Many types of employment-related agreements condition the receipt of payment upon termination of employment upon the execution and delivery of a non-revocable waiver and release of claims. Many of these agreements may be in violation of IRC Section 409A, potentially subjecting the employee to significant tax liability. However, many of these agreements can be corrected without penalty if the action is taken before December 31, 2012.
Section 409A governs the taxation of many non-qualified deferred compensation arrangements, whether provided under a plan or program that covers multiple employees, or as part of an individual employment or severance arrangement. Often, the receipt of a separation payment or other compensation may be conditioned upon the delivery of a general release of employment-related claims by the employee. One of the requirements of Section 409A is that the time of payment must be set forth in the document and cannot be subject to discretion as to the year of payment by the employee.
In Notice 2010-6, the Internal Revenue Service announced that where a severance payment is conditioned upon, and paid within a specified time of, the delivery of a waiver and release of claims, the agreement may violate Section 409A where the period of payment may span two taxable years of the employee. The rationale is that by making the payment contingent upon delivery of the executed waiver, the employee may be able to manipulate the taxable year in which the payment is received.
The IRS has provided guidance for the correction of this problem, provided the corrective action is taken before December 31, 2012. This correction generally avoids the imposition of Section 409A taxes and penalties and additional disclosure to the IRS.
Employers should review their employee agreements, such as change in control, severance, and employment agreements, to determine whether this problem exists and whether the problem can be corrected before December 31, 2012.