Copyright 2005 Alvarez & Marsal Tax Advisory Services, LLC. All rights reserved.

SJSU / TEIHigh Technology Tax Institute

November 6, 2006

Section 409A - Deferred Compensation Update

Brian CumberlandNational Managing DirectorCompensation & Benefits

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NOTICE

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF

(I) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR

(II) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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Agenda: Section 409A – Deferred Compensation

• Section 409A – Update• Consequences of Bad Deferrals• Deferred Compensation - Included / Excluded• Limitation of Timing of Distributions• Operational Issues

– Separation Pay Rules

– Stock Option Exclusion

• Section 409A – Recent Guidance

• Case Study – Discounted Stock Options

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Section 409A - Update

• Section 409A enacted as part of American Jobs Creation Act of 2004• Notice 2005-1 – Transitional Guidance• Proposed Regulations – Issued October 4, 2005• Notice 2006-79 – Additional Transitional Relief• Finalized Regulations – IRS Targeting End of Year

• Until further guidance issued, T/Ps can rely on:– Notice 2005-1

– Preamble to Proposed Regulations

– Proposed Regulations

– Good-faith interpretation to the extent not covered by other releases

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Consequences of Bad Deferrals

• If certain deferral requirements are not met– All plan deferrals are included in gross income as soon as no longer

subject to a substantial risk of forfeiture

– Also subject to 20% additional tax, plus interest

• Form defects may affect all plan participants• Operational defects affect only those that benefit

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Deferred Compensation – Plans Included

• Any deferral agreement, method, or arrangement– Independent contractor and director plans

– Certain partnership and one person plans

– Earnings (actual or notional)

• SERPs, “make-up" or "mirror" plans, § 457(f) plans• Severance pay• RSUs, phantom plans• Foreign deferral plans• Discounted stock options• Right to dividends• Stock options with deferral feature

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Deferred Compensation – Plans Excluded

• Certain welfare benefit arrangements• Qualified, SEP, SIMPLE, and § 457(b) plans• ISOs and ESPPs• Property transfers with substantial risk of forfeiture – Section 83• Stock Options and SARs with an Exercise Price equal to FMV at time

of grant– Watch exercise extensions

• Certain separation payments• Certain foreign deferral plans

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Limitations on Timing of Distributions

• Employee’s separation from service• Death or disability• Specified time or fixed schedule established at deferral

– Age 65 is a specified time

– Occurrence of an event is not (e.g., child enters college)

• Change in control• Unforeseeable emergency

• No acceleration of time or schedule of payment

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Separation Pay Rules

• Voluntary separation– “Key Employee” of Public Company

6 month payment delay

• Involuntary separation – CBU plans excluded

– Short term deferral rule may exclude SROF until termination full payment within year or 2 ½ months after end of year

– Special separation pay rule No more than 2 years after year of termination No more than 2 x average compensation (limited to qualified plan compensation

limit – now $210,000) for last three years

– Watch “Reasonable Cause” terminations

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Stock Option Exclusion

• Stock options granted at FMV – No deferral feature

– Can receive vested or non-vested stock on exercise

– Certain substitutions after corporate transaction allowed

– Service recipient stock only Special controlled group rule 50% owned subsidiaries 20% owned if special relationship (JV…)

– Stock must be common stock

– Watch exercise extensions!

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Stock Option Exclusion - Fair Market Value

• Stock traded on an established market– Last sale before or first sale after grant date– Average selling price 30 days before or after grant– Valuation must be consistent for programs

• Stock NOT traded on an established market– NOT preferred stock– Reasonable valuation method– Presumed reasonable if:

Independent Valuation issued within 12 months, Guidance in Reg. § 1.83-5 used for nonlapse restrictions, or Reasonable, good faith written report (young companies)

• Illiquid Stock– First 10 years of active business– No put or call rights– Valuation by person with significant knowledge or experience

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Section 409A – Recent Guidance

• Notice 2006-4– Background:

Amounts earned and vested as of December 31, 2004, are generally grandfathered

Stock options issued with an Exercise Price equal to or great than FMV, are exempted from section 409A

Concern with stock options issued before January 1, 2005, as to whether issued at FMV

– For grants prior to January 1, 2005, FMV may be determined in accordance with Incentive Stock Options

“Good-Faith” attempt to set exercise price

– Does not apply to options issued after December 31, 2004 Must follow Notice 2005-1 or Proposed Regulations

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Section 409A – Recent Guidance

• Notice 2006-33– Further extended transitional relief to December 31, 2007

– Additional time to make amendments

– Additional time to make elections Except amounts are payable in 2006 Amounts cannot be accelerated into 2006

– Certain Options / SARs not subject to additional transitional relief, if: Granted by companies registered under SEC Section 12, Granted to a person subject to SEC Section 16(a), and Company reported or expects to report financial expense on discounted option

