The payment of severance in the event of a termination of employment is often conditioned on the execution of a release agreement. This requirement may violate the documentary requirements of Code Section 409A ("409A") if the employee is able to control the year of payment through the timing of delivery of the release. The IRS views this as a violation of 409A whether or not the release execution period straddles two tax years. In 2010, the IRS issued transition relief under Notices 2010-6 and 2010-80, allowing employers to amend noncompliant severance arrangements that were in effect as of December 31, 2010, to comply with the release execution requirements of 409A, but only if the arrangement is amended no later than December 31, 2012.
An arrangement with a noncompliant release-based payment that is not corrected may cause the employee recipient to be subject to a 20 percent federal penalty tax, plus an additional 20 percent state penalty tax if the employee resides in California. Prior to the end of this year, employers should review all severance arrangements that condition payment upon the execution of a release to ensure that the employee does not have the ability to control the year of payment through the timing of delivery of the release. Any noncompliant arrangement should be amended on or before December 31, 2012, using one of the IRS-designated approaches.