The IRS recently issued Notice 2007-78, which extends the deadline for full documentary compliance under Internal Revenue Code Section 409A until December 31, 2008. However, the Notice continues to impose a December 31, 2007 deadline for other items.
I. Previous Guidance
Effective January 1, 2005, Section 409A was enacted to impose three substantive rules for nonqualified deferred compensation (“NQDC”) plans.
- Election Timing: Subject to certain exceptions, elections to defer compensation generally must be made by the last day of the calendar year (i.e., December 31st) before the calendar year in which services are performed with respect to such compensation.
- Time and Form of Payment: All plans or agreements with deferred compensation must specify permitted times and forms of payment in the document.
- Six-Month Delay Rule: NQDC payments to key employees of public companies because of termination of employment generally may not commence until six months after the executive’s termination date.
In April 2007, the IRS issued final regulations under Section 409A. The final regulations broadly included most arrangements that create a legally binding right to compensation in one year that is payable in a later year (including certain equity compensation arrangements and employment agreements) as NQDC covered by Section 409A. The final regulations required NQDC plan documents to be amended by December 31, 2007. These regulations also provided certain transition relief that expires December 31, 2007.
II. New Guidance
The IRS issued Notice 2007-78 on September 10, 2007. The Notice provides the following guidance and relief.
- NQDC arrangements need not be amended in writing until December 31, 2008 (so long as any noncompliant provisions are disregarded in the administration of the arrangement).
- The permitted times and forms of payment of NQDC amounts, however, must be in writing by December 31, 2007.
- The transition relief provided under the final regulations still expires on December 31, 2007.
- Additional guidance was provided as to how Section 409A applies to employment agreements and automatic cash-outs of annuities or installment payments.
- The IRS announced its intention to adopt a voluntary compliance program where taxpayers could identify and correct certain unintentional violations of Section 409A in exchange for more limited tax consequences than what Section 409A currently provides. Under the statute, failure to comply with Section 409A will result in taxation of the NQDC as well as interest and a 20 percent excise tax.
We expect that the IRS may issue additional guidance, including other possible extensions.
III. Interim Administration and Action Items
Although full documentary compliance with Section 409A is not required until December 31, 2008, NQDC arrangements need to be administered in good faith compliance with Section 409A beginning January 1, 2005. Effective January 1, 2008, NQDC arrangements must be operated in compliance with the final regulations. Accordingly, employers should consider taking the following actions by December 31, 2007.
- Identify all arrangements that could be subject to Section 409A.
- Designate compliant distribution events and forms of payments in writing.
- Unlink certain nonqualified plan payments from qualified plans.
- Consider permitting plan participants to revise their existing payment elections.
- Obtain deferral elections for 2008 deferrals.
- Prepare for full Section 409A compliance by amending plans in writing or, at a minimum, identifying NQDC compliance issues.