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Section 409A – Recent Guidance

• Notice 2005-94– Background: Annual reporting required under Notice 2005-1

Form W-2 – Code Y in Box 12 for deferrals Form W-2 – Code Z for failing section 409A

– Suspends an Employer’s reporting requirements concerning section 409A for 2005

Deferrals Section 409A violations that EE has neither actually nor constructively received

– Future guidance may require correction of reporting

– Does not effect individual’s filing, tax liability, or interest on underpayment of taxes

– Company still need to report NQDC FICA in Box 11

• Additional guidance to be issued by end of year

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Section 409A – Recent Guidance

• Notice 2006-79– Background:

Income inclusion for deferrals held in offshore trust or restricted on change in ER’s financial health. 409A(b)

GOZA provides that such amounts are not subject to grandfather provisions

– Notice gave arrangement that were in violation, time to conform

– Assets set aside by March 21, 2006, must come into compliance by December 31, 2007

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Case Study – Discounted Stock Options

• Wall Street Journal article “The Perfect Payday – Some CEOs reap millions by landing stock options when they are most valuable. Luck – or something else?” – Discussed timing of stock option awards to some CEOs

– Examined the period 1995 through 2002

– Concern is whether the stock options were backdated

• Granting options at a discount, ok as long as plan allows• Potential Issues

– Securities fraud

– Accounting issues– Discount is a charge to earnings– Overstate profits, possible restatement

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Case Study – Discounted Stock Options

• IRS Focused On• Discounted Stock Options – Tax Issues• Section 409A – Deferred Compensation Rules

– Stock options are not subject to Section 409A, if Exercise Price equals or exceed FMV at time of grant

– Section 409A Plans must provide a distribution date

– Failure results in 20% excise tax to Executive, plus interest component

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Case Study – Discounted Stock Options

• Section 162(m) - $1 million dollar deduction limitation– For stock options, Exercise Price must equal or exceed FMV at time of

grant • Unless performance based vesting

– Failure results in a disallowed deduction• For options granted to CEO and top 4 officers• Exception if Executive exercises after retirement• Amendment to tax return

• Section 422 – Incentive Stock Options– Exercise Price must equal or exceed FMV at time of grant– Failure results in:

• Executive: Is not entitled to preferential tax treatment• Company: Is required to withhold FIT and FICA

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Questions

Questions?

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Brian Cumberland – National Managing Director2911 Turtle Creek Boulevard, Suite 300 Direct: (214) 599-8311Dallas, Texas 75219 Mobile: (214) 232-5372Email: bcumberland@alvarezandmarsal.com

Relevant ExperienceBrian Cumberland leads the Firm’s Compensation and Benefits practice. Prior to joining A&M, Mr. Cumberland led KPMG’s Compensation and Benefits Group for the Southwest. Prior to relocating to the Dallas office, Brian was in KPMG’s Washington National Tax Practice. Brian has experience in various facets of executive compensation and qualified plan consulting.

Representative AccomplishmentsBrian has participated in a variety of compensation & benefit consulting engagements, including:

• Executive Compensation, including issues related to stock options, restricted stock, non-qualified retirement plans, deferred compensation, global compensation strategies, golden parachute rules and the one million-deduction limitation. Assist with the development of compensation strategies, benchmarking compensation, annual incentive, and long-term compensation programs to align with a company’s business strategies and with consideration of the tax and accounting ramifications.

• Qualified Plans, including areas such as plan design, qualification issues and discriminating testing. Brian also has extensive experience coordinating diagnostic reviews of qualified plans, IRS compliance and filings requirements, and entering into closing agreements with the IRS.

• Partnered with Fortune 1000 companies to develop and deliver human resources services on both national and international levels. Worked with clients to develop worldwide strategic direction. Identified industry “best practices” and how these could be used to meet client growth strategies. Implemented cost effective benefit plans and compensation programs through the use of teams and consensus building.

A representative list of clients served is as follows:Affiliated Computer Services, Alcon Laboratories, AmeriCredit Corp, Bracewell & Giuliani, Bimbo Bakeries, Brinker International, Centex Homes, Corrugated Services, Devon Energy, Halliburton, Hicks Muse, Home Interiors, J. B. Hunt, J.C. Penney, Lennox, Lyondell Chemical Corporation, Magnum Hunter, Metro PCS, Pegasus Solutions, Radio Shack, Rosewood, Tenet Healthcare, Torchmark, Tyson Foods, TXU, USAA.

BackgroundBrian received a BBA in Finance from the University of Texas and a J.D. from St. Mary’s School of Law. He also received an LL.M-Taxation from the University of Denver. Brian is a member of the American Bar Association and the Texas State Bar.

 NOTE: Alvarez & Marsal employs CPAs but is not a licensed CPA firm.

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