The Internal Revenue Service and the Treasury have announced their intention to publish guidance under Section 457 – applicable to nonqualified deferred compensation plans of state and local governments and tax-exempt entities – concerning the definitions of a bona fide severance pay plan under Section 457(e)(11) and substantial risk of forfeiture under Section 457(f)(1)(B). Click here for a copy of Notice 2007-62. In general, this guidance project would apply certain concepts developed in the Section 409A regulations to counterpart provisions of Section 457. Any comments on the anticipated guidance or related issues are requested by October 15, 2007.
Bona fide severance pay plans are not subject to Section 457, pursuant to Section 457(e)(11). The anticipated guidance would treat an arrangement as qualifying for that exception if:
- The benefit is payable only upon involuntary severance of employment. On this point, the anticipated guidance would include exceptions for window programs, collectively bargained severance pay plans, and certain reimbursement or in-kind benefit arrangements similar to the exceptions in Treas. Reg. §1.409A-1(b)(9)(ii), (iv) and (v); and
- The amount payable does not exceed twice the employee’s annual rate of pay (taking into account only pay up to the Section 401(a)(17) limit for the year of severance); and
- The plan provides that payments must be completed by the end of the employee’s second taxable year following the year of severance. Such a definition would have some similarity to, but would not track, the ERISA regulation for treating severance pay plans as welfare rather than pension plans for Title I purposes.
Section 457(f) provides that compensation under an “ineligible” nonqualified plan of a state or local government or tax-exempt employer – a plan that is neither a Section 457(b) “eligible” plan nor excepted under Section 457(e) or 457(f)(2) – is taxable in the first tax year in which there is no substantial risk of forfeiture of the rights to such compensation. Ineligible plans are also separately subject to Section 409A. The anticipated guidance would generally adopt under Section 457(f) the rules relating to substantial risks of forfeiture included in Treas. Reg. §1.409A-1(d). (Comments are specifically requested with respect to application in the governmental and tax-exempt context of the element of these Section 409A rules providing that, to constitute a substantial risk of forfeiture, a condition must be related to the service recipient’s business activities or organizational goals (or to the service provider’s performance).) Under this approach, as reflected in the Notice, a substantial risk of forfeiture would lapse for Section 457(f) purposes no later than it would lapse for Section 409A purposes, with the consequence that such compensation would never become subject to Section 409A (because Section 409A does not apply to amounts taxable under Section 457(f) within the short-term deferral period of Treas. Reg. §1.409A-1(b)(4)(i)); subsequent earnings on such amounts would, however, be subject to Section 409A unless an exception independently applied.
The anticipated guidance would be prospective, with no inference for any prior period. Taxpayers are, however, permitted to rely on the anticipated guidance in the interim. Comments on the need for transition relief are specifically solicited.