As discussed in previous Drinker Biddle Client Alerts, Dec. 31, 2008, is an important date for many sponsors of Internal Revenue Code (IRC) Section 403(b) programs and sponsors of nonqualified deferred compensation arrangements under IRC Section 457(f). With the year-end fast approaching, now is the time for sponsors of IRC Section 403(b) programs and IRC Section 457(f) plans to ensure that their programs and plans are in compliance.

Section 403(b) Programs

The final regulations under IRC Section 403(b) are generally effective for taxable years beginning after Dec. 31, 2008. However, there are certain exceptions, including those for certain church-related organizations under very limited circumstances and for programs that are offered pursuant to collective bargaining agreements. The final regulations will not be effective for IRC 403(b) programs of a limited number of church-related organizations until plan years following Dec. 31, 2009. With respect to any IRC 403(b) program offered under a collective bargaining agreement that was ratified and in effect on July 26, 2007, the final regulations will not be effective before the earlier of the date on which the collective bargaining agreement terminates or July 26, 2010.

The final regulations require that most IRC Section 403(b) programs have a fully compliant written document in place as of Jan.1, 2009, and be operationally compliant as of that date. Please follow these links to access our previous Drinker Biddle Client Alerts, To Be or Not to 403(b): That is The Question (and, After Years of Waiting, We Finally Have the Answers) and To Be Or Not To 403(b): That Is The Question (and After Years of Waiting, We Finally Have the Answers) – Part II, which provide detailed information regarding the requirements of the final regulations under IRC Section 403(b). Note that, in accordance with IRS Revenue Procedure 2007-71, under certain circumstances some “orphaned” IRC Section 403(b) programs (i.e., programs to which contributions have not been made since Dec. 31, 2004) are exempt from the written document requirement in the final regulations.

Drinker Biddle Comments:

  • Sponsors of IRC Section 403(b) programs should ensure that all of those programs are reviewed well before year-end to determine: (i) the applicability of the final regulations under IRC Section 403(b), and (ii) the applicability of the written document requirement.
  • IRC Section 403(b) programs to which the written document requirement is applicable should be amended to comply with the final regulations by Jan. 1, 2009.
  • Sponsors of IRC Section 403(b) programs should contact the service providers for such programs to ensure that the programs will be operationally compliant with the final regulations under IRC Section 403(b) as of Jan.1, 2009, if applicable, including the information-sharing agreement requirements set forth in the final regulations.

Section 457(f) Plans

Most sponsors of nonqualified deferred compensation arrangements under IRC Section 457(f) already know that the interaction of the provisions of IRC Section 457(f) and IRC Section 409A can be complicated. Many nonqualified deferred compensation arrangements sponsored by state and local governments and tax-exempt organizations are subject to IRC Section 457(f). Additionally, both taxable and tax-exempt sponsors of nonqualified deferred compensation arrangements may be subject to the provisions of IRC Section 409A. The deadline for amendments required to conform IRC Section 457(f) arrangements to the requirements of IRC Section 409A is Dec. 31, 2008. Please follow these links to access our previous Drinker Biddle Client Alerts, Tax-Exempt Organizations Beware: Restrictive New IRS Section 457(f) Guidance is Coming, Final Code Section 409A Regulations: What’s New, What’s Not Covered and What Do You Do Now? and Interpretations with Respect to 457(f) Plans: IRS Guidance Issued Under Code Section 409A Affecting Nonqualified Deferred Compensation Plans, which provide detailed information regarding IRC Section 409A and the application of IRC Section 409A to IRC Section 457(f) arrangements.

Generally, the issue of most concern for sponsors of IRC Section 457(f) arrangements is what it means for an amount to be subject to a “substantial risk of forfeiture.” This is because benefits provided under IRC Section 457(f) arrangements are taxable when they are no longer subject to a substantial risk of forfeiture. In Notice 2007-62, issued in August 2007 (the subject of a previous Drinker Biddle Client Alert), the IRS indicated that the inclusion of certain features in a program, such as covenants not to compete, “rolling vesting” (i.e., the feature by which an employer and employee mutually agree to delay the vesting date by written election of the employee one year or more before vesting otherwise would have occurred) and employee deferral elections would likely result in the benefits provided under the program not being considered subject to a substantial risk of forfeiture under IRC Section 457(f).

In Notice 2007-62, the IRS indicated that it would provide guidance on the interplay of various provisions in IRC Section 457(f) and IRC Section 409A, including guidance on the inclusion of the features described above in IRC Section 457(f) arrangements. Such guidance has not been issued to date, but may still be received before year-end and may include a limited extension of time (e.g., 90 days) to bring IRC Section 457(f) arrangements into compliance. Many sponsors of IRC Section 457(f) arrangements are taking action now to ensure that such arrangements are in compliance with IRC Section 409A, based on the current available guidance.

Drinker Biddle Comments:

  • Tax-exempt employers should identify all arrangements to which IRC Section 457(f) may apply, particularly the arrangements that contain covenants not to compete, rolling vesting and employee deferral elections.
  • For any arrangements that contain covenants not to compete, rolling vesting and employee deferrals, plan sponsors must decide whether to modify such arrangements this year to address compliance with IRC Section 409A (absent final guidance from the IRS) or whether to wait until final guidance is received. A sponsor of an IRC Section 457(f) arrangement must determine whether IRC Section 409A is applicable to that arrangement. If so, the sponsor must ensure that the arrangement is in compliance with IRC Section 409A as of Dec. 31, 2008, even if the sponsor decides not to address until later the above-described IRC Section 457(f) issues that lack final IRS guidance. Ultimately, a two-step redesign process would be required for those arrangements.