Section 409A of the Internal Revenue Code was adopted as part of the American Jobs Creation Act of 2004. This Section applies to amounts which were deferred or became vested under a non-qualified deferred compensation plan after January 1, 2005.
On April 10, 2007, the Internal Revenue Service issued Final Regulations under Section 409A. Those regulations and subsequent guidance from the IRS make it clear that plans or arrangements which provide for deferred compensation generally must comply in form with Section 409A no later than December 31, 2008.
We have communicated with clients in the past about Section 409A and its requirements. However, in light of the looming compliance deadline, we want to again remind those clients who maintain a deferred compensation plan of the upcoming deadline.
Which plans and arrangements are subject to Section 409A?
Generally, the Section applies to plans and other arrangements (such as a company policy or an employment agreement) which defer the payment of compensation earned in one year to a later year. Such plans are often maintained for management or highly compensated employees.
The statute is very broad. Thus, some common plans or arrangements which may be subject to Section 409A include:
- non-qualified elective deferred compensation plans;
- supplemental executive retirement plans (SERPs);
- "ineligible" Section 457(f) plans for tax-exempt employers;
- bonus or incentive plans with deferred payments;
- phantom stock plans;
- change in control agreements;
- severance pay plans which pay more than the lesser of 2 times annual compensation or $460,000;
- stock options or stock appreciation rights (SARs)-- when issued at a discount to fair market value; or
- deferred incentive or change in control payments under an executive employment agreement.
When is deferred compensation not subject to Section 409A?
Not all deferrals of compensation are subject to Section 409A. Exceptions generally include:
- qualified retirement plans (for example, 401(k) plans, defined benefit pension plans, profit sharing plans, employee stock ownership plans, etc.);
- bona fide vacation leave, sick leave, compensatory time, disability pay or death benefit plans;
- grants of restricted stock;
- stock options and stock appreciation rights which are not issued at a discount to fair market value;
- most severance pay plans; and
- amounts (such as bonuses) which are required to be paid within 2 1/2 months after the end of the year in which they are earned and vested.
What does Section 409A require?
Section 409A imposes several restrictions on non-qualified deferred compensation. The rules require that all nonqualified deferred compensation arrangements must be contained in a written document, and impose reporting requirements on plan sponsors. In addition, 409A restricts:
- the circumstances under which benefits may be paid to participants;
- the ability to make elections to defer compensation;
- the ability to receive withdrawals or accelerate payments; and
- the investment vehicles in which assets accumulated may be invested.
What do we need to do about our deferred compensation plans or other arrangements?
Any plan or arrangement which is subject to Section 409A generally was required to operate in compliance with Section 409A effective January 1, 2005. All documents providing for nonqualified deferred compensation must be amended to comply with Section 409A no later than December 31, 2008.