Interim Guidance for Nonqualified Deferred Compensation Plans Extended Through 2008
Earlier this week the IRS issued Notice 2007-86, delaying until January 1, 2009 the effective date of the final regulations under Internal Revenue Code Section 409A, which apply to deferred compensation plans and arrangements of all types. As a result, employers and their employees have until the end of next year to review and restructure their deferred compensation plans, employment agreements, severance policies, and equity programs in order to make sure they comply with the final regulations, both in terms of how they are operated and in terms of the written documents that govern these arrangements. As discussed further below, the IRS also extended the application of transition guidance through December 31, 2008. Finally, the IRS followed up the next day by issuing Notice 2007-89, providing guidance on how employers can meet their wage withholding and information reporting requirements for 2007 with respect to Section 409A-related compensation.
This extension is good news for employers, employees, and their advisors, given that the final regulations' original January 1, 2008 effective date was fast approaching. Last month the IRS postponed the deadline for documentary compliance with the final regulations until the end of 2008. While providing some relief, that still meant that major design decisions and establishment of compliance procedures were required by the end of this year. Consequently, the guidance issued this week, providing an additional year for such decisions and procedures, means everyone can breathe a bit easier.
In connection with the extension, the following key transition rules apply:
- Before 2009, nonqualified deferred compensation plans must be operated in compliance with the statutory provisions of Section 409A and applicable interim guidance that has been issued by the IRS. To the extent an issue is not addressed in interim guidance, a "reasonable, good faith interpretation" of Section 409A applies.
- New elections about how, and when, amounts subject to Section 409A will be paid out can generally be made through December 31, 2008. However, after December 31, 2007, amounts otherwise payable in 2008 cannot be deferred beyond 2008, and amounts otherwise payable after 2008 cannot be accelerated into 2008.
- Payout elections under a nonqualified plan, such as an excess benefit plan, that are linked to qualified plan elections in accordance with pre-existing plan terms are still permissible through December 31, 2008.
- Discounted stock options (other than backdated options) and stock appreciation rights (SARs) that are still outstanding can be replaced with non-discounted options and SARs, which are exempt from Section 409A, up to December 31, 2008.
- "Good reason" termination clauses in employment agreements can be adjusted before December 31, 2008, but only if the current good reason condition constitutes a substantial risk of forfeiture.
- Information reporting of amounts deferred in 2007 is not required.
- Amounts includible in income for 2007 under Section 409A must be reported on Form W-2 or 1099 (as applicable) and, in the case of an employee, are subject to income tax withholding.
The IRS also reiterated its intent to issue guidance in the near future establishing a limited voluntary compliance program for some unintentional operational Section 409A failures. Details have not been provided, but the IRS anticipates that such failures could be corrected in the same taxable year in which they occur or result in only limited amounts being subject to income inclusion and penalties under Section 409A.
As described in other Alerts, Section 409A casts a wide net, applying to every organization— large or small, private or public, for-profit or tax-exempt—and to all employees, not just top executives, on all sorts of plans, programs, agreements and policies that are now considered "deferred compensation" even though historically no one has ever thought of them as such. If you have not already begun the Section 409A compliance review for your organization, now is the time to begin, as the extended deadlines provide a fresh opportunity to inventory, analyze and restructure (as necessary) all of your arrangements that are considered "deferred compensation" under Section 409A.