The Department of Treasury and the Internal Revenue Service have issued the anticipated final regulations under section 409A of the Internal Revenue Code. Employers must act now to identify arrangements, agreements, and plans subject to section 409A; review these plans for compliance with the final regulations; and amend the plans (often requiring approval by the Board of Directors) by no later than December 31, 2007.

The final regulations clarify and in some cases liberalize the proposed regulations. Changes include the following:

  • Stock options and SARs –
    • Extending the Term of a Stock Right – The final regulations allow employers to extend the exercise period of stock options and SARs up to the earlier of (i) the date the stock right would have expired by its own terms, or (ii) the date that is the tenth anniversary of the original grant date.
    • Service Recipient Stock – The final regulations expand who is an eligible issuer (for purposes of the exclusion of certain stock rights from 409A) to include related entities in which an entity owns at least a 50% controlling interest.
  • Plan Aggregation Rules – For purposes of the plan aggregation requirement in the event of a plan’s failure to comply with 409A, the final regulations expand the different categories of plans to nine categories, including elective and nonelective account plans, nonaccount plans, and stock rights.
  • Severance – The final regulations:
    • Exclude certain excepted payments to involuntarily terminated employees from deferred compensation and, therefore, from the six-month delay for publicly traded companies.
    • Exclude amounts paid to reimburse medical expenses during the COBRA continuation period.
    • Provide that termination for good reason (involving a material negative change) may constitute an involuntary termination for purposes of excluding certain separation pay arrangements from 409A.
  • Termination of Employment – The final regulations clarify that an employee who cuts back and provides 20% or less of the level of services the employee had been providing is deemed to have had a termination of employment unless the employer and employee rebut this presumption.
  • Six-Month Delay – The final regulations:
    • Allow the employer to use an alternative method to determine who is a specified employee subject to the six-month delay, provided the alternative method is reasonably designed to cover all of the specified employees determined using the primary method provided for in the regulations.
    • Liberalize who is a specified employee in the context of mergers, acquisitions, and spin offs.

The final regulations make numerous other changes – this is not an exclusive list.

The final regulations require the material terms of deferred compensation plans to be in writing, including provisions on initial and subsequent deferral elections, payment triggers, and time and form of payment. In addition, employers that are publicly traded companies must include the six-month delay for specified employees in the plan. Employers must amend their deferred compensation plans by no later than December 31, 2007 to comply with section 409A.

The final regulations under section 409A are available at the IRS web site, (

Please contact the attorney with whom you work regarding section 409A.