Year-end deadlines still apply for implementation of final regulations under Section 409A of the U.S. Internal Revenue Code. Although the Internal Revenue Service (IRS) has extended the deadline for most plan amendments to December 31, 2008, its Notice 2007-78 issued on September 10, 2007 requires affected plans to be operated in compliance with the final regulations and other guidance from and after January 1, 2008. In addition, an arrangement subject to Section 409A must designate in writing a compliant time and form of payment on or before December 31, 2007. In some cases, significant plan re-designs are still required by December 31, 2007.
What Plans Are Affected?
Section 409A of the U.S. Internal Revenue Code regulates the design and operation of a broad array of deferred compensation arrangements for U.S. taxpayers. Severance plans, supplemental pension plans, long-term bonuses, stock plans and even payments under employment agreements are covered under Section 409A. Since U.S. citizens and permanent residents are subject to tax on their worldwide income regardless of residency, Section 409A affects U.S. citizens and green-card holders working in Canada as well as U.S. residents. Generally speaking, deferred compensation provided for in a non-compliant arrangement will be included in income during the year in which it is vested, plus interest and a 20% additional tax. To avoid penalties, payment of deferred compensation for U.S. taxpayers is subject to strict rules regarding the time and form of payout. Such payment must adhere to the new timing rules for advance election, which generally require the election to be made prior to the end of the calendar year preceding the calendar year in which services are performed. These rules were the subject of prior Osler Updates on October 5, 2006 and May 9, 2007.
2007 Year-End Action Plan for 409A Compliance:
- Allow changes in payment timing now. Under a special transition rule, participants may change their payout timing now without having to comply with the regulated five-year wait for changes. This is possible provided the change is made irrevocable by December 31, 2007 and does not delay any payments scheduled to commence in 2007 or accelerate any payment into 2007. This presents a good opportunity to communicate the necessary plan changes which will generally require stricter plan provisions than are currently in place.
- Collect elections to defer 2008 compensation. Generally, the deadline for deferrals of 2008 compensation or bonuses and for selecting the timing of future payments is December 31, 2007.
- If your plan is covered, make sure there is a written time and form for payment of benefits and arrange for the plan to be in operational compliance by December 31, 2007. The formula to calculate payments and the timing of payments must be fixed and determinable, in compliance with Section 409A, by the year-end deadline, ignoring noncompliant provisions in the plan document. The new law permits deferred compensation to be paid only on one of six events: any fixed date or schedule specified in the plan or the date of separation from service, death, disability, change in control, or unforeseen emergency. Any 2008 amendments must be retroactive and reflect actual plan operations.
- Identify exceptions. Try to be exempt from Section 409A, if possible. Some arrangements may not need to comply with Section 409A if they are exempt or grandfathered. Exemptions are available, for example, for some types of severance pay, arrangements subject to special tax benefits (i.e. qualified plans and incentive stock options,) certain broad-based retirement plans maintained outside the United States, and for short-term deferrals which are paid to participants within two and a half months after the end of the year in which the compensation became vested. Further, certain deferred amounts are “grandfathered” under prior U.S. rules. Amounts are grandfathered if the deferred compensation was earned and vested prior to December 31, 2004 and the rules will not apply as long as there was no material modification of the plan after October 3, 2004.
- Identify the Key Employees who will be subject to a six-month delay. For public companies, a group of the top-paid 50 officers (as well as certain 1% and 5% owners) are subject to a six-month delay for payment of deferred compensation after separation from employment. Each year, the group of “specified employees” who are subject to this rule may change and should be re-established.
Is the Final Deadline Really Final?
The current deadlines are the result of a previous extension from December 31, 2006 and the partial documentary extension granted under IRS Notice 2007-78. Ninety-two U.S. law firms, including Osler, Hoskin & Harcourt LLP, joined forces and submitted a joint letter to the IRS on August 21, 2007 requesting extensions to December 31, 2008 of both the upcoming deadline for amending documents into compliance with Section 409A and of all transition relief. The letter also requested that the applicability date of the final regulations be extended to January 1, 2009. At the time of writing this communication, IRS officials had determined not to grant further extensions beyond the slight relief provided in Notice 2007-78. Unless the IRS grants further extensions, employers must act by December 31, 2007 to comply in operation with the final regulations and to satisfy the requirements set out in Notice 2007-78.