Since 2004, complying with the new tax rules for deferred compensation under Internal Revenue Code ("Code") § 409A has been a source of ongoing discussion. You likely have received several executive alerts regarding the subject. The final documentary compliance deadline (December 31, 2008) fast approaches, and it appears that there will be no more postponements. As a result, any agreement or plan that provides for deferred compensation (i.e., almost any form of compensation paid in a calendar year later than the year in which it is earned) should be put into writing and comply with Code § 409A by December 31, 2008. Code § 409A and its penalties do not apply to only traditional executive compensation, such as deferred compensation plans and equity compensation/stock option plans; they also apply to employment agreements, severance agreements/plans, change in control agreements/plans, consulting agreements, and non-compete agreements that provide for deferred compensation.
The consequences for Code § 409A compliance failures are significant, and fall upon the executive rather than the employer. Failure to comply with Code § 409A will result in accelerated income taxation with related penalties, including a penalty tax (of at least 20% of the amount of deferred compensation), plus penalties and interest on the underpayment.
Most deferred compensation arrangements may be brought into compliance with Code § 409A without materially changing the economic terms. However, it is important to identify Code § 409A compliance issues so that applicable corporate governance requirements may be satisfied and any necessary contractual consents may be obtained.