Earlier this year, the Internal Revenue Service released Notice 2010-6 (the Notice), which provides a correction program giving employers a further opportunity to amend nonqualified deferred compensation plan documents to comply with Section 409A of the Internal Revenue Code (409A). The most generous aspect of this relief expires on December 31, 2010, so now is the time for employers to review and revise nonqualified deferred compensation arrangements that for any reason may not have been amended for 409A by the regular deadline of December 31, 2008. In addition, before the end of each year, employers should review and correct any failures to operate their nonqualified plans in accordance with 409A, in order to take advantage of the relief provided under the operational correction program the IRS adopted in 2008 (Notice 2008-113).

Remember, a broad range of plans are potentially covered by the restrictions of Section 409A, including salary deferral plans, SERPs, phantom stock, stock appreciation rights, stock options, commission, bonus and long-term incentive arrangements, reimbursement policies, severance plans, change in control payments, and employment agreements which contain such benefits. The end of the transition period under 409A was December 31, 2008. Since that time, all nonqualified deferred compensation plans and arrangements should have been in full compliance (in operation and in documentation) with the final regulations under 409A.

Notice 2010-6 also provides additional details regarding the 409A requirements, so it would be advisable for all nonqualified deferred compensation arrangements to be reviewed (or re-reviewed) in light of the new guidance. We stand ready to help clients take advantage of the 409A correction programs, but will not review any documents without your request. If you would like us to review your nonqualified deferred compensation arrangements, please contact us as soon as possible, but no later than October 31, 2010.

Overview of Section 409A

 As noted in our prior updates (see sidebar), Section 409A restricts deferral elections, distribution elections and distribution events under nonqualified deferred compensation plans. For example, 409A permits distributions only upon separation from service, disability, unforeseeable emergency, change in control, or under a fixed schedule and only as these terms are specifically defined in 409A.

If a plan is subject to 409A, but does not comply with the applicable restrictions both in form and in operation, participants generally will be taxed on their vested benefits, suffer an additional 20% tax and also may incur interest charges. The potential cost to the individual participant may be very significant.

Document Correction Relief under 409A

Notice 2010-6 allows certain plans that failed to be amended by the original December 31, 2008 deadline to be amended in 2010 or potentially later, so as to avoid or limit the 409A taxes and penalties that would normally be associated with the document compliance failures. In some cases, correcting a document error under the Notice can eliminate the immediate income tax, 20% additional tax and interest charges altogether; in other cases, it can substantially limit adverse tax treatment under 409A.

Special Transition Relief for 2010

If a plan is eligible for correction under the Notice and is corrected no later than December 31, 2010, the plan will be treated as being correct on January 1, 2009 (the date by which plan documents were to be in full compliance with 409A), so that participants generally will not be subject to taxes and penalties under 409A due to the plan document failure. However, any payment made under the plan prior to December 31, 2010, must be corrected under the operational correction program no later than December 31, 2010.

Types of Document Errors Which Can Be Corrected

A wide variety of plan document failures can be corrected under Notice 2010-6. This chart generally illustrates several of the main types of such plan document failures, and the general correction methods to be used. A sampling of errors that can be corrected under the Notice include:

  • Use of improper definitions for distribution events (such as an improper definition of “separation from service”)
  • Providing for distributions on events which are not permitted to trigger distribution under 409A (such as impermissibly permitting distribution on an IPO)
  • Permitting more times and forms of payment than are allowed by 409A for a single payment event (such as providing an immediate lump sum payment for involuntary terminations of employment, but providing installment payments in the case of voluntary terminations)
  • Allowing employees or employers to change the time and form of distribution without following the proper 409A election procedures (such as by permitting an employee to determine the time of payment by deciding when to execute a release)

General Provisions and Limitations on Document Correction

The document correction relief comes with some strings attached:

  • Typically, correction is permitted only prior to the occurrence of the event triggering payment.
  • Generally, if an event that would be impacted by the correction occurs within 1 year of the correction, then the participant will be taxed on part (usually 50%) of the amount that would have been subject to the prior provision, and if the tax is not timely reported and paid, the relief is lost. (If the document is corrected by December 31, 2010, these adverse tax consequences can be avoided.)
  • The relief generally does not apply to stock rights (such as SARs and stock options) and only limited relief applies to nonqualified plans in which the time, form and amount of payment under the plan is “linked” to another plan.
  • In most cases, the employer and the plan participants will need to include statements on their tax returns disclosing the document failure, the section of the Notice utilized to correct the failure, the amount involved and certain related information (including, to the extent applicable, the amount reported by the employer as includible in the participant’s income under 409A as part of the correction).
  • The Notice only permits correction for plan document failures that are inadvertent and unintentional. In order to take advantage of the relief to correct a plan document failure, the employer must identify all other plans that have substantially similar failures and correct those failures as well.
  • The relief under the Notice is not available to employers or plan participants if they are under audit for any year in which the document failure existed.

Correcting Operational Errors

In 2008, the IRS adopted a program to allow employers to correct certain operational failures under 409A. The program is set forth in Notice 2008-113, and addresses certain common errors, such as distributing benefits too early or too late, or failing to honor proper deferral elections. Generally, the relief is more generous the earlier an error is identified and corrected. In addition, Notice 2008-115 and related guidance indicates that compliance with 409A is determined on a year-by-year basis. A violation (in operation or form) only results in income taxes on benefits which are vested in the year(s) that a failure exists, thereby providing a further avenue for correcting 409A issues with respect to unvested benefits. The relief under these Notices is described in a prior First Alert (see sidebar).


The transition relief in Notice 2010-6 gives employers one more opportunity to have their nonqualified deferred compensation plans reviewed and revised for 409A. For those employers who were not able to have their plans reviewed prior to December 31, 2008, now is the time to act. Employers should also review operational compliance under 409A at least once a year, in order to take timely advantage of the operational correction programs