With certain limitations, severance arrangements resulting from terminations for “good reason” are not subject to Section 409A.
What is a termination for “good reason”? Whether a termination of employment is considered to be for good reason is determined based on the facts and circumstances of such termination. For an employee to terminate the employment relationship with good reason, the employer must have taken action that result in a material negative change in the duties the employee performs, the conditions under which the employee provides services or the employee’s compensation.
What is the IRS safe harbor definition of “good reason”? IRS regulations provide a safe harbor definition of termination for good reason. The safe harbor definition requires that any one or more of the following conditions arise without the consent of the employee and that the employee terminate service within two years after the condition arises:
(1) A material diminution in the employee’s base compensation;
(2) A material diminution in the employee’s authority, duties or responsibilities;
(3) A material diminution in the authority, duties or responsibilities of the supervisor to whom the employee is required to report, including a requirement that the employee report to a corporate officer or employee instead of reporting directly to the board of directors of a corporation (or other similar governing body with respect to an entity other than a corporation);
(4) A material diminution in the budget over which the employee retains authority;
(5) A material change in the geographic location at which the employee must perform the services; or
(6) Any other action or inaction that constitutes a material breach of an applicable employment agreement by the employer.
What else is required to meet the safe harbor definition of “good reason”? In addition, the safe harbor requires that: (i) the amount, time and form of payment upon termination must be substantially identical to the amount, time and form of payment payable under an involuntary termination (to the extent such a right to payment exists); and (ii) the employee must provide notice to the employer of the existence of good reason within ninety (90) days of the initial existence of the condition and provide the employer at least thirty (30) days to remedy the condition.
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