the Employee Retirement Income Security Act of 1974 (ERISA), as amended (29 U.S.C. 1002(3)). The requirements of section 409A are applied as if a separate plan or plans is maintained for each service provider.

(2) Plan aggregation rules—(i) In general. Except as provided in paragraph (c)(2)(ii) of this section, with respect to arrangements between a service provider and a service recipient—

(A) All amounts deferred with respect to that service provider under all account balance plans of the service recipient (as defined in §31.3121(v)(2)-1(c)(1)(ii)(A) of this chapter) other than a separation pay arrangement described in paragraph (c)(2)(i)(C) of this section are treated as deferred under a single plan;

(B) All amounts deferred with respect to that service provider under all nonaccount balance plans of the service recipient (as defined in §31.3121(v)(2)-1(c)(2)(i) of this chapter) other than a separation pay arrangement described in paragraph (c)(2)(i)(C) of this section are treated as deferred under a separate single plan;

(C) All amounts deferred with respect to that service provider under all separation pay arrangements (as defined in paragraph (m) of this section) of the service recipient due to an involuntary termination or participation in a window program are treated as deferred under a single plan; and

(D) All amounts deferred with respect to that service provider under all plans of the service recipient that are not described in paragraph (c)(2)(i)(A), (B) or (C) of this section (for example, discounted stock options, stock appreciation rights or other equity-based compensation described in §31.3121(v)(2)-1(b)(4)(ii) of this chapter) are treated as deferred under a separate single plan.

(ii) Dual status. Arrangements in which a service provider participates are not aggregated to the extent the service provider participates in one set of arrangements due to status as an employee of the service recipient (employee arrangements) and another set of arrangements due to status as an independent contractor of the service recipient (independent contractor arrangements). For example, where a service provider deferred amounts under an arrangement while providing services as an independent contractor, and then becomes eligible for and defers amounts under a separate arrangement after being hired as an employee, the two arrangements will not be aggregated for purposes of this paragraph (c)(2). Where an employee also serves as a director of the service recipient (or a similar position with respect to a non-corporate service recipient), the arrangements under which the employee participates as a director of the service recipient (director arrangements) are not aggregated with employee arrangements, provided that the director arrangements are substantially similar to arrangements provided to service providers providing services only as directors (or similar positions with respect to non-corporate service recipients). For example, an employee director who participates in an employee arrangement and a director arrangement generally may treat the two arrangements as separate plans, provided that the director arrangement is substantially similar to an arrangement providing benefits to a non-employee director. Director arrangements and independent contractor arrangements are aggregated for purposes of this paragraph (c)(2).

(3) Establishment of arrangement—(i) In general. To satisfy the requirements of section 409A, an arrangement must be established and maintained by a service recipient, in both form and operation, in accordance with the requirements of section 409A and these regulations. For purposes of this paragraph (c)(3), an arrangement is established on the latest of the date on which it is adopted, the date on which it is effective, and the date on which the material terms of the plan are set forth in writing. For purposes of this paragraph (c)(3)(i), an arrangement will be deemed to be set forth in writing if it is set forth in any other form that is approved by the Commissioner. The material terms of the arrangement include the amount (or the method or formula for determining the amount) of deferred compensation to be provided under the arrangement and the time when it will be paid. Notwithstanding the foregoing, an arrangement will be deemed to be established as of the date the participant obtains a legally binding right to deferred compensation, provided that the arrangement is otherwise established under the rules of this paragraph (c)(3)(i) by the end of the calendar year in which the legally binding right arises, or with respect to an amount not payable in the year immediately following the year in which the legally binding right arises (the subsequent year), the 15^th day of the third month of the subsequent year.

(ii) Amendments to the arrangement. In the case of an amendment that increases the amount deferred under an arrangement providing for the deferral of compensation, the arrangement is not considered established with respect to the additional amount deferred until the arrangement, as amended, is established in accordance with paragraph (c)(3)(i) of this section.

(iii) Transition rule for written plan requirement. For purposes of this section, an unwritten arrangement that was adopted and effective before December 31, 2006, is treated as established under this section as of the later of the date on which it was adopted or became effective, provided that the material terms of the arrangement are set forth in writing on or before December 31, 2006.

(iv) Plan aggregation rules. The plan aggregation rules of paragraph (c)(2)(i) of this section do not apply to the requirements of paragraphs (c)(3)(i) and (ii) of this section. Accordingly, an arrangement that fails to meet the requirements of section 409A solely due to a failure to meet the requirements of paragraph (c)(3)(i) or (ii) is not aggregated with other arrangements that meet such requirements.

(d) Substantial risk of forfeiture—(1) In general. Compensation is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial. For purposes of this paragraph (d), a condition related to a purpose of the compensation must relate to the service provider’s performance for the service recipient or the service recipient’s business activities or organizational goals (for example, the attainment of a prescribed level of earnings, equity value or an initial public offering). Any addition of a substantial risk of forfeiture after the legally binding right to the compensation arises, or any extension of a period during which compensation is subject to a substantial risk of forfeiture, in either case whether elected by the service provider, service recipient or other person (or by agreement of two or more of such persons), is disregarded for purposes of determining whether such compensation is subject to a substantial risk of forfeiture. An amount is not subject to a substantial risk of forfeiture merely because the right to the amount is conditioned, directly or indirectly, upon the refraining from performance of services. For purposes of section 409A, an amount will not be considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the amount subject to a substantial risk of forfeiture (ignoring earnings) is materially greater than the amount the recipient otherwise could have elected to receive. For example, a salary deferral generally may not be made subject to a substantial risk of forfeiture. But, for example, where a bonus arrangement provides an election between a cash payment of a certain amount or restricted stock units with a materially greater value that will be forfeited absent continued services for a period of years, the right to the restricted stock units generally will be treated as subject to a substantial risk of forfeiture.

(2) Stock rights. A stock right will be treated as not subject to a substantial risk of forfeiture at the earlier of the first date the holder may exercise the stock right and receive cash or property that is substantially vested (as defined in §1.83-3(b)) or the first date that the stock right is not subject to a forfeiture condition that would constitute a substantial risk of forfeiture. Accordingly, a stock option that the service provider may exercise immediately and receive substantially vested stock will be treated as not subject to a substantial risk of forfeiture, even if the stock option automatically terminates upon the service provider’s separation from service.

(3) Enforcement of forfeiture condition—(i) In general. In determining whether the possibility of forfeiture is substantial in the case of rights to compensation granted by a service recipient to a service provider that owns a significant amount of the total combined voting power or value of all classes of equity of the service recipient or of its parent, all relevant facts and circumstances will be taken into account in determining whether the probability of the service recipient enforcing such condition is substantial, including—

(A) The service provider’s relationship to other equity holders and the extent of their control, potential control and possible loss of control of the service recipient;

(B) The position of the service provider in the service recipient and the extent to which the service provider is subordinate to other service providers;

(C) The service provider’s relationship to the officers and directors of the service recipient (or similar positions with respect to a noncorporate service recipient);

(D) The person or persons who must approve the service provider’s discharge; and

(E) Past actions of the service recipient in enforcing the restrictions.

(ii) Examples. The following examples illustrate the rules of paragraph (d)(3)(i) of this section:

Example 1. A service provider would be considered as having deferred compensation subject to a substantial risk of forfeiture, but for the fact that the service provider owns 20 percent of the single class of stock in the transferor corporation. If the remaining 80 percent of the class of stock is owned by an unrelated individual (or members of such an individual’s family) so that the possibility of the corporation enforcing a restriction on such rights is substantial, then such rights are subject to a substantial risk of forfeiture.

Example 2. A service provider would be considered as having deferred compensation subject to a substantial risk of forfeiture, but for the fact that the service provider who is president of the corporation, also owns 4 percent of the voting power of all the stock of a corporation. If the remaining stock is so diversely held by the public that the president, in effect, controls the corporation, then the possibility of the corporation enforcing a restriction on the right to deferred compensation of the president is not substantial, and such rights are not subject to a substantial risk of forfeiture.

(e) Performance-based compensation—(1) In general. The term performance-based compensation means compensation where the amount of, or entitlement to, the compensation is contingent on the satisfaction of preestablished organizational or individual performance criteria relating to a performance period of at least 12 consecutive months in which the service provider performs services. Organizational or individual performance criteria are considered preestablished if established in writing by not later than 90 days after the commencement of the period of service to which the criteria relates, provided that the outcome is substantially uncertain at the time the criteria are established. Performance-based compensation may include payments based on performance criteria that are not approved by a compensation committee of the board of directors (or similar entity in the case of a non-corporate service recipient) or by the stockholders or members of the service recipient. Notwithstanding the foregoing, performance-based compensation does not include any amount or portion of any amount that will be paid either regardless of performance, or based upon a level of performance that is substantially certain to be met at the time the criteria is established. Except as provided in paragraph (e)(3) of this section, compensation is not performance-based compensation merely because the amount of such compensation is based on the value of, or increase in the value of, the service recipient or the stock of the service recipient.

(2) Payments based upon subjective performance criteria. The term performance-based compensation may include payments based upon subjective performance criteria, provided that—

(i) The subjective performance criteria relate to the performance of the participant service provider, a group of service providers that includes the participant service provider, or a business unit for which the participant service provider provides services (which may include the entire organization); and

(ii) The determination that any subjective performance criteria have been met is not made by the participant service provider or a family member of the participant service provider (as defined in section 267(c)(4) applied as if the family of an individual includes the spouse of any member of the family), or a person under the supervision of the participant service provider or such a family member, or where any amount of the compensation of the person making such determination is controlled in whole or in part by the service provider or such a family member.

(3) Equity-based compensation. Compensation is performance-based compensation if it is based solely on an increase in the value of the service recipient, or stock of the service recipient, after the date of a grant or award. If the amount of compensation the service provider will receive under a grant or award is not based solely on an increase in the value of the service recipient, or stock of the service recipient, after the date of the grant or award (for example, a stock appreciation right granted with an exercise price that is less than the fair market value of the stock as of the date of grant), and that other amount would not otherwise qualify as performance-based compensation, the compensation attributable to the grant or award does not qualify as performance-based compensation. Notwithstanding the foregoing, an award of equity-based compensation may constitute performance-based compensation if entitlement to the compensation is subject to a condition that would cause the award to otherwise qualify as performance-based compensation, such as a performance-based vesting condition. The eligibility to defer compensation under an equity-based compensation award constitutes an additional deferral feature with respect to the award for purposes of the definition of a deferral of compensation under paragraph (b)(5) of this section.

(f) Service provider—(1) In general. The term service provider includes—

(i) An individual, corporation, subchapter S corporation or partnership;

(ii) A personal service corporation (as defined in section 269A(b)(1)), or a noncorporate entity that would be a personal service corporation if it were a corporation; or

(iii) A qualified personal service corporation (as defined in section 448(d)(2)), or a noncorporate entity that would be a qualified personal service corporation if it were a corporation.

(2) Service providers using an accrual method of accounting. Section 409A does not apply to a deferral under an arrangement between taxpayers if, for the taxable year in which the service provider taxpayer obtains a legally binding right to the compensation, the service provider uses an accrual method of accounting for Federal tax purposes.

(3) Independent contractors—(i) In general. Except as otherwise provided in paragraph (f)(3)(iv) of this section, section 409A does not apply to an amount deferred under an arrangement between a service provider and service recipient with respect to a particular trade or business in which the service provider participates, if during the service provider’s taxable year in which the service provider obtains a legally binding right to the payment of the amount deferred—

(A) The service provider is actively engaged in the trade or business of providing services, other than as an employee or as a director of a corporation;

(B) The service provider provides significant services to two or more service recipients to which the service provider is not related and that are not related to one another (as defined in paragraph (f)(3)(ii) of this section); and

(C) The service provider is not related to the service recipient, applying the definition of related person contained in paragraph (f)(3)(ii) of this section subject to the modification that the language “50 percent” is used instead of “20 percent” each place it appears in sections 267(b) and 707(b)(1).

(ii) Related person. For purposes of this paragraph (f)(3), a person is related to another person if the persons bear a relationship to each other that is specified in section 267(b) or 707(b)(1), subject to the modifications that the language “20 percent” is used instead of “50 percent” each place it appears in sections 267(b) and 707(b)(1), and section 267(c)(4) is applied as if the family of an individual includes the spouse of any member of the family; or the persons are engaged in trades or businesses under common control (within the meaning of section 52(a) and (b)). In addition, an individual is related to an entity if the individual is an officer of an entity that is a corporation, or holds a position substantially similar to an officer of a corporation with an entity that is not a corporation.

