Section 409A of the Internal Revenue Code became law some ten years ago, imposing significant new restrictions on deferred compensation arrangements of all types and significant penalties on employees who participate in arrangements that violate the new rules. Since that date, the Internal Revenue Service (“IRS”) has issued numerous notices, proposed regulations and, ultimately, final regulations. Together, this IRS guidance has clarified the law and provided various opportunities for employers to correct both plan document and operational violations.
The Enforcement Shoe Drops - The Hunt Begins
It was probably inevitable that the other shoe, the enforcement shoe, would drop some day. That day is here; the hunt for Section 409A violators has begun. The IRS recently announced that is will commence a formal audit program to determine whether employers are complying with the requirements of Section 409A. The program will initially be restricted to approximately 50 large employers and to the ten most highly compensated employees of those companies. The focus of the audits will be on:
- Initial deferral elections
- Subsequent deferral elections
- Distributions of deferred compensation subject to Section 409A
Depending on what the IRS finds in conducting these initial audits, the audit program could be expanded, revised, or, we should be so fortunate, terminated.
What Employers Should Do Now
Whether or not you have already done so, and whether or not you are a potential target of the IRS’s initial Section 409A audit initiative, we recommend that you take the following steps to protect employees from the harsh penalties imposed by Section 409A:
- Determine what plans, employment agreements, and other arrangements you maintain that are subject to Section 409A (“your 409A Plans”).
- Review the documentation of all of your 409A Plans to make sure the documents comply with Section 409A.
- Evaluate whether you are complying with Section 409A in operating your 409APlans, paying particular attention to the areas the IRS has indicated it will focus on in its new audit program.
- Take appropriate steps to correct any deficiencies in either the documentation of your 409A Plans or their operation.