In 2004, Congress enacted Section 409A of the Internal Revenue Code, which significantly changed the tax rules that apply to nonqualified deferred compensation arrangements. In this context, “nonqualified” means any arrangements other than qualified retirement plans (i.e., pension plans, profit sharing plans, 401(k) plans) that meet all the requirements of the Internal Revenue Code to achieve a preferred tax status.
The scope of arrangements that can fall within nonqualified deferred compensation arrangements is very broad. It could include something as simple as an employment agreement that requires the employer to make payments to the employee in the years after the employee has performed the services for which he or she is being paid. Some kinds of routine bonus arrangements can even be covered, as can nonqualified stock options, phantom stock plans and stock appreciation rights, sometimes referred to as SARs.
The Internal Revenue Service has just finalized its regulations implementing Section 409A. The regulations require that every nonqualified deferred compensation plan or agreement be amended by December 31, 2007, if necessary, to comply with the new rules. Failure to do so will likely result in unfortunate tax consequences to the service provider, including possible acceleration of taxes and liability for a 20% excise tax on top of regular income taxes.
Please contact us to review any agreements you have, or plans in which you participate, that provide for nonqualified deferred compensation or equity grants. We have assembled a team to review all these agreements and prepare any required amendments. If you are not certain about a particular arrangement, the safest course is to let us take a look at it and tell you if it needs to be amended. Even if compliant, it may still be prudent to amend the arrangement to clarify certain provisions to ensure proper treatment. Please send your documents to us right away so there is plenty of time to complete the necessary amendments. This may be very difficult to accomplish in a timely manner if you do not send your agreement in until sometime in the fall.