(iii) Significant services. Whether a service provider is providing significant services depends on the facts and circumstances of each case. However, for purposes of paragraph (f)(3)(i) of this section, a service provider who provides services to two or more service recipients to which the service provider is not related and that are not related to one another is deemed to be providing significant services to two or more of such service recipients for a given taxable year, if the revenues generated from the services provided to any service recipient or group of related service recipients during such taxable year do not exceed 70 percent of the total revenue generated by the service provider from the trade or business of providing such services.

(iv) Management services. A service provider is treated as related to a service recipient for purposes of paragraph (f)(3)(i) of this section if the service provider provides management services to the service recipient. For purposes of this paragraph (f)(3)(iv), the term management services means services that involve the actual or de facto direction or control of the financial or operational aspects of a trade or business of the service recipient, or investment advisory services provided to a service recipient whose primary trade or business includes the management of financial assets (including investments in real estate) for its own account, such as a hedge fund or a real estate investment trust.

(g) Service recipient. Except as otherwise specifically provided in these regulations, the term service recipient means the person for whom the services are performed and with respect to whom the legally binding right to compensation arises, and all persons with whom such person would be considered a single employer under section 414(b) (employees of a controlled group of corporations), and all persons with whom such person would be considered a single employer under section 414(c) (employees of partnerships, proprietorships, etc., under common control). For example, where the service provider is an employee, the service recipient generally is the employer. Notwithstanding the foregoing, section 409A applies to a plan that provides for the deferral of compensation, even though the payment of the compensation is not made by the person for whom services are performed.

(h) Separation from service—(1) Employees—(i) In general. An employee separates from service with the service recipient if the employee dies, retires, or otherwise has a termination of employment with the employer. However, for purposes of this paragraph (h)(1), the employment relationship is treated as continuing intact while the individual is on military leave, sick leave, or other bona fide leave of absence (such as temporary employment by the government) if the period of such leave does not exceed six months, or if longer, so long as the individual’s right to reemployment with the service recipient is provided either by statute or by contract. If the period of leave exceeds six months and the individual’s right to reemployment is not provided either by statute or by contract, the employment relationship is deemed to terminate on the first date immediately following such six-month period.

(ii) Termination of employment. Whether a termination of employment has occurred is determined based on the facts and circumstances. Where an employee either actually or purportedly continues in the capacity as an employee, such as through the execution of an employment agreement under which the employee agrees to be available to perform services if requested, but the facts and circumstances indicate that the employer and the employee did not intend for the employee to provide more than insignificant services for the employer, an employee will be treated as having a separation from service for purposes of this paragraph (h)(1). For purposes of the preceding sentence, an employer and employee will not be treated as having intended for the employee to provide insignificant services where the employee continues to provide services as an employee at an annual rate that is at least equal to 20 percent of the services rendered, on average, during the immediately preceding three full calendar years of employment (or, if employed less than three years, such lesser period) and the annual remuneration for such services is at least equal to 20 percent of the average annual remuneration earned during the final three full calendar years of employment (or, if less, such lesser period). Where an employee continues to provide services to a previous employer in a capacity other than as an employee, a separation from service will not be deemed to have occurred for purposes of this paragraph (h)(1) if the former employee is providing services at an annual rate that is 50 percent or more of the services rendered, on average, during the immediately preceding three full calendar years of employment (or if employed less than three years, such lesser period) and the annual remuneration for such services is 50 percent or more of the annual remuneration earned during the final three full calendar years of employment (or if less, such lesser period). For purposes of this paragraph (h)(1)(ii), the annual rate of providing services is determined based upon the measurement used to determine the service provider’s base compensation (for example, amounts of time required to earn salary, hourly wages, or payments for specific projects).

(2) Independent contractors—(i) In general. An independent contractor is considered to have a separation from service with the service recipient upon the expiration of the contract (or in the case of more than one contract, all contracts) under which services are performed for the service recipient if the expiration constitutes a good-faith and complete termination of the contractual relationship. An expiration does not constitute a good faith and complete termination of the contractual relationship if the service recipient anticipates a renewal of a contractual relationship or the independent contractor becoming an employee. For this purpose, a service recipient is considered to anticipate the renewal of the contractual relationship with an independent contractor if it intends to contract again for the services provided under the expired contract, and neither the service recipient nor the independent contractor has eliminated the independent contractor as a possible provider of services under any such new contract. Further, a service recipient is considered to intend to contract again for the services provided under an expired contract if the service recipient’s doing so is conditioned only upon incurring a need for the services, the availability of funds, or both.

(ii) Special rule. Notwithstanding paragraph (h)(2)(i) of this section, the plan is considered to satisfy the requirement described in §1.409A-3(a)(1) that amounts deferred under the plan may be paid or made available to the participant upon a separation from service with the service recipient if, with respect to amounts payable to a participant who is an independent contractor, a plan provides that—

(A) No amount will be paid to the participant before a date at least 12 months after the day on which the contract expires under which services are performed for the service recipient (or, in the case of more than one contract, all such contracts expire); and

(B) No amount payable to the participant on that date will be paid to the participant if, after the expiration of the contract (or contracts) and before that date, the participant performs services for the service recipient as an independent contractor or an employee.

(i) Specified employee—(1) In general. The term specified employee means a key employee (as defined in section 416(i) without regard to section 416(i)(5)) of a service recipient any stock of which is publicly traded on an established securities market or otherwise. For purposes of this paragraph (i)(1), an employee is a key employee if the employee meets the requirements of section 416(i)(1)(A)(i), (ii) or (iii) (applied in accordance with the regulations thereunder and disregarding section 416(i)(5)) at any time during the 12-month period ending on an identification date. If a person is a key employee as of an identification date, the person is treated as a specified employee for the 12-month period beginning on the first day of the fourth month following the identification date. A service recipient may designate any date in a calendar year as the identification date provided that a service recipient must use the same identification date with respect to all arrangements, and any change to the identification date may not be effective for a period of 12 months. If no identification date is designated, the identification date is December 31. The service recipient may designate an identification date through inclusion in each plan document or through a separate document, provided that the service recipient will not be treated as having designated an identification date on any date before the execution of the document containing the designation. Notwithstanding the foregoing, any designation of an identification date made on or before December 31, 2006, may be applied to any separation from service occurring on or after January 1, 2005. Whether any stock of a service recipient is publicly traded on an established securities market or otherwise must be determined as of the date of the employee’s separation from service.

(2) Spinoffs and mergers. Where a new corporation or entity (new corporation) is established as part of a corporate division governed by section 355 from a corporation that is publicly traded on an established securities market or otherwise (old corporation), any employee of the new corporation who was a key employee of the old corporation immediately prior to the spinoff is a key employee of the new corporation until the end of the 12-month period beginning on the first day of the fourth month following the old corporation’s last identification date preceding the spinoff transaction. Where two corporations (pre-merger corporations) are merged or become part of the same controlled group of corporations so as to be treated as a single service recipient under paragraph (g) of this section, any employee of the merged corporation who was a key employee of either of the pre-merger corporations immediately before the merger is a key employee of the merged corporation until the first day of the fourth month after the identification date of the merged corporation next following the merger.

(3) Nonresident alien employees. For purposes of determining key employees, a service recipient generally must include all employees, including employees who are nonresident aliens. However, a plan may provide without causing an amount to be treated as an additional deferral as to any affected participant that for purposes of applying the six-month delay to specified employees, all employees that are nonresident aliens during the entire 12-month period ending with the relevant identification date are excluded for purposes of determining which employees meet the requirements of section 416(i)(1)(A)(i), (ii) or (iii) (applied in accordance with the regulations thereunder and disregarding section 416(i)(5)); provided that a service recipient must apply such exclusion with respect to all arrangements of the service recipient, and any change to include such nonresident alien employees may not be effective for a period of 12 months.

(j) Nonresident alien—(1) Except as provided in paragraph (j)(2) of this section, for purposes of this section the term nonresident alien means an individual who is—

(i) A nonresident alien within the meaning of section 7701(b)(1)(B); or

(ii) A dual resident taxpayer within the meaning of §301.7701(b)-7(a)(1) of this chapter with respect to any taxable year in which such individual is treated as a nonresident alien for purposes of computing the individual’s U.S. income tax liability.

(2) The term nonresident alien does not include—

(i) A nonresident alien with respect to whom an election is in effect for the taxable year under section 6013(g) to be treated as a resident of the United States;

(ii) A former citizen or long-term resident (within the meaning of section 877(e)(2)) who expatriated after June 3, 2004, and has not complied with the requirements of section 7701(n); or

(iii) An individual who is treated as a citizen or resident of the United States for the taxable year under section 877(g).

(k) Established securities market. For purposes of section 409A and the regulations thereunder, the term established securities market means an established securities market within the meaning of §1.897-1(m).

(l) Stock right. For purposes of section 409A and these regulations, the term stock right means a stock option (other than an incentive stock option described in section 422 or an option granted pursuant to an employee stock purchase plan described in section 423) or a stock appreciation right.

(m) Separation pay arrangement. For purposes of section 409A and the regulations thereunder, the term separation pay arrangement means any arrangement that provides separation pay or, where an arrangement provides both amounts that are separation pay and that are not separation pay, that portion of the arrangement that provides separation pay. For purposes of this paragraph (m), the term separation pay means any amount of compensation where one of the conditions to the right to the payment is a separation from service, whether voluntary or involuntary, including payments in the form of reimbursements of expenses incurred, and the provision of other taxable benefits. Separation pay includes amounts payable due to a separation from service, regardless of whether payment is conditioned upon the execution of a release of claims, noncompetition or nondisclosure provisions, or other similar requirement. Notwithstanding the foregoing, any amount, or entitlement to any amount, that acts as a substitute for, or replacement of, amounts deferred by the service recipient under a separate nonqualified deferred compensation plan constitutes a payment of compensation or deferral of compensation under the separate nonqualified deferred compensation plan, and does not constitute separation pay.

(a) Initial elections as to the time and form of payment—(1) In general. An arrangement that is, or constitutes part of, a nonqualified deferred compensation plan meets the requirements of section 409A(a)(4)(B) only if the arrangement provides that compensation for services performed during a service provider’s taxable year (the service year) may be deferred at the service provider’s election only if the election to defer such compensation is made and becomes irrevocable not later than the end of such period as may be permitted in this paragraph (a). An election will not be considered to be revocable merely because the service provider may make an election to change the time and form of payment pursuant to paragraph (b) of this section. Whether an arrangement provides a service provider an opportunity to elect the time or form of payment of compensation is determined based upon all the facts and circumstances surrounding the determination of the time and form of payment of the compensation. For purposes of this section, an election to defer includes an election as to the time of the payment, an election as to the form of the payment or an election as to both the time and the form of the payment, but does not include an election as to the medium of payment (for example, an election between a payment of cash or a payment of property). Except as otherwise provided in these regulations, an election will not be considered made until such election becomes irrevocable under the terms of the relevant arrangement. Thus, a plan may provide that an election to defer may be changed at any time prior to the last permissible date for making such an election. Where an arrangement provides the service provider a right to make an initial deferral election, and further provides that the election remains in effect until terminated or modified by the service provider, the election will be treated as made as of the date such election becomes irrevocable as to compensation for services performed during the relevant service year. For example, where an arrangement provides that a service provider’s election to defer a set percentage will remain in effect until changed or revoked, but that as of each December 31 the election becomes irrevocable with respect to salary payable with respect to services performed in the immediately following year, the initial deferral election with respect to salary payable with respect to services performed in the immediately following year will be deemed to have been made as of the December 31 upon which the election became irrevocable.

(2) General rule. An arrangement that is, or constitutes part of, a nonqualified deferred compensation plan meets the requirements of section 409A(a)(4)(B) if the plan provides that compensation for services performed during a service provider’s taxable year (the service year) may be deferred at the service provider’s election only if the election to defer such compensation is made not later than the close of the service provider’s taxable year next preceding the service year.

(3) Initial deferral election with respect to short-term deferrals. With respect to a legally binding right to a payment of compensation in a subsequent taxable year that, absent a deferral election, would not be treated as a deferral of compensation pursuant to §1.409A-1(b)(4), an election to defer such compensation may be made in accordance with the requirements of paragraph (b) of this section, applied as if the amount were a deferral of compensation and the scheduled payment date for the amount were the date the substantial risk of forfeiture lapses. Notwithstanding the requirements of paragraph (b) of this section, such a deferral election may provide that the deferred amounts will be payable upon a change in control event (as defined in §1.409A-3(g)(5)) without regard to the 5-year additional deferral requirement.

