Yesterday, IRS issued Notice 2007-78, extending to December 31, 2008, the deadline to amend or adopt written documents for nonqualified deferred compensation plans subject to Internal Revenue Code Section 409A (“409A”). While the notice extends the deadline to adopt amendments to documents to comply with 409A, the final regulations continue to be effective as of January 1, 2008, and document amendments, once adopted, must be effective retroactively to that date. In addition, arrangements that include deferred compensation as of January 1, 2008 must provide a designation in writing of the time and form of payment of that deferred compensation before January 1, 2008.
This can be accomplished by the existing plan documents if they provide a 409A compliant time and form of payment, disregarding any provisions in the plan that do not comply with 409A. Alternatively, a separate written document may be adopted that provides a time and form of payment for a specifically identified amount. For example, many deferred compensation arrangements have employees complete deferral election forms under which they designate the time and form of payment applicable to their deferred compensation accounts, which may constitute sufficient written designation as described in Notice 2007-78.
To the extent that existing definitions of permissible payment events within a plan document do not fully conform to definitions under 409A, the writing required by the end of 2007 does not have to amend those definitions. As long as the plan is operated in compliance with Section 409A, the retroactive plan amendment may supply the definition used by the plan in operation. For example, a plan may have a definition of disability that is different from the one in the final regulations. As long as the plan is operated in accordance with the final regulations so that a payment due upon disability is only made if the disability meets the definition in the regulations, the plan can be amended as late as December 31, 2008, to reflect the application of the correct definition.
In addition, the notice reiterates that the transition rules permitting changes in the time and form of payment of deferred amounts without having to comply with the one year in advance and five-year additional payment deferral rule are NOT extended beyond December 31, 2007. With respect to severance payable under employment agreements, employers that want to modify certain “good reason” termination rights to conform to the safe harbor contained in the final regulations may do so on or before December 31, 2007, but only so long as the good reason conditions under the existing agreement before amendment would be treated as creating a substantial risk of forfeiture to the severance benefits.
The guidance also clarifies when an extension or renewal of an employment agreement containing a right to deferred compensation will be treated as a continuation of the existing deferred compensation arrangement (such that any change in the time and form of payment might be subject to the five-year delay requirement) versus the negotiation of a new deferred compensation arrangement. In general, if the deferred compensation under the employment agreement is not payable at the end of the original term of the agreement if it is not extended, renewed or replaced, then the right to the deferred compensation under a new employment agreement is treated as a new deferred compensation arrangement.
In addition, the Treasury Department has announced that it will establish a limited voluntary compliance program in the near future to provide an opportunity for correcting unintentional operational failures to comply with 409A. Under the program, such failures may be corrected in the same taxable year in which they occurred or result in only limited amounts becoming includible in income and subject to the additional excise tax under 409A. Finally, the notice makes it clear that relief granted to certain off-shore trust arrangements funding deferred compensation is not extended beyond December 31, 2007.
What to Do
Although operational compliance is still needed by January 1, 2008, this welcome relief to the document compliance deadline will enable employers to use the balance of 2007 to make the decisions needed on how to amend their deferred compensation arrangements to comply with the final regulations. Documenting those decisions and operational terms can then occur next year, as needed. Since many arrangements subject to 409A will need to be reviewed and approved by Compensation Committees and Boards of Directors, this added time to finalize the written documents will prove helpful to many employers who were otherwise faced with a very short remaining time frame in which not only to evaluate options and make decisions, but also to document those decisions fully. Keep in mind, however, that documentation of the time and form of payment for all deferred compensation must still be in place by year-end. Therefore, documentation covering payment options and elections will be required for all arrangements by December 31, 2007.