Employers trying to comply with one of the most complex U.S. tax code sections can breathe a little easier this week. The IRS has issued relief for certain inadvertent plan language failures under Section 409A of the U.S. tax code that would otherwise trap employers who improperly drafted deferred compensation plans.
IRS Notice 2010-6, issued January 5, 2010, is long-awaited welcome news for employers who encounter minor documentation errors. It even provides a small amount of relief for plans not meeting even basic rules under Section 409A (e.g., that don’t require payment only upon permissible payment events) by limiting penalties that result from documents with certain impermissible plans terms after corrections are made.
The notice addresses the following written documentation errors, among others:
- failure to include the required six-month delay for specified employees;
- interpretations of ambiguous language for payment timing, such as “as soon as practicable” (which may not be treated as a document failure at all);
- payments conditioned on employment-related actions, such as the execution of a non-competition agreement or a release of claims, which may affect the timing of payment;
- impermissible payment periods, such as “within 180 days following separation from service”; and
- impermissible payment events, such as payment “upon an initial public offering” or impermissible discretion to accelerate the timing of payment.
Some corrections can be made without any penalties, others require payments and tax reporting, but all applicable corrections are subject to reduced penalties. In all cases, eligibility for correction requires satisfaction of additional requirements, including that neither the employer nor individual taxpayer is being audited by the IRS, and that all other substantially similar document failures in other non-qualified deferred compensation plans be corrected at the same time.
The new guidance provides a helpful reminder that it is important to skillfully apply knowledge of Section 409A’s detailed rules when drafting deferred compensation arrangements, and it will also assist employers who acquire non-compliant plans in acquisitions.