(4) Initial deferral election with respect to certain forfeitable rights. With respect to a legally binding right to a payment in a subsequent year that is subject to a forfeiture condition requiring the service provider’s continued services for a period of at least 12 months from the date the service provider obtains the legally binding right, an election to defer such compensation may be made on or before the 30^th day after the service provider obtains the legally binding right to the compensation, provided that the election is made at least 12 months in advance of the earliest date at which the forfeiture condition could lapse.

(5) Initial deferral election with respect to a service recipient with a fiscal year other than the calendar year. In the case of a service recipient with a fiscal year other than the calendar year, a plan may provide that fiscal year compensation may be deferred at the service provider’s election only if the election to defer such compensation is made not later than the close of the service recipient’s fiscal year next preceding the first fiscal year in which are performed any services for which such compensation is payable. For purposes of this paragraph (a)(5), the term fiscal year compensation means compensation relating to a period of service coextensive with one or more consecutive fiscal years of the service recipient, of which no amount is paid or payable during the service period. For example, fiscal year compensation generally would include a bonus based on a service period of the two consecutive fiscal years ending September 30, 2009, where the amount will be paid after the completion of the service period, but would not include either a bonus based on a calendar year service period or salary that would otherwise be paid during the service recipient’s fiscal year.

(6) First year of eligibility. In the case of the first year in which a service provider becomes eligible to participate in a plan (as defined in §1.409A-1(c)), the service provider may make an initial deferral election within 30 days after the date the service provider becomes eligible to participate in such plan, with respect to compensation paid for services to be performed subsequent to the election. In the case of a plan that does not provide for service provider elections with respect to the time or form of a payment, the time and form of the payment must be specified on or before the date that is 30 days after the date the service provider becomes eligible to participate in such plan. For compensation that is earned based upon a specified performance period (for example, an annual bonus), where a deferral election is made in the first year of eligibility but after the beginning of the service period, the election will be deemed to apply to compensation paid for services performed subsequent to the election if the election applies to the portion of the compensation equal to the total amount of the compensation for the service period multiplied by the ratio of the number of days remaining in the performance period after the election over the total number of days in the performance period.

(7) Performance-based compensation. In the case of any performance-based compensation based upon a performance period of at least 12 months, provided that the service provider performed services continuously from a date no later than the date upon which the performance criteria are established through a date no earlier than the date upon which the service provider makes an initial deferral election, an initial deferral election may be made with respect to such performance-based compensation no later than the date that is six months before the end of the performance period, provided that in no event may an election to defer performance-based compensation be made after such compensation has become both substantially certain to be paid and readily ascertainable.

(8) Nonqualified deferred compensation arrangements linked to qualified plans. With respect to an amount deferred under an arrangement that is, or constitutes part of, a nonqualified deferred compensation plan, where under the terms of the nonqualified deferred compensation arrangement the amount deferred under the plan is the amount determined under the formula under which benefits are determined under a qualified employer plan (as defined in §1.409A-1(a)(2)) applied without respect to one or more limitations applicable to qualified employer plans under the Internal Revenue Code or other applicable law, or is determined as an amount offset by some or all of the benefits provided under the qualified employer plan, the operation of the qualified employer plan with respect to changes in benefit limitations applicable to qualified employer plans under the Internal Revenue Code or other applicable law does not constitute a deferral election even if such operation results in an increase of amounts deferred under the nonqualified deferred compensation arrangement, provided that such operation does not otherwise result in a change in the time or form of a payment under the nonqualified deferred compensation plan. In addition, with respect to such a nonqualified deferred compensation arrangement, the following actions or failures to act will not constitute a deferral election under the nonqualified deferred compensation arrangement even if in accordance with the terms of the nonqualified deferred compensation arrangement, the actions or inactions result in an increase in the amounts deferred under the arrangement, provided that such actions or inactions do not otherwise affect the time or form of payment under the nonqualified deferred compensation plan:

(i) A service provider’s action or inaction under the qualified plan with respect to whether to elect to receive a subsidized benefit or an ancillary benefit under the qualified plan.

(ii) The amendment of a qualified plan to add or remove a subsidized benefit or an ancillary benefit, or to freeze or limit future accruals of benefits under the qualified plan.

(iii) A service provider’s action or inaction under a qualified plan subject to section 402(g), including an adjustment to a deferral election under the qualified plan subject to section 402(g), provided that for any given calendar year, the service provider’s action or inaction does not result in an increase in the amounts deferred under all nonqualified deferred compensation arrangements in which the service provider participates in excess of the limit with respect to elective deferrals under section 402(g) in effect for the taxable year in which such action or inaction occurs.

(iv) A service provider’s action or inaction under a qualified plan with respect to elective deferrals or after-tax contributions by the service provider to the qualified plan that affects the amounts that are credited under a nonqualified deferred compensation arrangement as matching amounts or other amounts contingent on service provider elective deferrals or after-tax contributions, provided that such matching or contingent amounts, as applicable, are either forfeited or never credited under the nonqualified deferred compensation arrangement in the absence of such service provider’s elective deferral or after-tax contribution, and provided further that all of the service provider’s actions or inactions do not result in an increase during such taxable year in the amounts deferred under all nonqualified deferred compensation arrangements in which the service provider participates in excess of the limit with respect to elective deferrals under section 402(g) in effect for the taxable year in which such action or inaction occurs. See paragraph (b)(6) of this section, Example 12 and Example 13.

(9) Separation pay. In the case of separation pay (as defined in §1.409A-1(m) due to an actual involuntary separation from service, where such separation pay is the subject of bona fide, arm’s length negotiations, the initial deferral election may be made at any time up to the time the service provider obtains a legally binding right to the payment. In the case of separation pay due to participation in a window program (as defined in §1.409A-1(b)(9)(v)), the initial deferral election may be made at any time up to the time the election to participate in the window program becomes irrevocable.

(10) Commissions. For purposes of this paragraph (a), in the case of commission compensation, a service provider earning such compensation is treated as providing the services to which such compensation relates only in the year in which the customer remits payment to the service recipient. For purposes of this paragraph (a)(10), the term commission compensation means compensation or portions of compensation earned by a service provider if a substantial portion of the services provided by such service provider to a service recipient consist of the direct sale of a product or service to a customer, the compensation paid by the service recipient to the service provider consists of either a portion of the purchase price for the product or service or an amount calculated solely by reference to the volume of sales, and payment of the compensation is contingent upon the service recipient receiving payment from an unrelated customer for the product or services. For this purpose, a customer is treated as an unrelated customer only if the customer is not related to either the service provider or the service recipient. A person is treated as related to another person if the person would be treated as related to the other person under §1.409A-1(f)(3)(ii) or the person would be treated as providing management services to the other person under §1.409A-1(f)(3)(iv).

(11) Initial deferral elections with respect to compensation paid for final payroll period—(i) In general. Unless an arrangement provides otherwise, compensation payable after the last day of the service provider’s taxable year solely for services performed during the final payroll period described in section 3401(b) containing the last day of the service provider’s taxable year or, with respect to a non-employee service provider, a period not longer than the payroll period described in section 3401(b), where such amount is payable pursuant to the timing arrangement under which the service recipient normally compensates service providers for services performed during a payroll period described in section 3401(b), or with respect to a non-employee service provider, a period not longer than the payroll period described in section 3401(b), is treated as compensation for services performed in the subsequent taxable year. The preceding sentence does not apply to any compensation paid during such period for services performed during any period other than such final payroll period, such as a payment of an annual bonus. Any amendment of an arrangement after December 31, 2006, to add a provision providing for a differing treatment of such compensation may not be effective for 12 months from the date the amendment is executed and enacted.

(ii) Transition rule. For purposes of this paragraph (a)(11), an arrangement that was adopted and effective before December 31, 2006, whether written or unwritten, will be treated as designating such compensation for service performed in the taxable year in which the payroll period ends, unless otherwise set forth in writing before December 31, 2006.

(12) Designation of time and form of payment with respect to a nonelective arrangement. An arrangement that provides for a deferral of compensation for services performed during a service provider’s taxable year that does not provide the service provider with an opportunity to elect the time of payment of such compensation must specify the time of payment no later than the time the service provider first has a legally binding right to the compensation. Similarly, an arrangement that provides for a deferral of compensation for services performed during a service provider’s taxable year that does not provide the service provider with an opportunity to elect the form of payment of such compensation must specify the form of payment no later than the time the service provider first has a legally binding right to the compensation. Such designation shall be treated as an initial deferral election for purposes of this section.

(13) Designation of time and form of payment with respect to earnings. An arrangement that provides for actual or notional earnings to be credited on amounts of deferred compensation may specify, in accordance with the requirements of this paragraph (a), that such earnings will be paid by a date not later than the 15^th day of the third month following the calendar year for which the earnings are credited. To satisfy the requirements of this paragraph (a)(13), actual or notional earnings must be credited at least annually and the measure for such earnings must be either a specified, nondiscretionary interest rate (or a specified, nondiscretionary formula describing an interest rate such as, for example, the interest on a Treasury bond + 2 percent) or a predetermined actual investment within the meaning of §31.3121(v)(2)-1(d)(2) of this chapter. For these purposes, a right to dividend equivalents with respect to a specified number of shares of service recipient stock (as defined in §1.409A-1(b)(5)(iii)) may be treated as a right to actual or notional earnings on an amount of deferred compensation.

(b) Subsequent changes in time and form of payment—(1) In general. The requirements of section 409A(a)(4)(C) are met if, in the case of a plan that permits a subsequent election to delay a payment or to change the form of payment of an amount of deferred compensation, the following conditions are met:

(i) The plan requires that such election may not take effect until at least 12 months after the date on which the election is made.

(ii) In the case of an election related to a payment not described in §1.409A-3(a)(2) (payment on account of disability), §1.409A-3(a)(3) (payment on account of death) or §1.409A-3(a)(6) (payment on account of the occurrence of an unforeseeable emergency), the plan requires that the payment with respect to which such election is made be deferred for a period of not less than 5 years from the date such payment would otherwise have been paid (or in the case of a life annuity or installment payments treated as a single payment, 5 years from the date the first amount was scheduled to be paid).

(iii) The plan requires that any election related to a payment described in §1.409A-3(a)(4) (payment at a specified time or pursuant to a fixed schedule) may not be made less than 12 months prior to the date the payment is scheduled to be paid (or in the case of a life annuity or installment payments treated as a single payment, 12 months prior to the date the first amount was scheduled to be paid).

(2) Definition of payments for purposes of subsequent changes in the time or form of payment—(i) In general. Except as provided in paragraphs (b)(2)(ii) and (iii) of this section, the term payment refers to each separately identified amount to which a service provider is entitled to payment under a plan on a determinable date, and includes amounts applied for the benefit of the service provider. An amount is separately identified only if the amount may be objectively determined. For example, an amount identified as 10 percent of the account balance as of a specified payment date would be a separately identified amount. A payment includes the provision of any taxable benefit, including payment in cash or in kind. In addition, a payment includes, but is not limited to, the transfer, cancellation or reduction of an amount of deferred compensation in exchange for benefits under a welfare benefit plan, fringe benefit excludible under section 119 or section 132, or any other benefit that is excluded from gross income.

(ii) Life annuities. The entitlement to a life annuity is treated as the entitlement to a single payment. For purposes of this paragraph (b)(2)(ii), the term life annuity means a series of substantially equal periodic payments, payable not less frequently than annually, for the life (or life expectancy) of the service provider or the joint lives (or life expectancies) of the service provider and the service provider’s designated beneficiary. A change in the form of a payment from one type of life annuity to another type of life annuity before any annuity payment has been made is not considered a change in the time and form of a payment, provided that the annuities are actuarially equivalent applying reasonable actuarial assumptions.

(iii) Installment payments. The entitlement to a series of installment payments that is not a life annuity is treated as the entitlement to a single payment, unless the arrangement provides at all times with respect to the amount deferred that the right to the series of installment payments is to be treated as a right to a series of separate payments. For purposes of this paragraph (b)(2)(iii), a series of installment payments refers to an entitlement to the payment of a series of substantially equal periodic amounts to be paid over a predetermined period of years, except to the extent any increase in the amount reflects reasonable earnings through the date the amount is paid.

(iv) Transition rule. For purposes of this section, an arrangement that was adopted and effective before December 31, 2006, whether written or unwritten, that fails to make a designation as to whether the entitlement to a series of payments is to be treated as an entitlement to a series of separate payments under paragraph (b)(2)(iii) of this section is treated as having made such designation as of the later of the date on which the arrangement was adopted or became effective, provided that such designation is set forth in writing before December 31, 2006.

