- Section 409A Correction Program for Non-Compliant Documents
- February 16, 2010 | Authors: Arthur Bachman; Wilhelm L. Gruszecki; Kari Knight Stevens
- Law Firm: Blank Rome LLP - Philadelphia Office
The IRS has announced a correction program (Notice 2010-6) that permits employers with deferred compensation programs subject to section 409A of the Internal Revenue Code to correct certain document failures and limit potential 409A exposure for their employees. This is in addition to a correction program announced in late 2008 (Notice 2008-113) that addresses operational failures of non-qualified deferred compensation plans.
In order to be eligible for the correction program: (1) the employee’s 1040 must not be under IRS audit; (2) the employer’s deferred compensation plans must not be under IRS audit; (3) the 409A document failure must be unintentional; (4) the employer must take steps to identify and correct other documents or arrangements with similar failures; (5) the employee may have to recognize as taxable income up to 50% of the amount subject to the correction (the amount that must be recognized depends on the nature of the failure and when it is corrected), including payment of the 20% excise tax under 409A with respect to such income; (6) certain information filings must be made with the IRS; and (7) the correction must be made before the occurrence of a payment event that gives rise to the operation of the incorrect provision.
As a general matter, Notice 2006-10 appears to confirm the concept that, except under very limited circumstances, there is no way to retroactively correct a payment that was made pursuant to non-409A compliant plan provisions. Such payment is subject to the 409A penalties in full.
In lieu of complying with the seven requirements discussed above, all 409A penalties may be avoided in connection with the document failures described below if the document is corrected before January 1, 2011 and the employer has operated the plan since January 1, 2009 in accordance with the document as amended. This provides a limited opportunity to bring documents into compliance without penalty to the employee.
The correction program is limited to the following plan defects:
- Describing a payment date as “as soon as reasonably practicable” following a permissible 409A triggering event, rather than using a fixed date following the triggering event.
- Failure to define an otherwise permissible triggering event or ambiguously defining an otherwise permissible triggering event.
- Use of an incorrect definition of an otherwise permissible triggering event (i.e, an incorrect definition of “separation from service”, “change in control” or “disability”).
- Use of an impermissible payment period (e.g., payment tied to the actual signing of a release agreement, rather than tied to the end of the consideration period).
- Use of an impermissible payment event or payment schedule.
- Failure to include six-month delay rule for specified employees.
- Use of impermissible initial and subsequent deferral elections.
The correction program is not available for discounted stock options.