By Brian M. Pinheiro and D. Renee Applegate, Ballard Spahr LLP
On Jan. 5, 2010, the IRS published long-awaited guidance allowing employers to fix certain provisions of their nonqualified deferred compensation plan documents that otherwise fail to satisfy the requirements of section 409A of the Internal Revenue Code.
Section 409A generally imposes restrictions on the timing of deferrals and the timing and form of payments from nonqualified deferred compensation plans. Such plans must satisfy section 409A in form and operation. Failure to satisfy section 409A results in substantial tax penalties for affected participants (generally, executives and directors).
The new correction guidance will help employers seeking to ensure section 409A compliance in advance of an IRS executive compensation audit. The IRS has announced that it intends to initiate new employment tax audits for up to 6,000 companies in 2010. Given that such audits likely will involve IRS review of nonqualified deferred compensation plans, an area of frequent employment tax noncompliance, many employers will take advantage of the opportunity to clean up any section 409A documentation failures.
Plan Document Failures
The section 409A correction guidance covers a wide range of plan document failures, including:
• Ambiguous or inconsistent defined terms (e.g., use of the phrase “termination of employment” in a manner that is inconsistent with the section 409A-defined “separation from service”).
• Inclusion of impermissible payment dates or events (e.g., a payment date that varies based on the executive’s execution of a noncompete agreement or a release of claims).
• Inclusion of impermissible payment schedules (e.g., multiple forms of payment for the same payment-triggering event).
• Retention of impermissible discretion to choose a form of payment or payment schedule.
• Failure to provide for a six-month delay in payment for key employees of publicly traded companies upon their separation from service.
• Erroneous deadlines for making deferral elections.
Participants who receive payments within one year following the date of the plan document correction are required to pay a reduced section 409A penalty in certain cases, though even the reduced penalty can be avoided if correction is completed by Dec. 31, 2010. The employer and the participant are required to disclose notice of the correction on their federal income tax returns.
Brian M. Pinheiro is a partner, and D. Renee Applegate is an associate, at law firm Ballard Spahr LLP.
© 2010 Ballard Spahr Andrews & Ingersoll, LLP. All Rights Reserved.
Editor’s Note: This article should not be construed as legal advice.
Severance Arrangements: How to Apply the Final § 409A Regulations, SHRM Online Compensation Discipline, January 2008
Deferred Compensation Plans Can Aid Cash Flow, Retention, SHRM Online Compensation Discipline, November 2007
Deferred Comp: Analysis of Final Section 409A Regulations, SHRM Online Compensation Discipline, April 2007
Review Agreements to Ensure Section 409A Compliance, SHRM Online Legal Issues, April 2007
Deferred Comp: Code Section 409A Imposes New Requirements, SHRM Online Compensation Discipline, December 2004