(3) Coordination with prohibition against acceleration of payments. For purposes of applying the prohibition against the acceleration of payments contained in §1.409A-3(h), the definition of payment is the same as the definition provided in paragraph (b)(2) of this section. However, even though a change in the form of a payment that results in a more rapid schedule for payments generally may not constitute an acceleration of a payment, the change in the form of payment must comply with the subsequent deferral rules. For example, although a change in form from a 10-year installment payment treated as a single payment to a lump-sum payment would not constitute an acceleration, the change in the form of the payment must still comply with the requirements of paragraph (b)(1) of this section, generally meaning that the election to change to a lump-sum payment could not be effective for 12 months and the lump-sum payment could not be made until at least 5 years after the date the installment payments were scheduled to commence.

(4) Application to multiple payment events. In the case of a plan that permits a payment upon each of a number of potential permissible payment events, such as the earlier of a fixed date or separation from service, the requirements of paragraph (b)(1) of this section are applied separately to each payment (as defined in paragraph (b)(2) of this section) due upon each payment event. Notwithstanding the foregoing, the addition of a permissible payment event to amounts previously deferred is subject to the rules of this paragraph (b) where the addition of the permissible payment event may result in a change in the time or form of payment of the amount deferred. For application of the rules governing accelerations of payments to the addition of a permissible payment event to amounts deferred, see §1.409A-3.

(5) Delay of payments under certain circumstances. A plan may provide, or be amended to provide, that a payment will be delayed to a date after the designated payment date under any of the following circumstances, and the provision will not fail to meet the requirements of establishing a permissible payment event and the delay in the payment will not constitute a subsequent deferral election, provided that once such a provision is applicable to an amount of deferred compensation, any failure to apply such a provision or modification of the plan to remove such a provision will constitute an acceleration of any payment to which such provision applied:

(i) Payments subject to section 162(m). A plan may provide that a payment will be delayed where the service recipient reasonably anticipates that the service recipient’s deduction with respect to such payment otherwise would be limited or eliminated by application of section 162(m); provided that the terms of the arrangement require the payment to be made either at the earliest date at which the service recipient reasonably anticipates that the deduction of the payment of the amount will not be limited or eliminated by application of section 162(m) or the calendar year in which the service provider separates from service.

(ii) Payments that would violate a loan covenant or similar contractual requirement. A plan may provide that a payment will be delayed where the service recipient reasonably anticipates that the making of the payment will violate a term of a loan agreement to which the service recipient is a party, or other similar contract to which the service recipient is a party, and such violation will cause material harm to the service recipient; provided that the terms of the arrangement require the payment to be made at the earliest date at which the service recipient reasonably anticipates that the making of the payment will not cause such violation, or such violation will not cause material harm to the service recipient, and provided that the facts and circumstances indicate that the service recipient entered into such loan agreement (including such covenant) or other similar contract for legitimate business reasons, and not to avoid the restrictions on deferral elections and subsequent deferral elections under section 409A.

(iii) Payments that would violate Federal securities laws or other applicable law. A plan may provide that a payment will be delayed where the service recipient reasonably anticipates that the making of the payment will violate Federal securities laws or other applicable law; provided that the terms of the arrangement require the payment to be made at the earliest date at which the service recipient reasonably anticipates that the making of the payment will not cause such violation. For purposes of this paragraph (b)(5)(iii), the making of a payment that would cause inclusion in gross income or the application of any penalty provision or other provision of the Internal Revenue Code is not treated as a violation of applicable law.

(iv) Other events and conditions. A service recipient may delay a payment upon such other events and conditions as the Commissioner may prescribe in generally applicable guidance published in the Internal Revenue Bulletin.

(6) Examples. The following examples illustrate the application of the provisions of this section:

Example 1. Initial election to defer salary. Employee A is an individual employed by Employer X. Employer X sponsors an arrangement under which Employee A may elect to defer a percentage of Employee A’s salary. Employee A has participated in the arrangement in prior years. To satisfy the requirements of this section with respect to salary earned in calendar year 2008, if Employee A elects to defer any amount of such salary, the deferral election (including an election as to the time and form of payment) must be made no later than December 31, 2007.

Example 2. Designation of time and form of payment where an initial deferral election is not provided. Employee A is an individual employed by Employer X. Employer X has a fiscal year ending September 30. On July 1, 2007, Employer X enters into a legally binding obligation to pay Employee A a $10,000 bonus. The amount is not subject to a substantial risk of forfeiture. Employer X does not provide Employee A an election as to the time and form of payment. Unless the amount is paid in accordance with the short-term deferral rule of §1.409A-1(b)(4), to satisfy the requirements of this section, Employer X must specify the time and form of payment on or before July 1, 2007.

Example 3. Initial election to defer bonus payable based on services during calendar year. Employee A is an individual employed by Employer X. Employer X has a fiscal year ending September 30. Employee A participates in a bonus plan under which Employee A is entitled to a bonus for services performed during the calendar year that, absent an election by Employee A, will be paid on March 15 of the following year. The amount is not subject to a substantial risk of forfeiture and does not qualify as performance based compensation. If Employee A elects to defer the payment of the bonus with respect to calendar year 2008, to satisfy the requirements of this paragraph, Employee A must elect the time and form of payment not later than December 31, 2007.

Example 4. Initial election to defer bonus payable based on services during fiscal year other than calendar year. Employee A is an individual employed by Employer X. Employer X has a fiscal year ending September 30. Employee A participates in a bonus plan under which Employee A is entitled to a bonus for services performed during Employer X’s fiscal year that, absent an election by Employee A, will be paid on December 15 of the calendar year in which the fiscal year ends. The amount is not subject to a substantial risk of forfeiture and does not qualify as performance based compensation as described in §1.409A-1(e). The amount qualifies as fiscal year compensation. If Employee A elects to defer the payment of the amount related to the fiscal year ending September 30, 2008, to satisfy the requirements of this section Employee A must elect the time and form of payment not later than September 30, 2007.

Example 5. Initial election to defer bonus payable only if service provider completes at least 12 months of services after the election. Employee A is an individual employed by Employer X. Employer X has a calendar year fiscal year. On March 1, 2006, Employer X grants Employee A a $10,000 bonus, payable on March 1, 2008, provided that Employee A continues performing services as an employee of Employer X through March 1, 2008. The amount does not qualify as performance-based compensation as described in §1.409A-1(e), and Employee A already participates in another account balance nonqualified deferred compensation plan. Employee A may make an initial deferral election on or before March 31, 2006 (within 30 days after obtaining a legally binding right), because at least 12 months of additional services are required after the date of election for the risk of forfeiture to lapse.

Example 6. Initial election to defer bonus that would otherwise constitute a short-term deferral. The same facts as Example 5, except that Employee A does not make an initial deferral election on or before March 31, 2006. Because the right to the compensation would not be treated as a deferral of compensation pursuant to §1.409A-1(b)(4) absent a deferral election (because the arrangement would be treated as a short-term deferral), Employee A may make an initial deferral election provided that the election may not become effective for 12 months and must defer the payment at least 5 years from March 1, 2008 (the first date the payment could become substantially vested). Accordingly, Employee A may make an election before March 1, 2007, provided that the election defers the payment to a date on or after March 1, 2013 (other than a payment due to death, disability, unforeseeable emergency, or a change in control event).

Example 7. Initial election to defer commissions. Employee A is an individual employed by Employer X. Employer X has a calendar year fiscal year. As part of Employee A’s services for Employer X, Employee A sells refrigerators. Under the employment arrangement, Employee A is entitled to 10 percent of the sales price of any refrigerator Employee A sells, payable only upon the receipt of payment from the customer who purchased the refrigerator. For purposes of the initial deferral rule, Employee A is treated as performing the services related to each refrigerator sale in the taxable year in which each customer pays for the refrigerator.

Example 8. Initial election to defer renewal commissions. The same facts as Example 7, except that Employee A also sells warranties related to the refrigerators sold. Under the warranty arrangement, refrigerator warranty customers are entitled in a future year to extend the warranty for an additional cost to be paid at the time of the extension. Under Employee A’s arrangement with Employer X, Employee A is entitled to 10 percent of the amount paid for an extension of any warranty, payable upon the receipt of payment from the customer extending the warranty. For purposes of the initial deferral rule, Employee A is treated as performing the services related to the amount paid for the extension of the warranty in the taxable year in which the customer pays for the warranty extension.

Example 9. Initial election to defer negotiated separation pay. Employee A is an individual employed by Employer X. Under the terms of a separation pay arrangement, Employee A is entitled upon an involuntary separation from service to an amount equal to two weeks of pay for every year of service at Employer X. Employer X decides to terminate Employee A’s employment involuntarily. As part of the process of terminating Employee A, Employer X enters into bona fide, arm’s length negotiations with respect to the terms of Employee A’s termination of employment. As part of the process, Employer X offers Employee A an amount that is in addition to any amounts to which Employee A is otherwise entitled, payable either as a lump sum payment at the end of three years or in three annual payments starting at the date of termination of employment. The election of the time and form of payment by Employee A may be made at any time before Employee A accepts the offer and obtains a legally binding right to the additional amount.

Example 10. Election of time and form of payments under a window program. Employee A is an individual employed by Employer X. Employer X establishes a window program, as defined in §1.409A-1(b)(9)(v). Individuals who elect to terminate employment under the window program are entitled to receive an amount equal to two weeks pay multiplied by every year of service with Employer X. The individuals participating in the window program may elect to receive the payment as either a lump sum payment payable on the first day of the month after making the election to participate in the window program, or as a payment of two equal annual installments on each January 1 of the first two years following the election to participate in the window program. Employee A is eligible to participate in the window program. Employee A may make the election as to the time and form of payment on or before the date Employee A’s election to participate in the window program becomes irrevocable.

Example 11. Initial election to defer salary earned during final payroll period beginning in one calendar year and ending in the subsequent calendar year. Employee A performs services as an employee of Employer X. Employer X pays the salary of its employees, including Employee A, on a bi-weekly basis. One bi-weekly payroll period runs from December 24, 2006, through January 6, 2007, with a scheduled payment date of January 13, 2001. Employer X sponsors, and Employee A participates in, a nonqualified deferred compensation arrangement under which Employee A may defer a specified percentage of his annual salary. The arrangement does not specify that any salary compensation paid for the payroll period in which falls January 1 is to be treated as compensation for services performed during the year preceding the year in which falls that January 1. For purposes of applying the initial deferral election rules, Employee A is deemed to have performed the services for the payroll period December 24, 2006, through January 6, 2007, during the calendar year 2007.

Example 12. Application of deferral election rules and anti-acceleration rules to a section 401(k) wrap plan. Employee A participates in a qualified retirement plan under section 401(a) with a qualified cash or deferred arrangement under section 401(k). Employee A also participates in a nonqualified deferred compensation arrangement. Under the terms of the nonqualified deferred compensation arrangement, Employee A elects, on or before December 31, to defer a specified percentage of his salary for the subsequent calendar year. Under the terms of the nonqualified deferred compensation arrangement and the qualified plan, as of the earliest date administratively practicable following the end of the year in which the salary is earned, the maximum amount that may be deferred under the qualified cash or deferred arrangement (not in excess of the amount specified under section 402(g) for the plan year) is credited to Employee A’s account under the qualified plan, and Employee A’s deferral under the nonqualified deferred compensation arrangement is reduced by a corresponding amount. The reduction has no effect on any other nonqualified deferred compensation arrangement in which Employee A participates. The reduction of Employee A’s account under the nonqualified deferred compensation arrangement is not treated as an accelerated payment of deferred compensation for purposes of section 409A.

Example 13. Application of deferral election rules and anti-acceleration rules to a nonqualified deferred compensation arrangement linked to a qualified defined benefit plan. Employee A participates in a qualified retirement plan that is a defined benefit plan. Employee A also participates in a nonqualified deferred compensation arrangement, under which the benefit payable is calculated under a formula, with that benefit then reduced by any benefit which Employee A has accrued under the qualified retirement plan. In 2007, Employee A fails to elect a subsidized benefit under the qualified retirement plan, with the effect that the amounts payable under the nonqualified deferred compensation arrangement are increased relative to the lesser benefit payable under the qualified plan. Also, in 2007, Employer X amends the qualified retirement plan to increase benefits under the plan, resulting in a relative decrease in the amounts payable under the nonqualified deferred compensation arrangement relative to the greater benefit payable under the qualified plan. Neither of these actions constitute a deferral election or an acceleration of a payment under the nonqualified deferred compensation arrangement.

