Significant IRC 409A Deadline is Fast Approaching
SIGNIFICANT IRC 409A DEADLINE IS FAST APPROACHING
Section 409A of the Internal Revenue Code and the associated regulations and guidance issued by the Department of Treasury set forth stringent requirements that nonqualified “deferred compensation” plans (a term which, as discussed below, is defined very broadly under Section 409A) must meet regarding the time and manner of payments, benefits, awards and elections. As of January 1, 2009, all nonqualified deferred compensation plans must be in written compliance with Section 409A.
BACKGROUND ON SECTION 409A
Section 409A was enacted in 2004 in the wake of Enron and other corporate scandals with the aim of curtailing creative manipulation of deferred compensation arrangements. Final regulations interpreting Section 409A were published in April 2007. Since January 1, 2005, nonqualified deferred compensation plans have been required to operate in good faith compliance with Section 409A. Nonqualified deferred compensation plans must be in written compliance as of January 1, 2009.
EXAMPLES OF NONQUALIFIED DEFERRED
COMPENSATION PLANS THAT ARE SUBJECT TO SECTION 409A
Section 409A applies to most nonqualified deferred compensation plans provided by employers for the benefit of employees and independent contractors. For purposes of Section 409A, “deferred compensation” is defined broadly, and includes compensation which is earned, or to which there is a legally binding right (without a substantial risk of forfeiture), in one tax year, and may be paid in a later tax year. A “deferred compensation plan” may therefore include:
- traditional nonqualified deferred compensation plans (e.g., excess benefit plans and supplemental executive retirement plans (SERPs));
- separation pay arrangements;
- offer letters and executive employment agreements;
- independent contractor/consulting agreements;
- commission, bonus, and incentive compensation plans;
- reimbursement arrangements;
- change-in-control agreements;
- certain stock option plans and agreements; and
- certain stock appreciation rights, restricted stock agreements, employee stock purchase plans and agreements, and equity awards.
Additionally, an employer may have unwritten practices which constitute nonqualified deferred compensation plans subject to Section 409A, and which will need to be reduced to writing.
As of January 1, 2009, (a) all covered deferred compensation arrangements must be set forth in writing and comply with Section 409A, and (b) existing plans and agreements must be amended to comply with Section 409A. In achieving written compliance, it is important to remember that, pursuant to Section 409A, a savings clause – a clause in the written plan documents which attempts to nullify any non-compliant provisions in the documents? will be disregarded. For this reason, it is imperative that a written document be drafted (or amended) to comply with Section 409A.
PENALTY FOR NON-COMPLIANCE
Deferred compensation arrangements which do not comply with Section 409A may be subject to:
- premature taxation (taxation immediately upon vesting rather than upon payment);
- additional federal income tax of 20%;
- additional state tax amounts, if applicable; and
- interest on underpaid amounts.
Employers may also face penalties if they fail to report, or make required withholdings from, compensation that should be taxed pursuant to Section 409A, and lawsuits from employees hit with unexpected penalties under Section 409A.
To comply with Section 409A, employers should take the following actions:
1. Identify the company’s deferred compensation plans and arrangements – including any traditional plans, as well as employment agreements and separation agreements and plans (including any templates), and unwritten compensation practices with deferred compensation components.
2. Determine whether those identified as deferred compensation plans are compliant with Section 409A; and
3. Draft and/or amend deferred compensation plans to comply with Section 409A as of January 1, 2009.
Please do not hesitate to contact us if you would like assistance in identifying and evaluating your company’s deferred compensation plans and achieving compliance with Section 409A.
IRS Circular 230 disclosure: Any tax advice contained in this communication (including any attachments or enclosures) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication. (The foregoing disclaimer has been affixed pursuant to U.S. Treasury regulations governing tax practitioners.)