Yesterday, the IRS published long-awaited guidance allowing employers to fix certain provisions of their nonqualified deferred compensation plan documents that otherwise fail to satisfy the requirements of section 409A of the Internal Revenue Code. Section 409A generally imposes restrictions on the timing of deferrals and the timing and form of payments from nonqualified deferred compensation plans. Such plans must satisfy section 409A in both form and operation. Failure to satisfy section 409A results in substantial tax penalties for affected participants (generally, executives and directors).
For a more detailed explanation of the section 409A requirements, please click here.
The new correction guidance is a welcome development for employers seeking to ensure section 409A compliance in advance of an IRS executive compensation audit. The IRS has already announced that it intends to initiate new employment tax audits for up to 6,000 companies in 2010. Given that such audits likely will involve IRS review of nonqualified deferred compensation plans (an area of frequent employment tax noncompliance), employers should take advantage of the opportunity to clean up any section 409A documentation failures.
The section 409A correction guidance covers a wide range of plan document failures, including:
- Ambiguous or inconsistent defined terms (e.g., use of the phrase "termination of employment" in a manner that is inconsistent with the section 409A-defined "separation from service")
- Inclusion of impermissible payment dates or events (e.g., a payment date that varies based on the executive's execution of a noncompete agreement or a release of claims)
- Inclusion of impermissible payment schedules (e.g., multiple forms of payment for the same payment-triggering event)
- Retention of impermissible discretion to choose a form of payment or payment schedule
- Failure to provide for a six-month delay in payment for key employees of publicly traded companies upon their separation from service
- Erroneous deadlines for making deferral elections
Participants who receive payments within one year following the date of the plan document correction are required to pay a reduced section 409A penalty in certain cases, though even the reduced penalty can be avoided if correction is completed by December 31, 2010. Both the employer and the participant are required to disclose notice of the correction on their respective federal income tax returns.