Example 14. Subsequent deferral election. Employee A participates in a nonqualified deferred compensation arrangement. Employee A elects to be paid in a lump sum payment at the earlier of age 65 or separation from service. Employee A anticipates that he will work after age 65, and wishes to defer payment to a later date. Provided that Employee A continues in employment and makes the election by his 64^th birthday, Employee A may elect to receive a lump sum payment at the earlier of age 70 or separation from service.

Example 15. Grant of right to current payment of dividends paid with respect to restricted stock. Employer X grants Employee A stock that is not substantially vested for purposes of section 83, and Employee A does not make an election under section 83(b). As part of the restricted stock grant, Employee A receives the right to payments in an amount equal to the dividends payable with respect to the restricted stock. At the time Employer B grants Employee A the right to the dividend payments, the grant also specifies that each dividend payment will be made no later than the end of the calendar year in which the dividends are paid to shareholders of that class of stock or, if later, the 15^th day of the third month following the date the dividends are paid to shareholders of that class of stock. The grant of the rights to dividend payments satisfies the requirement that deferred amounts be paid at a specified time or pursuant to a specified schedule.

Example 16. Subsequent deferral election rule — change in form of payment from lump sum payment to life annuity. Employee A participates in a nonqualified deferred compensation arrangement. Employee A elects to be paid in a lump sum payment at age 65. Employee A wishes to change the payment form to a life annuity. Provided that Employee A makes the election on or before his 64^th birthday, Employee A may elect to receive a life annuity commencing at age 70.

Example 17. Subsequent deferral election rule — change in form of payment from life annuity to lump sum payment. Employee A participates in a nonqualified deferred compensation arrangement. Employee A elects to be paid in a life annuity at age 65. Employee A wishes to change the payment form to a lump sum payment. Provided that Employee A makes the election on or before his 64^th birthday, Employee A may elect to receive a lump sum payment at age 70.

Example 18. Subsequent deferral election rule — installment payments designated as separate payments. Employee A participates in a nonqualified deferred compensation arrangement that provides for payment in a series of 5 equal annual amounts, each designated as a separate payment. The first payment is scheduled to be made on January 1, 2008. Provided that Employee A makes the election on or before January 1, 2007, Employee A may elect for the first payment to be made on January 1, 2013. If Employee A makes that election, the remaining payments may continue to be due upon January 1 of the four calendar years commencing on January 1, 2009.

Example 19. Subsequent deferral election rule — change in form of payment from installment payments to lump sum payment. Employee A participates in a nonqualified deferred compensation arrangement that provides for payment in a series of 5 equal annual amounts that are not designated as a series of 5 separate payments. The first amount is scheduled to be paid on January 1, 2008. Employee A wishes to receive the entire amount equal to the sum of all five of the amounts to be paid as a lump sum payment. Provided that Employee A makes the election on or before January 1, 2007, Employee A may elect to receive a lump sum payment on or after January 1, 2013.

Example 20. Subsequent deferral election rule — change in time of payment from payment at specified age to payment at later of specified age or separation from service. Employee A participates in a nonqualified deferred compensation arrangement that provides for a lump sum payment at age 65. Employee A wishes to add a payment provision such that the payment is payable upon the later of a predetermined age or separation from service. Provided that Employee A makes such election on or before his 64^th birthday, Employee A may elect to receive a lump sum payment upon the later of age 70 or separation from service.

(c) Special rules for certain resident aliens. For the first calendar year in which an individual is classified as a resident alien, a nonqualified deferred compensation arrangement is deemed to meet the requirements of paragraph (a) of this section if, with respect to compensation payable for services performed during that first calendar year or with respect to compensation the right to which is subject to a substantial risk of forfeiture as of January 1 of that first calendar year, an initial deferral election is made by the end of such first calendar year, provided that the initial deferral election may not apply to amounts paid or first payable on or before the date of such initial deferral election. For any year subsequent to the first calendar year in which an individual is classified as a resident alien, this paragraph (c) does not apply, provided that a calendar year may again be treated as the first calendar year in which an individual is classified as a resident alien if such individual has not been classified as a resident alien for at least five consecutive calendar years immediately preceding the year in which the individual is again classified as a resident alien.

(a) In general. The requirements of this section are met only if the arrangement provides that an amount of deferred compensation may be paid only on account of one or more of the following:

(1) The service provider’s separation from service (as defined in §1.409A-1(h)).

(2) The service provider becoming disabled (in accordance with paragraph (g)(4) of this section).

(3) The service provider’s death.

(4) A time (or pursuant to a fixed schedule) specified under the plan (in accordance with paragraph (g)(1) of this section).

(5) A change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation (in accordance with paragraph (g)(5) of this section).

(6) The occurrence of an unforeseeable emergency (in accordance with paragraph (g)(3) of this section).

(b) Designation of payment upon a permissible payment event. Except as otherwise specified in this section, an arrangement provides for the payment upon an event described in paragraph (a)(1), (2), (3), (5) or (6) of this section if the arrangement provides for a payment date that is objectively determinable at the time the event occurs (for example, 3 months following the date of initial disability or December 31 of the calendar year in which the disability first occurs). In addition, an arrangement may provide that a payment is to be made during an objectively determinable calendar year following the year in which the event occurs (for example, the calendar year following the year in which the service provider dies), provided that where no specific date within such calendar year is objectively determinable, the payment date is deemed to be January 1 of such calendar year for purposes of applying the subsequent deferral election rules of §1.409A-2(b). An arrangement may provide for payment upon the earliest or latest of more than one event, provided that each event is described in paragraphs (a)(1) through (6) of this section. An arrangement may also provide that a payment upon an event described in paragraph (a)(1), (2), (3), (5) or (6) of this section is to be made in accordance with a fixed schedule that is objectively determinable based on the date of the event, provided that the schedule must be fixed at the time the permissible payment event is designated, and any change in the fixed schedule will constitute a change in the time and form of payment. For example, an arrangement may provide that a service provider is entitled to three substantially equal payments payable on each of the first three anniversaries of the date of the service provider’s separation from service. In addition, an arrangement may provide that payments are to be made pursuant to a schedule of payments based upon objectively determinable calendar years following the year in which the event occurs, (for example, three substantially equal payments to be made during the three calendar years following the year in which the service provider dies), provided that where payment dates within such calendar years are not specified under the terms of the arrangement, the payment dates are deemed to be January 1 of such calendar years for purposes of applying the subsequent deferral election rules of §1.409A-2(b).

(c) Designation of alternative specified dates or payment schedules based upon date of permissible event. In general, in the case of an arrangement that provides that a payment upon an event described in paragraph (a)(1), (2), (3), (5) or (6) of this section is to be made on an objectively determinable date or year in accordance with paragraph (b) of this section, or in accordance with a fixed schedule that is objectively determinable based on the date of the event in accordance with paragraph (b) of this section, the objectively determined date or fixed schedule must apply consistently regardless of the date on which the specified event occurs. However, an arrangement may allow for an alternative payment schedule if the event occurs on or before one (but not more than one) specified date. For example, an arrangement may provide that a service provider will receive a lump sum payment of the service provider’s entire benefit under the arrangement on the first day of the month following a separation from service before age 55, but will receive 5 substantially equal annual payments commencing on the first day of the month following a separation from service on or after age 55.

(d) When a payment is treated as made upon the designated payment date. Except as otherwise specified in this section, a payment is treated as made upon the date specified under the arrangement (including a date specified under paragraph (a)(4) of this section) if the payment is made at such date or a later date within the same calendar year or, if later, by the 15^th day of the third calendar month following the date specified under the arrangement. If calculation of the amount of the payment is not administratively practicable due to events beyond the control of the service provider (or service provider’s estate), the payment will be treated as made upon the date specified under the arrangement if the payment is made during the first calendar year in which the payment is administratively practicable. Similarly, if the funds of the service recipient are not sufficient to make the payment at the date specified under the plan without jeopardizing the solvency of the service recipient, the payment will be treated as made upon the date specified under the arrangement if the payment is made during the first calendar year in which the funds of the service recipient are sufficient to make the payment without jeopardizing the solvency of the service recipient.

(e) Disputed payments and refusals to pay. If a payment is not made, in whole or in part, as of the date specified under the arrangement because the service recipient refuses to make such payment, the payment will be treated as made upon the date specified under the arrangement if the service provider accepts the portion (if any) of the payment that the service recipient is willing to make (unless such acceptance will result in a forfeiture of the claim to the remaining amount), makes prompt and reasonable, good faith efforts to collect the payment, and the payment is made during the first calendar year in which the service recipient and the service provider enter into a legally binding settlement of such dispute, the service recipient concedes that the amount is payable, or the service recipient is required to make such payment pursuant to a final and nonappealable judgment or other binding decision. For purposes of this paragraph (e), a service recipient is not treated as having refused to make a payment where pursuant to the terms of the plan the service provider is required to request payment, or otherwise provide information or take any other action, and the service provider has failed to take such action. In addition, for purposes of this paragraph (e), the service provider is deemed to have requested that a payment not be made, rather than the service recipient having refused to make such payment, where the service recipient’s decision to refuse to make the payment is made by the service provider or a member of the service provider’s family (as defined in section 267(c)(4) applied as if the family of an individual includes the spouse of any member of the family), or any person or group of persons over whom the service provider or service provider’s family member has effective control, or any person any portion of whose compensation is controlled by the service provider or service provider’s family member.

(f) Special rule for certain resident aliens. An arrangement that is, or constitutes part of, a nonqualified deferred compensation plan is deemed to meet the requirements of this section with respect to any amount payable in the first calendar year in which a service provider is classified as a resident alien, and with respect to any amount payable in a subsequent calendar year if no later than the December 31 of the first calendar year in which the service provider is classified as a resident alien, the plan is amended as necessary so that the times and forms of payment of amounts payable in a subsequent year comply with the provisions of this section. For any year subsequent to the first calendar year in which an individual is classified as a resident alien, this paragraph (f) does not apply, provided that a calendar year may again be treated as the first calendar year in which an individual is classified as a resident alien if such individual has not been classified as a resident alien for at least five consecutive calendar years immediately preceding the year in which the service provider is again classified as a resident alien.

(g) Definitions and special rules—(1) Specified time or fixed schedule. Amounts are payable at a specified time or pursuant to a fixed schedule if objectively determinable amounts are payable at a date or dates that are objectively determinable at the time the amount is deferred. An amount is objectively determinable for this purpose if the amount is specifically identified or if the amount may be determined pursuant to a nondiscretionary formula (for example, 50 percent of an account balance). A specified time or fixed schedule also includes the designation of a calendar year or years that are objectively determinable at the time the amount is deferred, provided that for purposes of the application of the subsequent deferral rules contained in §1.409A-2(b), the specified time or fixed schedule of payments is deemed to refer to January 1 of the relevant calendar year or years. An arrangement may provide that a payment upon the lapse of a substantial risk of forfeiture is to be made in accordance with a fixed schedule that is objectively determinable based on the date the substantial risk of forfeiture lapses (disregarding any acceleration of the lapsing of the substantial risk of forfeiture other than due to the occurrence of a condition applicable as of the date the legally binding right to the payment arose that itself would constitute a substantial risk of forfeiture), provided that the schedule must be fixed at the time the time and form of payment are designated, and any change in the fixed schedule will constitute a change in the time and form of payment. For example, an arrangement that provides for a bonus payment subject to the condition that the service provider complete three years of service, but provided further that such requirement of continued services would lapse upon the occurrence of an initial public offering that if applied alone would subject the right to the payment to a substantial risk of forfeiture, may provide that a service provider is entitled to substantially equal payments on each of the first three anniversaries of the date the substantial risk of forfeiture lapses (the earlier of three years of service or the date of an initial public offering).

(2) Required delay in payment to a specified employee pursuant to a separation from service. In the case of any specified employee (as defined in §1.409A-1(i)), the requirements of paragraph (a)(1) of this section permitting a payment upon a separation from service are satisfied only if payments may not be made before the date that is six months after the date of separation from service (or, if earlier, the date of death of the specified employee). The arrangement must provide the manner in which the six-month delay will be implemented in the case of a service provider who is a specified employee. For example, an arrangement may provide that payments to which a specified employee would otherwise be entitled during the first six months following the date of separation from service are accumulated and paid at another specified date or specified schedule, such as the first date of the seventh month following the date of separation from service. The arrangement may also provide that each installment payment to which a specified employee is entitled upon a separation from service is delayed by six months. A service recipient may amend a plan at any time to change the method for applying the six-month delay, provided that the amendment may not be effective for a period of 12 months. Notwithstanding the foregoing, an amendment to a plan may be effective immediately in the case of a service recipient that amends the arrangement prior to the date upon which the service recipient’s stock first becomes readily tradable on an established securities market. Notwithstanding the foregoing, this paragraph (g)(2) also does not apply to a payment made under the circumstances described in paragraph (h)(2)(i) (domestic relations order), (h)(2)(ii) (conflicts of interest), or (h)(2)(v) (payment of employment taxes) of this section.

