Vesting Plans and Producer Book Ownership

By | August 5, 2019

Somehow, someway, many agency owners do not seem to know that the law regarding vesting plans relative to producer book ownership changed around 15 years ago. That is correct, 15 years ago!

This change applies to vesting plans, deferred compensation plans, phantom stock plans, different kinds of option plans and so on and so forth. And to be direct — the argument that “Every agency in my town, county, and state has one and nothing has happened, so I don’t believe you!” is childish. So is the argument, “The IRS hasn’t said anything yet” implying this means the law does not exist. These are the two most common points agency owners make when I address this situation with them.

I also know many accountants and consultants who will not address these rules with their clients because the pushback is so significant and the rules so complex. Only true specialists in this area of tax law should be writing the applicable contracts. The accountants and consultants often do not want to admit they are not the experts. Ignorance and pride is a dangerous combination.

The rules guiding these scenarios are known as “409A” rules which refer to the IRS Code number regarding deferred compensation. Deferred compensation includes many kinds of compensation, not just strictly deferred compensation, and includes old fashioned vesting plans where producers own some portion of their book, the most common scenario.

Deferred compensation includes many kinds of compensation, not just strictly deferred compensation, and includes old fashioned vesting plans where producers own some portion of their book.

These rules were written based on a law Congress passed following the collapse of Enron. Congress wanted to prevent key executives/shareholders from becoming unfairly enriched. In Congress’ inimical way, they wrote the law so clearly, it took the U.S. Treasury about five years to understand it adequately enough to write the actual tax code so that everyone, including the IRS, would know what the law meant. The last I checked the rule book specific to 409A was about 600 pages.

Six hundred pages means 409A rules are very complex. Complexity means agency owners who probably have never heard of 409A tax rules do not have opinions that matter, such as “Everyone else is doing it.” No place exists on corporate tax returns asking for copies of vesting plans and most agency owners don’t tell their CPA that they have them because they don’t know this is important, required information. The IRS does not find out about the plans until someone’s tax return shows an anomaly such as at the time of a sale or through the bad luck of an unassociated audit. In both cases it is too late to fix the situation retroactively.

Questions to Ask

Specific to CPAs, I get many agency owners who say, “Why hasn’t my CPA said anything?” The two most important questions to ask yourself are:

1) Did you tell them you had deferred compensation/vesting plans?

2) How well does your CPA stay on top of tax law, especially complex tax law?

CPAs who may know about your plan and know the law, do not address 409A with their clients because they feel that as long as no one talks about it, the IRS is unlikely to discover it. Just let sleeping dogs lie. That approach only works until the agency is sold. During a sale all kinds of documentation is created. In many cases, third-party buyers will not buy an agency that has an existing deferred compensation/vesting plan unless the agency has received clearance from a 409A specialized tax attorney advising it meets the IRS guidelines. Most vesting plans I’ve seen have not been approved by 409A specialized tax attorneys. Therefore, it makes little sense to continue employing the ostrich strategy.

I am not a tax attorney specializing in 409A, so I am not qualified to discuss 409A regulations in detail. With 600 pages of dense tax code, you need a specialist. In general, though, the issue comes to the forefront if an employee owns some portion of their book as a form of sweat equity or if they earn deferred income based on their performance. Even if no money changes hands immediately, the IRS wants its taxes immediately unless the plan truly qualifies under 409A. This requirement makes sense because if the plan does not qualify as a true deferred compensation plan, the only alternative is that it is immediate compensation.

Deferred Compensation

Deferred compensation is generally some form of compensation, including equity and equity like consideration, that is paid more than X months (let’s use 13 months as an example) after the employee’s actions generate that value. For example, let’s say the vesting plan gives the producer 40% of their book. They make $100,000 of sales (commissions) this year, but they do not get the 40% value of their book until they retire. That is deferred compensation (assuming retirement is in the distance).

The penalties for violating these rules are considered by many to be the worst penalties in the entire tax code and can apply to both employers and employees. One of the most onerous provisions of 409A is that the tax is due immediately even though no money has been exchanged. Using the example above, let’s say the producer has a $500,000 commission book with 40% vesting and the producer is 45 years old and won’t receive his/her $200,000 ($500,000 X 40%) until he/she turns 65. If the vesting plan does not meet the IRS’s requirements, then the producer would potentially owe income taxes on that $200,000 immediately even though they have not received the income associated with the tax! They may also be subject to penalties and interest for failure to pay their taxes on time.

The employer may also be subject to fines and taxes for failure to report this income. The total in taxes and penalties can easily exceed 50% and yet, no money has been exchanged between the agency owners and the producer. When I describe this scenario, most people exclaim, “That is unfair!” as if being unfair means they don’t have to comply.

Again, because the penalties are so high, knowledgeable third-party buyers will not buy into an agency with such agreements unless a 409A specialized tax attorney has signed off on them. It takes time to unwind these agreements, too. So, if you have them, fix them sooner rather than later. Give yourself the gift of time.

Why It’s Important

Given how unfair these rules are perceived to be and how heavy the penalties are and because so many businesses with such agreements haven’t been discovered by the IRS, denial is a common coping mechanism.

The good news is deferred compensation agreements and different kinds of sweat equity ownership agreements are fantastic tools for attracting and then keeping quality talent. Many of the best organic growth agencies/brokers use some form of sweat equity compensation. Talented people want to be rewarded appropriately and this is a great tool for both sides. The options as to how to craft the exact mechanism and agreement that fits your agency perfectly are numerous. I keep learning of new ways to craft these agreements and many of the methods are unique to a given situation.

Another piece of good news is that once you have such an agreement, you can, with your attorney’s approval, use it over and over again. The place to go to create a great agreement for your agency is through a tax attorney that specializes in 409A agreements (in my opinion, a regular CPA or a regular tax attorney is unlikely to have the true expertise required for this specialization).

Deferred compensation plans bite back when done wrong whether during an IRS review or at the time of sale, unless you can find an ignorant buyer. Deal with these agreements now to avoid the stress, extra money, and potential penalties. And use these to attract and keep the best talent!

Burand is the founder and owner of Burand & Associates LLC based in Pueblo, Colo. Phone: 719-485-3868. E-mail:

About Chris Burand

Burand is the founder and owner of Burand & Associates LLC based in Pueblo, Colo. Phone: 719-485-3868. E-mail: More from Chris Burand

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Insurance Journal West August 5, 2019
August 5, 2019
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