- IRS Issues Transition Relief Under Section 409A, But Don't Stop Compliance Efforts
- November 15, 2007 | Authors: Margaret (Peggy) D. Lin; Christy L. Anderson
- Law Firms: Faegre & Benson LLP - Minneapolis Office ; Faegre & Benson LLP - Boulder Office
On October 22, 2007, the Internal Revenue Service issued Notice 2007-86, which extends the deadline for compliance with detailed final regulations under Internal Revenue Code Section 409A until January 1, 2009.
Section 409A was added to the Code in October 2004. It made sweeping changes to the treatment of deferred compensation arrangements, which may include bonus, severance, or deferred payment or commission arrangements, supplemental plans, employment agreements and equity arrangements. Deferred compensation arrangements subject to Section 409A must be carefully structured to comply with detailed rules regarding elections to defer compensation, the time and form of payment of that compensation, and how and when payments can be further deferred. The penalty for non-compliance is steep. Amounts deferred under an arrangement that does not comply with 409A are subject to current income tax, interest, and a 20% excise tax.
Section 409A guidance has come in steps. Effective January 1, 2005, all arrangements subject to Section 409A were required to operate in good-faith compliance with the new law. Notice 2005-1, issued in December 2004, set out rules for this compliance. In October 2005, the IRS issued proposed regulations, which were then issued in final form in April 2007. The final regulations provided that good-faith compliance would end on December 31, 2007 and, beginning January 1, 2008, full documentary and operational compliance with the detailed rules and nuances of the final regulations would be required.
In response to the request for additional time for employers and others to analyze all of their Section 409A arrangements and to decide how to comply with the final regulations, the IRS has provided additional transition relief. Among other relief, Notice 2007-86 provides:
The good-faith operational compliance period is extended through December 31, 2008. After January 1, 2008, compliance with the final regulations (but not the proposed regulations) will constitute reasonable, good-faith operational compliance with Section 409A.
Payment elections may be changed through December 31, 2008. Plans may provide or be amended to provide for new payment elections by December 31, 2008, without violating Section 409A’s strict limits on further deferrals or prohibition against accelerated distributions. Payment elections made during 2008 can only apply to amounts payable in 2009 or later, and cannot accelerate a payment into 2008 that would otherwise be paid in a future year. (New payment elections with respect to amounts otherwise payable in 2008, or to accelerate a payment into 2008 that would otherwise be paid in a future year, still need to be made by December 31, 2007.)
Linked plan elections may continue through December 31, 2008. In general, it is not permissible under Section 409A for the time and form of payment under a deferred compensation plan to be controlled by the time and form of payment under a qualified plan (such as, for example, a pension plan). The transition guidance permits “linked plan” elections to continue through December 31, 2008.
Substitutions for discounted stock options and SARs may continue through December 31, 2008. Most unexercised discounted stock options and SARs (other than those granted by publicly traded companies to officers and directors who report under Section 16 of the Exchange Act) may be replaced during 2008, as long as the cancellation is not in exchange for cash or vested property in 2008.
All Section 409A arrangements must be amended by December 31, 2008 to reflect compliance with the final regulations. Many employers are well on their way to gathering and analyzing all of their arrangements that may be subject to Section 409A. The IRS transition relief should not detract from this compliance effort, especially for companies that need board approval for changes to their deferred compensation arrangements.