(3) Unforeseeable Emergency—(i) Definition. For purposes of paragraph (a)(6) of this section, an unforeseeable emergency is a severe financial hardship of the service provider or beneficiary resulting from an illness or accident of the service provider or beneficiary, the service provider’s or beneficiary’s spouse, or the service provider’s or beneficiary’s dependent (as defined in section 152(a)); loss of the service provider’s or beneficiary’s property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance, for example, as a result of a natural disaster); or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the service provider or beneficiary. For example, the imminent foreclosure of or eviction from the service provider’s or beneficiary’s primary residence may constitute an unforeseeable emergency. In addition, the need to pay for medical expenses, including non-refundable deductibles, as well as for the costs of prescription drug medication, may constitute an unforeseeable emergency. Finally, the need to pay for the funeral expenses of a spouse or a dependent (as defined in section 152(a)) may also constitute an unforeseeable emergency. Except as otherwise provided in this paragraph (g)(3)(i), the purchase of a home and the payment of college tuition are not unforeseeable emergencies. Whether a service provider or beneficiary is faced with an unforeseeable emergency permitting a distribution under this paragraph is to be determined based on the relevant facts and circumstances of each case, but, in any case, a distribution on account of unforeseeable emergency may not be made to the extent that such emergency is or may be relieved through reimbursement or compensation from insurance or otherwise, by liquidation of the service provider’s assets, to the extent the liquidation of such assets would not cause severe financial hardship, or by cessation of deferrals under the arrangement. An arrangement may provide for a payment upon any unforeseeable emergency, but does not have to provide for a payment upon all unforeseeable emergencies, provided that any event upon which a payment may be made qualifies as an unforeseeable emergency.

(ii) Amount of payment permitted upon an unforeseeable emergency. Distributions because of an unforeseeable emergency must be limited to the amount reasonably necessary to satisfy the emergency need (which may include amounts necessary to pay any Federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution). Determinations of amounts reasonably necessary to satisfy the emergency need must take into account any additional compensation that is available if the plan provides for cancellation of a deferral election upon a payment due to an unforeseeable emergency. See paragraph (h)(2)(vii) of this section. The payment may be made from any arrangement in which the service provider participates that provides for payment upon an unforeseeable emergency, provided that the arrangement under which the payment was made must be designated at the time of payment.

(4) Disability—(i) In general. For purposes of this section, a service provider is considered disabled if the service provider meets one of the following requirements:

(A) The service provider is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months.

(B) The service provider is, by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than 3 months under an accident and health plan covering employees of the service provider’s employer.

(ii) Limited plan definition of disability. An arrangement may provide for a payment upon any disability, and need not provide for a payment upon all disabilities, provided that any disability upon which a payment may be made under the arrangement complies with the provisions of this paragraph (g)(4).

(iii) Determination of disability. An arrangement may provide that a service provider will be deemed disabled if determined to be totally disabled by the Social Security Administration. An arrangement may also provide that a service provider will be deemed disabled if determined to be disabled in accordance with a disability insurance program, provided that the definition of disability applied under such disability insurance program complies with the requirements of this paragraph (g)(4).

(5) Change in the ownership or effective control of a corporation, or a change in the ownership of a substantial portion of the assets of a corporation—(i) In general. Pursuant to section 409A(a)(2)(A)(v), an arrangement may permit a payment upon the occurrence of a change in the ownership of the corporation (as defined in paragraph (g)(5)(v) of this section), a change in effective control of the corporation (as defined in paragraph (g)(5)(vi) of this section), or a change in the ownership of a substantial portion of the assets of the corporation (as defined in paragraph (g)(5)(vii) of this section) (collectively referred to as a change in control event). To qualify as a change in control event, the occurrence of the event must be objectively determinable and any requirement that any other person, such as a plan administrator or board of directors compensation committee, certify the occurrence of a change in control event must be strictly ministerial and not involve any discretionary authority. The arrangement may provide for a payment on any change in control event, and need not provide for a payment on all such events, provided that each event upon which a payment is provided qualifies as a change in control event. For rules regarding the ability of the service recipient to terminate the arrangement and pay amounts of deferred compensation upon a change in control event, see paragraph (h)(2)(viii)(B) of this section.

(ii) Identification of relevant corporation—(A) In general. To constitute a change in control event as to the service provider, the change in control event must relate to—

(1) The corporation for whom the service provider is performing services at the time of the change in control event;

(2) The corporation that is liable for the payment of the deferred compensation (or all corporations liable for the payment if more than one corporation is liable); or

(3) A corporation that is a majority shareholder of a corporation identified in paragraph (g)(5)(ii)(A)(1) or (2) of this section, or any corporation in a chain of corporations in which each corporation is a majority shareholder of another corporation in the chain, ending in a corporation identified in paragraph (g)(5)(ii)(A)(1) or (2) of this section.

(B) Majority shareholder. For purposes of this paragraph (g)(5)(ii), a majority shareholder is a shareholder owning more than 50 percent of the total fair market value and total voting power of such corporation.

(C) Example. The following example illustrates the rules of this paragraph (g)(5)(ii):

Example. Corporation A is a majority shareholder of Corporation B, which is a majority shareholder of Corporation C. A change in ownership of Corporation B constitutes a change in control event to service providers performing services for Corporation B or Corporation C, and to service providers for which Corporation B or Corporation C is solely liable for payments under the plan (for example, former employees), but is not a change in control event as to Corporation A or any other corporation of which Corporation A is a majority shareholder. Notwithstanding the foregoing, a sale of Corporation B may constitute an independent change in control event for Corporation A, Corporation B and Corporation C if the sale constitutes a change in the ownership of a substantial portion of Corporation A’s assets (see paragraph (g)(5)(vii) of this section).

(iii) Attribution of stock ownership. For purposes of paragraph (g)(5) of this section, section 318(a) applies to determine stock ownership. Stock underlying a vested option is considered owned by the individual who holds the vested option (and the stock underlying an unvested option is not considered owned by the individual who holds the unvested option). For purposes of the preceding sentence, however, if a vested option is exercisable for stock that is not substantially vested (as defined by §1.83-3(b) and (j)), the stock underlying the option is not treated as owned by the individual who holds the option.

(iv) Special rule for certain delayed payments pursuant to a change in control event. Compensation payable pursuant to the purchase by the service recipient of service recipient stock or a stock right held by a service provider, or payment of amounts of deferred compensation calculated by reference to the value of service recipient stock, may be treated as paid at a specified time or pursuant to a fixed schedule in conformity with the requirements of section 409A if paid on the same schedule and under the same terms and conditions as payments to shareholders generally pursuant to a change in control event described in paragraph (g)(5)(v) of this section (change in the ownership of a corporation) or as payments to the service recipient pursuant to a change in control event described in paragraph (g)(5)(vii) of this section (change in the ownership of a substantial portion of a corporation’s assets), and any amounts paid pursuant to such a schedule and such terms and conditions will not be treated as violating the initial or subsequent deferral elections rules, to the extent that such amounts are paid not later than five years after the change in control event.

(v) Change in the ownership of a corporation—(A) In general. For purposes of section 409A, a change in the ownership of a corporation occurs on the date that any one person, or more than one person acting as a group (as defined in paragraph (g)(5)(v)(B) of this section), acquires ownership of stock of the corporation that, together with stock held by such person or group, constitutes more than 50 percent of the total fair market value or total voting power of the stock of such corporation. However, if any one person, or more than one person acting as a group, is considered to own more than 50 percent of the total fair market value or total voting power of the stock of a corporation, the acquisition of additional stock by the same person or persons is not considered to cause a change in the ownership of the corporation (or to cause a change in the effective control of the corporation (within the meaning of paragraph (g)(5)(vi) of this section)). An increase in the percentage of stock owned by any one person, or persons acting as a group, as a result of a transaction in which the corporation acquires its stock in exchange for property will be treated as an acquisition of stock for purposes of this section. This section applies only when there is a transfer of stock of a corporation (or issuance of stock of a corporation) and stock in such corporation remains outstanding after the transaction (see paragraph (g)(5)(vii) of this section for rules regarding the transfer of assets of a corporation).

(B) Persons acting as a group. For purposes of paragraph (g)(5)(v)(A) of this section, persons will not be considered to be acting as a group solely because they purchase or own stock of the same corporation at the same time, or as a result of the same public offering. However, persons will be considered to be acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition of stock, or similar business transaction with the corporation. If a person, including an entity, owns stock in both corporations that enter into a merger, consolidation, purchase or acquisition of stock, or similar transaction, such shareholder is considered to be acting as a group with other shareholders in a corporation prior to the transaction giving rise to the change and not with respect to the ownership interest in the other corporation. See §1.280G-1, Q&A-27(d), Example 4.

(vi) Change in the effective control of a corporation—(A) In general. For purposes of section 409A, notwithstanding that a corporation has not undergone a change in ownership under paragraph (g)(5)(v) of this section, a change in the effective control of a corporation occurs only on the date that either—

(1) Any one person, or more than one person acting as a group (as determined under paragraph (g)(5)(v)(B) of this section), acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) ownership of stock of the corporation possessing 35 percent or more of the total voting power of the stock of such corporation; or

(2) A majority of members of the corporation’s board of directors is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of the corporation’s board of directors prior to the date of the appointment or election, provided that for purposes of this paragraph (g)(5)(vi)(A) the term corporation refers solely to the relevant corporation identified in paragraph (g)(5)(ii) of this section, for which no other corporation is a majority shareholder for purposes of that paragraph (for example, if Corporation A is a publicly held corporation with no majority shareholder, and Corporation A is the majority shareholder of Corporation B, which is the majority shareholder of Corporation C, the term corporation for purposes of this paragraph (g)(5)(vi)(A)(2) would refer solely to Corporation A).

(B) Multiple change in control events. A change in effective control also may occur in any transaction in which either of the two corporations involved in the transaction has a change in control event under paragraphs (g)(5)(v) or (g)(5)(vii) of this section. Thus, for example, assume Corporation P transfers more than 40 percent of the total gross fair market value of its assets to Corporation O in exchange for 35 percent of O’s stock. P has undergone a change in ownership of a substantial portion of its assets under paragraph (g)(5)(vii) of this section and O has a change in effective control under this paragraph (g)(5)(vi) of this section.

(C) Acquisition of additional control. If any one person, or more than one person acting as a group, is considered to effectively control a corporation (within the meaning of this paragraph (g)(5)(vi)), the acquisition of additional control of the corporation by the same person or persons is not considered to cause a change in the effective control of the corporation (or to cause a change in the ownership of the corporation within the meaning of paragraph (g)(5)(v) of this section).

(D) Persons acting as a group. Persons will not be considered to be acting as a group solely because they purchase or own stock of the same corporation at the same time, or as a result of the same public offering. However, persons will be considered to be acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition of stock, or similar business transaction with the corporation. If a person, including an entity, owns stock in both corporations that enter into a merger, consolidation, purchase or acquisition of stock, or similar transaction, such shareholder is considered to be acting as a group with other shareholders in a corporation only with respect to the ownership in that corporation prior to the transaction giving rise to the change and not with respect to the ownership interest in the other corporation. See §1.280G-1, Q&A-27(d), Example 4.

(vii) Change in the ownership of a substantial portion of a corporation’s assets—(A) In general. Change in the ownership of a substantial portion of a corporation’s assets. For purposes of section 409A, a change in the ownership of a substantial portion of a corporation’s assets occurs on the date that any one person, or more than one person acting as a group (as determined in paragraph (g)(5)(v)(B) of this section), acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) assets from the corporation that have a total gross fair market value equal to or more than 40 percent of the total gross fair market value of all of the assets of the corporation immediately prior to such acquisition or acquisitions. For this purpose, gross fair market value means the value of the assets of the corporation, or the value of the assets being disposed of, determined without regard to any liabilities associated with such assets.

