IRS Issues Stock Rights Guidance Under Section 457A

On June 10, the IRS issued a revenue ruling confirming that a non-statutory stock option or stock only-settled stock appreciation right (SOSAR) that is exempt from Section 409A is also exempt from Section 457A.

Section 457A provides special rules for foreign corporations and domestic pass-through entities owned by foreign persons or tax exempt organizations that generally subject such entities’ nonqualified deferred compensation arrangements to tax on vesting, rather than on payment as provided under Section 409A.

Previously, the IRS’s position had been in some doubt, given language in Section 457A that exempts 409A-exempt stock rights other than any “right to compensation based on the appreciation in value of a specified number of equity units of the service recipient.” It wasn’t entirely clear how the “other-than” language in the statute and the IRS’s guidance could be reconciled, since the “other than” language appears to refer to all stock appreciation rights. The revenue ruling addresses this apparent discrepancy by citing legislative history indicating that the “other than” language was specifically not intended to apply to stock options and SOSARs. The IRS reasoned that if stock options are exempt, SOSARs should also be exempt, given the economic equivalence between net-settled stock options and SOSARs.

Thus, the only difference in coverage of stock rights between Section 409A and Section 457A is with respect to stock appreciation rights that are or may be settled in cash (CSARs), which are subject to Section 457A but may still be exempt from Section 409A if certain conditions (FMV exercise price, etc.) are met.