I. Background. If you hit a brick wall at midnight on December 31, 2008, with regard to the Section 409A documentary compliance deadline, the IRS is providing a second chance for you to reassess your Section 409A compliance and to bring your deferred compensation documents in line. For those of you not in the know, Section 409A of the Internal Revenue Code requires a nonqualified plan or agreement to reflect the various time and form of payment rules described in that section and in related guidance.

In brief, Section 409A requires that payment of deferred compensation1 be made upon permitted payment events such as separation from service, change in control, disability, an unforeseeable emergency or death (the first four payment events are defined terms), or that the time of payment be specified in the document. A noncompliant document may result in, among other things, current ordinary income tax plus a 20 percent additional tax imposed on the executive – computed on amounts deferred and vested under the plan. The ordinary and additional taxes apply regardless of whether the deferred amount has actually been paid.

Employers had until December 31, 2008, to amend their nonqualified plans and/or agreements to include Section 409A compliant provisions. Now that this deadline is past, the IRS, recognizing that many drafting errors are inadvertent and unintentional, has created a document correction program. In many cases, the correction requires inclusion of income and compliance with certain information and reporting requirements as a condition of correction.

II. Transition Relief Period. Many of the corrections described in this program require the employee to include a portion of the deferred compensation in income in the year of correction or, if the payment event occurs within one year of the correction, in the year following the year of correction and to pay the additional 409A taxes. If the correction involves one of the corrections described in Section IV, however, and the document is amended by December 31, 2010, these requirements do not apply. In the case of nonqualified plans that are linked plans (i.e., the amount deferred under one plan is determined by, or the time and form of payment is affected by, an amount deferred under another plan) and one or both plans fail to satisfy Section 409A, the correction period for de-linking the plans and bringing one or both plans into compliance ends on December 31, 2011. Please note that linked plans are not eligible for relief under this program.

III. What To Do Now. This program is a good opportunity to check with benefits counsel regarding any further corrections and/or clarifications that may be required under a nonqualified plan or agreement to make it Section 409A compliant and to take advantage of the transition relief period to amend these documents. Please keep in mind that Section 409A affects any document that permits deferral of compensation. Examples of deferred compensation plans and agreements affected by Section 409A include, in addition to a typical nonqualified deferred compensation plan, employment agreements, severance agreements, restricted stock unit awards, performance rights awards, annual bonus plans, long-term and short-term incentive plans and supplemental employment retirement programs.

IV. Errors Covered Under The Program. Drafting errors that may be corrected under this program are listed below.2 Examples are shown in the table on the following page. References to rows below refer to rows in this table.

  • Ambiguous Terms. See Rows A and B.
  • Non-Compliant Provisions.
    • Impermissible Definition of Payment Events. See Rows C, D and E.
    • Impermissible Payment Periods Following A Permissible Payment Event. See Rows F and G.
    • Correction of Impermissible Payment Events And Payment Schedules.
      • A combination of impermissible payment events and permissible payment events. See Row H.
      • Only impermissible payment events. See Row I.
      • Impermissible alternative payment schedules. See Row J.
      • Impermissible employer or employee discretion with respect to a payment schedule following a permissible payment event. See Rows K and L.
      • Impermissible subsequent deferral election. See Row M.
      • Impermissible employer discretion to accelerate a payment event. See Row N.
      • Impermissible Reimbursement of In-Kind Benefit Provisions. See Row O.
    • Failure to Include Six-Month Delay of Payment for Specified Employees.3 See Row P.
    • Impermissible Initial Deferral Elections. See Row Q.
    • Amendment Period Following The Initial Adoption Of The Plan. See Row R.

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