(B) Transfers to a related person—(1) There is no change in control event under this paragraph (g)(5)(vii) when there is a transfer to an entity that is controlled by the shareholders of the transferring corporation immediately after the transfer, as provided in this paragraph (g)(5)(vii)(B). A transfer of assets by a corporation is not treated as a change in the ownership of such assets if the assets are transferred to—

(i) A shareholder of the corporation (immediately before the asset transfer) in exchange for or with respect to its stock;

(ii) An entity, 50 percent or more of the total value or voting power of which is owned, directly or indirectly, by the corporation;

(iii) A person, or more than one person acting as a group, that owns, directly or indirectly, 50 percent or more of the total value or voting power of all the outstanding stock of the corporation; or

(iv) An entity, at least 50 percent of the total value or voting power of which is owned, directly or indirectly, by a person described in paragraph (g)(5)(vii)(B)(1)(iii) of this section.

(2) For purposes of this paragraph (g)(5)(vii)(B) and except as otherwise provided, a person’s status is determined immediately after the transfer of the assets. For example, a transfer to a corporation in which the transferor corporation has no ownership interest before the transaction, but which is a majority-owned subsidiary of the transferor corporation after the transaction is not treated as a change in the ownership of the assets of the transferor corporation.

(C) Persons acting as a group. Persons will not be considered to be acting as a group solely because they purchase assets of the same corporation at the same time. However, persons will be considered to be acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition of assets, or similar business transaction with the corporation. If a person, including an entity shareholder, owns stock in both corporations that enter into a merger, consolidation, purchase or acquisition of assets, or similar transaction, such shareholder is considered to be acting as a group with other shareholders in a corporation only to the extent of the ownership in that corporation prior to the transaction giving rise to the change and not with respect to the ownership interest in the other corporation. See 1.280G-1, Q&A-27(d), Example 4.

(6) Certain back-to-back arrangements—(i) In general. Notwithstanding the generally applicable limitations on payments described under paragraph (a) of this section, an arrangement between a service recipient and a service provider that is also a service recipient (a service provider/service recipient) may provide for payment upon the occurrence of a payment event described in paragraph (a)(1), (2), (3), (5) or (6) of this section, where the time and form of payment is defined as the same time and form of payment provided under an arrangement subject to section 409A between the service provider/service recipient and a specified service provider to the service provider/service recipient, if the arrangement between the service provider/service recipient and the service recipient expressly provides for such time and form of payment and otherwise satisfies the requirements of section 409A.

(ii) Example. The provisions of this paragraph (g)(6) are illustrated by the following example:

Example. Company B (service provider/service recipient) provides services to Company C (service recipient). Employee A (service provider) provides services to Company B. Pursuant to a nonqualified deferred compensation plan meeting the requirements of section 409A, Employee A is entitled to a payment of deferred compensation upon a separation from service from Company B. Under an arrangement between Company B and Company C, Company C agrees to pay an amount of deferred compensation to Company B upon Employee A’s separation from service from Company B, in accordance with the time and form of payment provided in the nonqualified deferred compensation plan between Employee A and Company B. Provided that the arrangement between Company B and Company C and the arrangement between Employee A and Company B otherwise comply with the requirements of section 409A, Company C’s payment to Company B of the amount due upon the separation from service of Employee A from Company B may constitute a permissible payment event for purposes of paragraph (a) of this section.

(h) Prohibition on acceleration of payments—(1) In general. Except as provided in paragraph (h)(2) of this section, an arrangement that is, or constitutes part of, a nonqualified deferred compensation plan may not permit the acceleration of the time or schedule of any payment or amount scheduled to be paid pursuant to a payment under the arrangement. For purposes of this paragraph (h), an impermissible acceleration does not occur if payment is made in accordance with plan provisions or an election as to the time and form of payment in effect at the time of initial deferral (or added in accordance with the rules applicable to subsequent deferral elections under §1.409A-2(b)) pursuant to which payment is required to be made on an accelerated schedule as a result of an intervening event that is an event described in paragraph (a)(1), (2), (3), (5) or (6) of this section. For example, a plan may provide that a participant will receive six installment payments commencing at separation from service, and also provide that if the participant dies after such payments commence but before all payments have been made, all remaining amounts will be paid in a lump sum payment. Additionally, it is not an acceleration of the time or schedule of payment of a deferral of compensation if a service recipient waives or accelerates the satisfaction of a condition constituting a substantial risk of forfeiture applicable to such deferral of compensation, provided that the requirements of section 409A (including the requirement that the payment be made upon a permissible payment event) are otherwise satisfied with respect to such deferral of compensation. For example, if a nonqualified deferred compensation arrangement provides for a lump sum payment of the vested benefit upon separation from service, and the benefit vests under the plan only after 10 years of service, it is not a violation of the requirements of section 409A if the service recipient reduces the vesting requirement to 5 years of service, even if a service provider becomes vested as a result and receives a payment in connection with a separation from service before the service provider would have completed 10 years of service.

(2) Exceptions—(i) Domestic relations order. An arrangement may permit such acceleration of the time or schedule of a payment under the arrangement to an individual other than the service provider as may be necessary to fulfill a domestic relations order (as defined in section 414(p)(1)(B)).

(ii) Conflicts of interest. An arrangement may permit such acceleration of the time or schedule of a payment under the arrangement as may be necessary to comply with a certificate of divestiture (as defined in section 1043(b)(2)).

(iii) Section 457 plans. An arrangement subject to section 457(f) may permit an acceleration of the time or schedule of a payment to a service provider to pay Federal, state, local and foreign income taxes due upon a vesting event, provided that the amount of such payment is not more than an amount equal to the Federal, state, local and foreign income tax withholding that would have been remitted by the employer if there had been a payment of wages equal to the income includible by the service provider under section 457(f) at the time of the vesting.

(iv) De minimis and specified amounts —(A) In general. An arrangement that does not otherwise provide for mandatory lump sum payments of benefits that do not exceed a specified amount may be amended to permit the acceleration of the time or schedule of a payment to a service provider under the arrangement, provided that—

(1) The payment accompanies the termination of the entirety of the service provider’s interest in the arrangement, and all similar arrangements that would constitute a nonqualified deferred compensation plan under §1.409A-1(c);

(2) The payment is made on or before the later of December 31 of the calendar year in which occurs the service provider’s separation from service from the service recipient, or the 15^th day of the third month following the service provider’s separation from service from the service recipient;

(3) The payment is not greater than $10,000; and

(4) The participant is provided no election with respect to receipt of the lump sum payment.

(B) Prospective deferrals. An amendment described in paragraph (h)(2)(iv)(A) of this section may be made with respect to previously deferred amounts under the arrangement as well as amounts to be deferred in the future. In addition, a nonqualified deferred compensation arrangement that otherwise complies with section 409A may provide, or be amended with regard to future deferrals to provide, that, if a service provider’s interest under the arrangement has a value below an amount specified by the plan at the time that amounts are payable under the plan, then the service provider’s entire interest under the plan must be distributed as a lump sum payment. However, once such a payment feature applies to an amount deferred, any change or elimination of such feature is subject to the rules governing changes in the time and form of payment.

(v) Payment of employment taxes. An arrangement may permit the acceleration of the time or schedule of a payment to pay the Federal Insurance Contributions Act (FICA) tax imposed under section 3101, section 3121(a) and section 3121(v)(2), where applicable, on compensation deferred under the arrangement (the FICA Amount). Additionally, an arrangement may permit the acceleration of the time or schedule of a payment to pay the income tax at source on wages imposed under section 3401 or the corresponding withholding provisions of applicable state, local, or foreign tax laws as a result of the payment of the FICA Amount, and to pay the additional income tax at source on wages attributable to the pyramiding section 3401 wages and taxes. However, the total payment under this acceleration provision must not exceed the aggregate of the FICA Amount, and the income tax withholding related to such FICA Amount.

(vi) Payments upon income inclusion under section 409A. An arrangement may permit the acceleration of the time or schedule of a payment to a service provider under the plan at any time the arrangement fails to meet the requirements of section 409A and these regulations. Such payment may not exceed the amount required to be included in income as a result of the failure to comply with the requirements of section 409A and the regulations.

(vii) Cancellation of deferrals following an unforeseeable emergency or hardship distribution. An arrangement may permit a cancellation of a service provider’s deferral election due to an unforeseeable emergency or a hardship distribution pursuant to §1.401(k)-1(d)(3). The deferral election must be cancelled, and not postponed or otherwise delayed, such that any later deferral election will be subject to the provisions governing initial deferral elections. See §1.409A-2(a).

(viii) Arrangement terminations. An arrangement may permit an acceleration of the time and form of a payment where the right to the payment arises due to a termination of the arrangement in accordance with one of the following:

(A) The service recipient’s discretion under the terms of the arrangement to terminate the arrangement within 12 months of a corporate dissolution taxed under section 331, or with the approval of a bankruptcy court pursuant to 11 U.S.C. §503(b)(1)(A), provided that the amounts deferred under the plan are included in the participants’ gross incomes in the latest of—

(1) The calendar year in which the plan termination occurs;

(2) The calendar year in which the amount is no longer subject to a substantial risk of forfeiture; or

(3) The first calendar year in which the payment is administratively practicable.

(B) The service recipient’s discretion under the terms of the arrangement to terminate the arrangement within the 30 days preceding or the 12 months following a change in control event (as defined in §1.409A-3(g)(5)(i)). For purposes of this paragraph (h)(2)(viii), an arrangement will be treated as terminated only if all substantially similar arrangements sponsored by the service recipient are terminated, so that the participant in the arrangement and all participants under substantially similar arrangements are required to receive all amounts of compensation deferred under the terminated arrangements within 12 months of the date of termination of the arrangements.

(C) The service recipient’s discretion under the terms of the arrangement to terminate the arrangement, provided that—

(1) All arrangements sponsored by the service recipient that would be aggregated with any terminated arrangement under §1.409A-1(c) if the same service provider participated in all of the arrangements are terminated;

(2) No payments other than payments that would be payable under the terms of the arrangements if the termination had not occurred are made within 12 months of the termination of the arrangements;

(3) All payments are made within 24 months of the termination of the arrangements; and

(4) The service recipient does not adopt a new arrangement that would be aggregated with any terminated arrangement under §1.409A-1(c) if the same service provider participated in both arrangements, at any time within five years following the date of termination of the arrangement.

(D) Such other events and conditions as the Commissioner may prescribe in generally applicable guidance published in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter).

(ix) Certain distributions to avoid a nonallocation year under section 409(p). An arrangement may provide for an acceleration of payment to prevent the occurrence of a nonallocation year (within the meaning of section 409(p)(3)) in the plan year of the employee stock ownership plan next following the current plan year, provided that the amount distributed may not exceed 125 percent of the minimum amount of distribution necessary to avoid the occurrence of a nonallocation year. Solely for purposes of determining permissible distributions under this paragraph (h)(2)(ix), synthetic equity (within the meaning of section 409(p)(6)(C)) granted during the current employee stock ownership plan plan year is disregarded for purposes of determining whether the subsequent plan year would result in a nonallocation year.

(3) Nonqualified deferred compensation arrangements linked to qualified plans. With respect to amounts deferred under an arrangement that is, or constitutes part of, a nonqualified deferred compensation plan, where under the terms of the nonqualified deferred compensation arrangement the amount deferred under the plan is the amount determined under the formula determining benefits under a qualified employer plan (as defined in §1.409A-1(a)(2)) applied without respect to one or more limitations applicable to qualified employer plans under the Internal Revenue Code or other applicable law, or is determined as an amount offset by some or all of the benefits provided under the qualified employer plan, the operation of the qualified employer plan with respect to changes in benefit limitations applicable to qualified employer plans under the Internal Revenue Code or other applicable law, does not constitute an acceleration of a payment under the nonqualified deferred compensation arrangement regardless of whether such operation results in a decrease of amounts deferred under the nonqualified deferred compensation arrangement. In addition, with respect to such nonqualified deferred compensation arrangements, the following actions or failures to act will not constitute an acceleration of a payment under the nonqualified deferred compensation arrangement regardless of whether in accordance with the terms of the nonqualified deferred compensation arrangement, the actions or inactions result in a decrease in the amounts deferred under the arrangement:

(i) A service provider’s action or inaction under the qualified employer plan with respect to whether to elect to receive a subsidized benefit or an ancillary benefit under the qualified employer plan.

(ii) The amendment of a qualified employer plan to increase benefits provided under the qualified plan, or to add or remove a subsidized benefit or an ancillary benefit.

