Employers should review plans and agreements subject to Internal Revenue Section Code 409A before the end of 2012. That’s when transitional relief afforded by the Internal Revenue Service expires for deferred compensation arrangements that make payment conditional on the employee’s execution of a release of claims (a “release-based payment”).

Section 409A governs the taxation of most non-qualified deferred compensation, whether provided under a plan or a program covering multiple employees or as part of an individual employment or severance agreement.

It is common practice to condition the receipt of deferred compensation on the employee’s execution of a general release of employment-related claims (or a non-competition agreement or other similar restrictive covenant agreement). One of the basic requirements of 409A is that the time of payment must be set forth in the governing document and cannot, generally speaking, be subject to manipulation by the employer or employee.

The IRS takes the position that if, for example, an employment agreement provides that a severance benefit will be paid only following the employer’s receipt of a general release of claims, the employee can control the year of payment by his or her decision when to deliver the release. The IRS considers this a violation of 409A’s requirement, even if the period during which the release can be delivered does not overlap calendar years.

The IRS has provided general corrective guidance for certain 409A compliance issues. The guidance included transition relief involving release-based payments, but that relief expires on December 31, 2012. Consequently, employers should review and, if necessary, revise before the end of this year their 409A plans and arrangements that provide release-based payments. Failure to do so may constitute a 409A violation with adverse tax consequences to the employee.