• Section 409A Compliance: the Clock is Ticking!
  • August 31, 2007 | Author: Richard D. Martinson
  • Law Firm: Riker Danzig Scherer, Hyland & Perretti LLP - Morristown Office
  • On April 10, 2007, the Treasury Department issued the long-anticipated final regulations under Section 409A of the Internal Revenue Code. The final regulations, which are effective January 1, 2008, confirm that taxpayers have until December 31, 2007 to implement, amend, modify or otherwise bring into compliance any contracts, plans or other arrangements constituting “deferred compensation plans” subject to Section 409A with the statute. Since any such deferred compensation plans not in compliance by January 1, 2008 are likely to bring about punitively expensive repercussions for employees operating under such plans, it is imperative that employers focus over the remaining months of 2007 on identifying and executing any actions necessary to achieve documentary and operational compliance prior to December 31.

    The following is a “laundry list” of action items employers would be well advised to consider in making sure that their deferred compensation arrangements meet the complex requirements of Section 409A:

    Identify arrangements subject to 409A: Review all nonqualified compensatory arrangements (whether with employees or independent contractors) involving deferred compensation that are or may be subject to Section 409A, including “traditional” nonqualified deferred compensation plans; employment agreements (whether or not in writing), offer letters and severance agreements; discounted stock options and/or SARs; restricted stock units, performance share awards, phantom stock plans and other equity-flavored awards; and annual and multi-year bonus and commission plans.

    Amend any such arrangements to provide documentary compliance: Since December 31, 2007 is the “drop-dead” date for documentary compliance with Section 409A, and since ensuring such compliance may involve time-consuming processes with long lead times (e.g., securing compensation committee adoption of necessary amendments) it is imperative that the amendment process begin substantially in advance of that date. Particular attention should be paid to arrangements involving the following: “tax gross-up” payments to employees; voluntary terminations by employees, particularly where no “good reason” standard is applicable; and provisions for deferred payments with nonspecific payment dates.

    Attend to operational compliance issues: Employers should review plans covered by Section 409A to insure that even compliant plans are operated in strict conformity to the operational terms thereof, since even if plan documents are in order, an operational failure will trigger application of Section 409A.

    Consider revising payment elections: Transition rules permit changes to previously made payment elections (i.e., elections specifying the dates or events triggering payments of previously deferred compensation) without penalty, provided such changes are effected prior to December 31, 2007. After that date, any such “subsequent elections” will be exceedingly difficult and materially less favorable to employees seeking to change a prior election.

    Revise discounted options and SARs: generally, any options and SARs issued after January 1, 2005 are subject to 409A if the exercise price thereunder is less than the fair market value (“FMV”) of the underlying stock on the grant date. Most of these “discount options” can be fixed prior to December 31, 2007 by retroactively amending such options to increase the exercise price to FMV as of the grant date, or alternatively by fixing a date certain on which such options may be exercised.

    You are encouraged to speak with your attorneys and other advisors if you think you may be affected by 409A.