(iii) A service provider’s action or inaction with respect to an elective deferral election under a qualified employer plan subject to section 402(g), including an adjustment to a deferral election made during a calendar year, provided that for any given calendar year, the service provider’s actions or inactions do not result in a decrease in the amounts deferred under all nonqualified deferred compensation plans in which the service provider participates in excess of an amount equal to the limit with respect to elective deferrals under section 402(g) in effect for the taxable year in which such action or inaction occurs.

(iv) A service provider’s action or inaction under a qualified employer plan with respect to elective deferrals or after-tax contributions by the service provider to the qualified employer plan that affects the amounts that are credited under a nonqualified deferred compensation arrangement as matching amounts or other amounts contingent on service provider elective deferrals or after-tax contributions, provided that such matching or contingent amounts, as applicable, are either forfeited or never credited under the nonqualified deferred compensation arrangement in the absence of such service provider’s elective deferral or after-tax contribution, and provided further that for any given calendar year, the service provider’s actions and inactions do not result in a decrease in the amounts deferred under all nonqualified deferred compensation plans in which the service provider participates in excess of an amount equal to the limit with respect to elective deferrals under section 402(g) in effect for the taxable year in which such action or inaction occurs. See §1.409A-2(b)(6), Example 12 and Example 13.

(a) Statutory effective dates—(1) In general. Except as otherwise provided in this section, section 409A is effective with respect to amounts deferred in taxable years beginning after December 31, 2004, and amounts deferred in taxable years beginning before January 1, 2005, if the plan under which the deferral is made is materially modified after October 3, 2004. Section 409A is effective with respect to earnings on amounts deferred only to the extent that section 409A is effective with respect to the amounts deferred. Accordingly, section 409A is not effective with respect to earnings on amounts deferred before January 1, 2005, unless section 409A is effective with respect to the amounts deferred.

(2) Identification of date of deferral for statutory effective date purposes. For purposes of determining whether section 409A is applicable with respect to an amount, the amount is considered deferred before January 1, 2005, if before January 1, 2005, the service provider had a legally binding right to be paid the amount, and the right to the amount was earned and vested. For purposes of this paragraph (a)(2), a right to an amount was earned and vested only if the amount was not subject to a substantial risk of forfeiture (as defined in §1.83-3(c)) or a requirement to perform further services. Amounts to which the service provider did not have a legally binding right before January 1, 2005 (for example because the service recipient retained discretion to reduce the amount), will not be considered deferred before January 1, 2005. In addition, amounts to which the service provider had a legally binding right before January 1, 2005, but the right to which was subject to a substantial risk of forfeiture or a requirement to perform further services after December 31, 2004, are not considered deferred before January 1, 2005, for purposes of the effective date. Notwithstanding the foregoing, an amount to which the service provider had a legally binding right before January 1, 2005, but for which the service provider was required to continue performing services to retain the right only through the completion of the payroll period (as defined in §1.409A-1(b)(3)) that includes December 31, 2004, is not treated as subject to a requirement to perform further services (or a substantial risk of forfeiture) for purposes of the effective date. For purposes of this paragraph (a)(2), a stock option, stock appreciation right or similar compensation that on or before December 31, 2004, was immediately exercisable for cash or substantially vested property (as defined in §1.83-3(b)) is treated as earned and vested, regardless of whether the right would terminate if the service provider ceased providing services for the service recipient.

(3) Calculation of amount of compensation deferred for statutory effective date purposes—(i) Nonaccount balance plans. The amount of compensation deferred before January 1, 2005, under a nonqualified deferred compensation plan that is a nonaccount balance plan (as defined in §31.3121(v)(2)-1(c)(2)(i) of this chapter) equals the present value as of December 31, 2004, of the amount to which the service provider would be entitled under the plan if the service provider voluntarily terminated services without cause on December 31, 2004, and received a payment of the benefits with the maximum value available from the plan on the earliest possible date allowed under the plan to receive a payment of benefits following the termination of services. Notwithstanding the foregoing, for any subsequent calendar year, the grandfathered amount may increase to equal the present value of the benefit the service provider actually becomes entitled to, determined under the terms of the plan (including applicable limits under the Internal Revenue Code), as in effect on October 3, 2004, without regard to any further services rendered by the service provider after December 31, 2004, or any other events affecting the amount of or the entitlement to benefits (other than a participant election with respect to the time or form of an available benefit).

(ii) Account balance plans. The amount of compensation deferred before January 1, 2005, under a nonqualified deferred compensation plan that is an account balance plan (as defined in §31.3121(v)(2)-1(c)(1)(ii) of this chapter) equals the portion of the service provider’s account balance as of December 31, 2004, the right to which is earned and vested (as defined in paragraph (a)(2) of this section) as of December 31, 2004.

(iii) Equity-based compensation plans. For purposes of determining the amounts deferred before January 1, 2005, under an equity-based compensation plan, the rules of paragraph (a)(3)(ii) of this section governing account balance plans are applied except that the account balance is deemed to be the amount of the payment available to the service provider on December 31, 2004 (or that would be available to the service provider if the right were immediately exercisable) the right to which is earned and vested (as defined in paragraph (a)(2) of this section) as of December 31, 2004. For this purpose, the payment available to the service provider excludes any exercise price or other amount that must be paid by the service provider.

(iv) Earnings. Earnings on amounts deferred under a plan before January 1, 2005, include only income (whether actual or notional) attributable to the amounts deferred under a plan as of December 31, 2004, or such income. For example, notional interest earned under the plan on amounts deferred in an account balance plan as of December 31, 2004, generally will be treated as earnings on amounts deferred under the plan before January 1, 2005. Similarly, an increase in the amount of payment available pursuant to a stock option, stock appreciation right or other equity-based compensation above the amount of payment available as of December 31, 2004, due to appreciation in the underlying stock after December 31, 2004, or accrual of other earnings such as dividends, is treated as earnings on the amount deferred. In the case of a nonaccount balance plan, earnings include the increase, due solely to the passage of time, in the present value of the future payments to which the service provider has obtained a legally binding right, the present value of which constituted the amounts deferred under the plan before January 1, 2005. Thus, for each year, there will be an increase (determined using the same interest rate used to determine the amounts deferred under the plan before January 1, 2005) resulting from the shortening of the discount period before the future payments are made, plus, if applicable, an increase in the present value resulting from the service provider’s survivorship during the year. However, an increase in the potential benefits under a nonaccount balance plan due to, for example, an application of an increase in compensation after December 31, 2004, to a final average pay plan or subsequent eligibility for an early retirement subsidy, does not constitute earnings on the amounts deferred under the plan before January 1, 2005.

(v) Definition of plan. For purposes of this paragraph (a), the term plan has the same meaning provided in §1.409A-1(c), except that the provisions treating all nonaccount balance plans under which compensation is deferred as a single plan does not apply for purposes of the actuarial assumptions used in paragraph (a)(3)(ii) of this section. Accordingly, different reasonable actuarial assumptions may be used to calculate the amounts deferred by a service provider in two different arrangements each of which constitutes a nonaccount balance plan.

(4) Material modifications—(i) In general. Except as otherwise provided, a modification of a plan is a material modification if a benefit or right existing as of October 3, 2004, is materially enhanced or a new material benefit or right is added, and such material enhancement or addition affects amounts earned and vested before January 1, 2005. Such material benefit enhancement or addition is a material modification whether it occurs pursuant to an amendment or the service recipient’s exercise of discretion under the terms of the plan. For example, an amendment to a plan to add a provision that payments of deferred amounts earned and vested before January 1, 2005, may be allowed upon request if service providers are required to forfeit 20 percent of the amount of the payment (a haircut) would be a material modification to the plan. Similarly, a material modification would occur if a service recipient exercised discretion to accelerate vesting of a benefit under the plan to a date on or before December 31, 2004. However, it is not a material modification for a service recipient to exercise discretion over the time and manner of payment of a benefit to the extent such discretion is provided under the terms of the plan as of October 3, 2004. It is not a material modification for a service provider to exercise a right permitted under the plan as in effect on October 3, 2004. The amendment of a plan to bring the plan into compliance with the provisions of section 409A will not be treated as a material modification. However, a plan amendment or the exercise of discretion under the terms of the plan that materially enhances an existing benefit or right or adds a new material benefit or right will be considered a material modification even if the enhanced or added benefit would be permitted under section 409A. For example, the addition of a right to a payment upon an unforeseeable emergency of an amount earned and vested before January 1, 2005, would be considered a material modification. The reduction of an existing benefit is not a material modification. For example, the removal of a haircut provision generally would not constitute a material modification. The establishment of or contributions to a trust or other arrangement from which benefits under the plan are to be paid is not a material modification of the plan, provided that the contribution to the trust or other arrangement would not otherwise cause an amount to be includible in the service provider’s gross income.

(ii) Adoptions of new arrangements. It is presumed that the adoption of a new arrangement or the grant of an additional benefit under an existing arrangement after October 3, 2004, and before January 1, 2005, constitutes a material modification of a plan. However, the presumption may be rebutted by demonstrating that the adoption of the arrangement or grant of the additional benefit is consistent with the service recipient’s historical compensation practices. For example, the presumption that the grant of a discounted stock option on November 1, 2004, is a material modification of a plan may be rebutted by demonstrating that the grant was consistent with the historic practice of granting substantially similar discounted stock options (both as to terms and amounts) each November for a significant number of years. Notwithstanding paragraph (a)(4)(i) and this paragraph (a)(4)(ii), the grant of an additional benefit under an existing arrangement that consists of a deferral of additional compensation not otherwise provided under the plan as of October 3, 2004, will be treated as a material modification of the plan only as to the additional deferral of compensation, if the plan explicitly identifies the additional deferral of compensation and provides that the additional deferral of compensation is subject to section 409A. Accordingly, amendments to conform a plan to the requirements of section 409A with respect to deferrals under a plan occurring after December 31, 2004, will not constitute a material modification of the plan with respect to amounts deferred that are earned and vested on or before December 31, 2004, provided that there is no concurrent material modification with respect to the amount of, or rights to, amounts deferred that were earned and vested on or before December 31, 2004. Similarly, a grant of an additional benefit under a new arrangement adopted after October 3, 2004, and before January 1, 2005, will not be treated as a material modification of an existing plan to the extent that the new arrangement explicitly identifies additional deferrals of compensation and provides that the additional deferrals of compensation are subject to section 409A.

(iii) Suspension or termination of a plan. A cessation of deferrals under, or termination of, a plan, pursuant to the provisions of such plan, is not a material modification. Amending an arrangement to stop future deferrals thereunder is not a material modification of the arrangement or the plan. Amending an arrangement to provide participants an election whether to terminate participation in a plan constitutes a material modification of the plan.

(iv) Changes to investment measures—account balance plans. With respect to an account balance plan (as defined in §31.3121(v)(2)-1(c)(1)(ii) of this chapter), it is not a material modification to change a notional investment measure to, or to add to existing investment measures, an investment measure that qualifies as a predetermined actual investment within the meaning of §31.3121(v)(2)-1(d)(2) of this chapter or, for any given taxable year, reflects a reasonable rate of interest (determined in accordance with §31.3121(v)(2)-1(d)(2)(i)(C) of this chapter). For this purpose, if with respect to an amount deferred for a period, a plan provides for a fixed rate of interest to be credited, and the rate is to be reset under the plan at a specified future date that is not later than the end of the fifth calendar year that begins after the beginning of the period, the rate is reasonable at the beginning of the period, and the rate is not changed before the reset date, then the rate will be treated as reasonable in all future periods before the reset date.

(v) Rescission of modifications. Any modification to the terms of a plan that would inadvertently result in treatment as a material modification under this section is not considered a material modification of the plan to the extent the modification in the terms of the plan is rescinded by the earlier of a date before the right is exercised (if the change grants a discretionary right) or the last day of the calendar year during which such change occurred. Thus, for example, if a service recipient modifies the terms of a plan on March 1 to allow an election of a new change in the time or form of payment without realizing that such a change constituted a material modification that would subject the plan to the requirements of section 409A, and the modification is rescinded on November 1, then if no change in the time or form of payment has been made pursuant to the modification before November 1, the plan is not considered materially modified under this section.

(vi) Definition of plan. For purposes of this paragraph (a)(4), the term plan has the same meaning provided in §1.409A-1(c), except that the provision treating all account balance plans under which compensation is deferred as a single plan, all nonaccount balance plans under which compensation is deferred as a separate single plan, all separation pay arrangements due to an actual involuntary separation from service or participation in a window program as a separate single plan, and all other nonqualified deferred compensation plans as a separate single plan, does not apply.

(b) [Reserved].

Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.