How do the specified employee rules under Code Section 409A apply when two public companies merge and both partners use the default rules to identify specified employees based on officer status within the respective company?

The Case Study

The merger closed after December 31, 2016 and before April 1, 2017.  Per the regulations, the acquiring entity’s next specified employee identification date and specified employee effective date govern, which is not an issue since both companies use the same dates (December 31 and April 1, respectively).

Determining the Specified Employees

During the period between the closing and the next specified employee effective date (the “Transition Period”), the merged entity determines its specified employees by:

  1. Combining the lists of specified employees of both companies participating in the merger that were in effect on the closing date,
  2. Ranking the employees in order of the amount of compensation used to determine each employee’s status as a specified employee, and
  3. Treating the top 50 employees, plus those other employees who qualify based on share ownership, as specified employees of the merged entity during the Transition Period.

Alternatively, the merged entity may elect an alternative method, such as a method in use prior to the closing.

In our situation, pre-closing, both merger partners identified specified employees based on officer status, except that the non-acquiring entity included a few highly-compensated employees, ranked in order of compensation, in order to get to 50 specified employees.  Since the acquiring merger partner did not look at compensation, and the non-acquiring partner only considered it to get to 50 specified employees, the merged entity elected for the Transition Period to continue to use an alternative method that just combined the two pre-closing lists of specified employees in their entirety, without ranking employees on the basis of compensation.

Per the regulations, an alternative method may consider up to 200 employees as specified employees and combining the two lists for the merged entity was within this parameter.

When Does the Transition Period End?

Of greater interest is the determination of when the Transition Period ends.

Per the regulations, it ends on the next specified employee effective date, in our situation, April 1, 2017.  However, the regulations imply that the merged entity will have an intervening specified employee identification date when it can look at its combined workforce to determine its specified employees.  In our situation, the merged entity does not have an intervening specified employee identification date.  The relevant regulations, on their face, would then appear to require that the merged entity, on April 1, 2017, use the list of specified employees determined by the acquiring entity based on its workforce on the preceding December 31, 2016, which would not include any specified employees from the non-acquiring entity.

So How Do the Specified Employee Rules Apply in Our Case Study?

In lieu of this result, which seems to be contrary to the intent of the regulations, the merged entity will continue to use its pre-closing alternative method and determine specified employees based solely on officer status on the preceding specified employee identification date (December 31, 2016) but picking up officers (and only officers) of each pre-merger partner.


Maura Ann McBreen is a partner in the Firm’s Chicago office and has over 30 years' experience in executive compensation and employee benefits. Maura Ann focuses on executive compensation and employee benefits, especially with regard to single employer, multi-employer, and multinational benefits. She addresses operational and fiduciary issues as they arise under tax-qualified retirement plans, including employee stock ownership plans, and leads our global pensions practice. She designs deferred compensation and equity-based incentive compensation plans, advises on issues under Code Sections 162(m), 280G, 409A and 457A and negotiates executive employment agreements.