Earlier this week, the Internal Revenue Service issued Notice 2010-6, which sets forth the method for correcting certain documentary failures that occur under Internal Revenue Code Section 409A. Documentary compliance with Section 409A was required on and after January 1, 2009. However, until issuance of Notice 2010-6, minor plan document violations could subject income recipients to harsh tax consequences.
Section 409A contains strict rules related to the timing and form of payment of deferred compensation. Section 409A provides that payments of deferred compensation are only permissible upon certain events (including, but not limited to, a separation from service, change in control and a specified future date). If these rules are violated, the recipient of the deferred compensation is subject to immediate income inclusion of the deferred amounts (even if they have not been paid), as well as an additional 20% tax. Penalties and interest can also apply. An employer usually has a corresponding withholding and reporting obligation related to its promise to pay non-compliant deferred compensation.
One of the more frustrating issues arising under Section 409A was the idea that an unintentional technical violation in the plan document that continued to exist on and after January 1, 2009, would result in all amounts deferred under the plan being subject to adverse tax consequences. Fortunately, with the release of Notice 2010-6, many of these violations are now correctable. In addition, if the corrections are made on a timely basis, there is often little or no penalty involved with correction.
Over 15 types of violations may be corrected under Notice 2010-6. The notice contains detailed procedural requirements for each type of violation in order to ensure that full correction is made. Many of the correction procedures require the payment of penalty amounts by the income recipient (particularly in situations where correction is made less than one year prior to payment). As an example of one correction available under Notice 2010-6, Section 409A requires that amounts be paid within 90 days following a permissible payment event. If a deferred compensation plan permits payment within 180 days following an otherwise permissible payment event, Notice 2010-6 allows amendment of the plan to shorten the period to 90 days. In connection with such correction, no penalty payment would be required.
To be eligible to correct a Section 409A document failure under Notice 2010-6, certain eligibility criteria must be satisfied. For example, neither the payor (e.g., the company) nor the payee (e.g., the employee) may be under audit with respect to the relevant deferred compensation plan at the time correction is made. In addition, both the payor and the payee will be required to include certain information with the filing of their respective tax returns for the year in which correction occurs.
Finally, Notice 2010-6 contains transition provisions that allow even more favorable correction treatment for corrections made prior to 2011. The IRS stated that the transition period is intended to allow employers an opportunity to voluntarily reexamine their deferred compensation plans and ensure that each of them is in full compliance with Section 409A.
Notice 2010-6 can be found here.