Section 409A of the Internal Code of 1986, as amended (“Section 409A”), impacts many common forms of compensation deferred by certain cash-basis taxpayers1 after 2004 or, in certain circumstances, earlier.2 Affected compensation includes, but is not limited to, fees deferred by cash-basis investment managers of offshore hedge funds and the plans governing payment of those amounts to the investment managers’ partners and employees. Failure to adhere to the technical rules of Section 409A can result in immediate taxation of such compensation, an additional 20% penalty tax on such amounts and increased interest on the resulting tax underpayment.
Late last year, the IRS and the Treasury Department released Notice 2007-86, which extended through Dec. 31, 2008, certain transition relief relating to rules governing nonqualified deferred compensation plans under Section 409A. Under that transition relief, cash-basis taxpayers are able to comply with Section 409A in 2008 by operating their arrangements in reasonable, good faith compliance with Section 409A, even if their written documents do not follow the strict technicalities prescribed by Section 409A. However, by the end of this year, all existing nonqualified deferred compensation arrangements must be in full operational and written compliance with Section 409A as set forth in the final Section 409A Regulations or taxpayers risk substantial penalties on that compensation.
Steps to be Taken
If you have not already done so and wish us to assist you, please, as soon as possible, contact the attorney with whom you usually work or one of the undersigned regarding the following:
- Written Compliance. Deferred fee agreements with offshore funds, management company deferred compensation plans, as well as all other arrangements subject to Section 409A (such as investment management agreements and subadvisory agreements), should be reviewed this year (even if recently updated) for compliance with Section 409A and amended by Dec. 31, 2008, if required.
- Payment Change Elections. Under the transition relief, a taxpayer generally may change the payment date for any payment subject to Section 409A that was originally scheduled to be made in 2009 or later, so long as the taxpayer does not accelerate payment into 2008. Those who wish to avail themselves of this transition relief must make any changes on or before Dec. 31, 2008.3