Compensation arrangements such as employment or severance agreements, that provide for payments that are contingent on the execution of a release, must be brought into compliance with documentation requirements of Section 409A of the Internal Revenue Code by December 31, 2012.
The Internal Revenue Service takes the position that employment agreements and other arrangements1 which provide for payments that are contingent on the execution of a release2 violate Section 409A of the Internal Revenue Code ("Section 409A"), unless the timing of the payment is fixed, pursuant to the IRS guidance, so that there is no possibility for the employee to be able to elect in which tax year the payment is made, by virtue of "timing" the execution of the release. Violation of Section 409A exposes the employee to a 20% excise tax and the employer to reporting obligations with respect to the violation.
The violation may be corrected by amending the agreement in question to:
- Provide for payment on the 60th or 90th day following separation, as long as the release is executed and effective before such date; or
- Provide for payment during a fixed period (no more than 90 days following separation), as long as the release is executed and effective before the end of such fixed period, and if such fixed period begins in one taxable year and ends in another taxable year, the payment must be made in the second taxable year.
All the amendments must be made by December 31, 2012.
Compensation arrangements that provide payments that are contingent on execution of a release must be reviewed and noncompliant provisions identified and amended as necessary in advance of the December 31, 2012, deadline.