The deadline for compliance with the final regulations under Section 409A of the U.S. Internal Revenue Code has been extended to December 31, 2008. This new relief (Notice 2007-86) includes a full extension of the transition period for an employer to designate a permitted time and form of payment of deferred compensation (or to allow participants to elect a time and form of payment of previously deferred compensation). The IRS also suspended the requirement to report annual deferrals of compensation subject to Section 409A on Forms W-2 and 1099 for the 2007 tax year (Notice 2007-89).
Section 409A outlines certain requirements applicable to nonqualified deferred compensation plans. If a plan does not meet those requirements, participants in the plan are required to immediately include amounts deferred under the plan in income and pay interest and an additional 20% tax on the amount included. For background on which compensation arrangements are covered and Section 409A rules in general, see our Osler Updates of October 5, 2006 and May 9, 2007.
Which Deadlines Have Been Extended?
- Changes to the time and form of payments of deferred compensation now may be made in either 2007 or 2008. During the remainder of 2007, no changes may be made that would affect any amounts that are otherwise payable in 2007 or that would cause an amount that would be paid in a later year to be accelerated into 2007. Similarly, during 2008, no changes may be made that would affect any amounts that are otherwise payable in 2008 or that would cause an amount that would be paid in a later year to be accelerated into 2008.
- The ability to link a payment election under a nonqualified deferred compensation plan to an election under a qualified plan or a foreign broad-based plan under nonqualified plan terms in effect on October 3, 2004 is extended through 2008.
- The period for substituting non-discounted stock options and stock appreciation rights for discounted stock options and stock appreciation rights (except for certain insiders in public companies) is extended through 2008.
- Good faith compliance with a reasonable interpretation of Section 409A is acceptable through 2008. Following the final regulations or prior IRS guidance in Notice 2005-1 (but not the proposed regulations) to interpret an issue is considered good faith compliance, even though the final regulations are not yet effective. The final regulations must be followed beginning in 2009.
Is It Still Necessary to Designate in Writing a Compliant Form and Time of Payment by December 31, 2007?
No, a plan’s written terms are not required to comply with Section 409A until December 31, 2008. However, each deferred compensation arrangement must be in good faith compliance with Section 409A and applicable guidance. This means that operational changes will likely be required for most plans. A plan will not be operating in good faith compliance if discretion provided under the terms of the plan is exercised in a manner that causes the plan to fail to meet the requirements of Section 409A. For example, if an employer retains the discretion under the terms of the plan to delay or extend payments under the plan in a manner that violates Section 409A and exercises such discretion, the plan will not be considered to be operated in good faith compliance with Section 409A.
- What Should be Done in 2007? Review payment timing. New elections may be filed in both 2007 and 2008, subject to conditions, without regard to the five year waiting period that would otherwise apply.
- Review operations and elections to identify any reliance on the proposed regulations, which will no longer apply in 2008.
- Continue to identify necessary plan amendments and changes needed to comply with the final regulations.
- Payroll departments should prepare to comply with Notice 2007-89 for reporting income actually includible under Section 409A for employees and independent contractors and related wage withholding for employees. The rule requiring employers to report on Form W-2 or Form 1099 all deferred compensation accrued for the current year, even though not yet includible in income, has been suspended for another year.
- Review good faith compliance with offshore trust restrictions (transition relief was not extended).
Is Further Guidance Coming?
The IRS has confirmed that a formal correction program for inadvertent Section 409A violations will be created and that guidance on this program is forthcoming.