In IRS Notice 2010-6 and Notice 2010-80, the IRS expanded rules outlined in the 2007 Final Regulations under Code Section 409A to describe a potential violation of that Section where certain severance type payments are made upon the execution of a release (or the expiration of a statutory rescission period). While certain severance agreements are exempt from 409A – those triggered by an involuntary termination or termination for good reason which are paid within 24 months and below certain dollar thresholds) – change of control agreements, voluntary resignations and negotiated severance payments often are governed by Section 409A if there is a potential that payments can straddle more than one tax year.
Under the above-mentioned Notices, the IRS has provided several safe harbor “fixes” for arrangements that allow the employee to manipulate the tax year of the payment by timing the return of the release of claims. One method is to specify that payment will be made in a fixed number of days after the return of the release and expiration of the rescission. However if the agreement could be paid in one of two tax years the amount would be paid in the later year. The second safe harbor correction method would provide for the agreement to be amended so that payment would be made on a fixed date of, for example, 60 or 90 days after termination of employment. Presumably the consideration period, the execution and return of the release and the rescission period maximums would expire before the fixed payment date.
If an agreement subject to Section 409A includes a discretionary provision described that allows the employee to select the tax year of payment, the amounts paid would be subject to the additional 20% federal penalty tax plus interest penalties. The 2010 Notices provide relief from such penalties for arrangements that were in place before 2011, if they are amended no later than December 31, 2012. If you believe one or more of your employment, change in control or severance arrangements may need to be amended.