This Executive Alert describes the rules established by the Final Regulations promulgated under Section 409A of the Internal Revenue Code (the “Code”) which permit the acceleration or delay of payments otherwise due under arrangements subject to Code Section 409A. Specifically, this Alert highlights the changes the final regulations published on April 10, 2007 (the “Final Regulations”), made to the distribution acceleration and delay rules previously set forth in the proposed regulations that were published by the U.S. Treasury and Internal Revenue Service on September 29, 2005 (the “Proposed Regulations”).

The Final Regulations generally follow the Proposed Regulations, but with several modifications that liberalize the rules set forth in the Proposed Regulations. As further discussed below, this liberalization will make it easier for employers and other service recipients (collectively, “employers”) to design and modify existing deferred compensation arrangements to comply with Code Section 409A with greater flexibility than originally permitted under the Proposed Regulations when electing to accelerate or delay payments under such arrangements. However, in order to ensure compliance with the Final Regulations and the resulting penalty taxes on employees and other service providers (collectively, “workers”), employers must undertake a review of all compensatory arrangements now to ensure the required amendments are made by December 31, 2007.

Acceleration of Distributions

A plan, program, agreement, or other arrangement that provides for a deferral of compensation (collectively, a “plan”) will be subject to Code Section 409A’s specific distribution timing rules. In our Executive Alert published on June 8, 2007 we discussed the specific rules governing distributions under the Final Regulations. Accordingly, a plan generally may not permit the acceleration of either (1) the time or schedule of any payment that is otherwise due to be paid thereunder, or (2) the amount to be paid under the Plan. This is known as the anti-acceleration rule.

The Proposed Regulations established specific exceptions to the anti-acceleration rule. The Final Regulations have modified those exceptions as follows:

• Cashout of De Minimis Amounts. Plans may require or provide employers the discretion to require a mandatory lump sum cash-out of a worker’s entire interest in a plan as long as the amount does not exceed the dollar limit under Code Section 402(g)(1)(B) ($15,500 in 2007). Unlike the Proposed Regulations, the Final Regulations do not require the worker to first separate from service to receive the cash-out. The plan must, however, be amended before the date of the payment for such action to be effective and the worker’s interest in all “like” plans, as determined under Code Section 409A’s plan aggregation rules, must be terminated and liquidated as a result of the cash-out. (Note: under the Proposed Regulations, a plan could provide for a cash-out of amounts that did not, in the aggregate, exceed $5,000.)

NEW—A plan that provides for an installment form of payment may also provide for an immediate cash-out of all remaining installment payments when the present value of the amount to be paid is less than the plan’s established threshold. A plan amendment is required before payments commence.

• In Satisfaction of Legal or Tax Requirements. Plans may provide for accelerated distributions upon the following events:

# Payments required to be made pursuant to a domestic relations order. Final Regulations clarify that payments cannot be made to the worker, but must be made to an individual other than the worker and can only be made to the extent required by the order.

#  Payments to comply with general federal, state, local or foreign tax obligations that arise from participation in the plan prior to amounts deferred under the plan being paid or made available. Includes amounts to cover income tax at source.

#  Payments to satisfy employment taxes under FICA or the Railroad Retirement Act, including any income tax at source on wages, imposed on amounts deferred under a plan.

# Payments made to avoid a non-allocation year under an employee stock ownership plan. Amount cannot exceed 125 percent of minimum amount of distribution necessary to avoid non-allocation year.

# Payments for taxes owed upon vesting of amount deferred under a Code Section 457(f) plan for a tax-exempt entity subject to a limitation.

# Payments to a federal officer or employee in the executive branch to comply with an ethics agreement with the federal government or any other worker to the extent reasonably necessary to avoid violating any applicable federal, state, local, or foreign ethics law or conflicts of interest law.

# Payments to the extent amounts must be included in income as a result of a plan’s failure to meet the requirements of Section 409A.

Termination of the Plan. Employers may permit accelerated distributions in the event of a termination or liquidation of a plan provided that:

# The termination and liquidation does not occur proximate to a downturn in the financial health of the employer;3 All similar plans that are subject to aggregation are terminated and liquidated;

# No payments in liquidation are made within 12 months of the date the employer takes all necessary actions to irrevocably terminate and liquidate the plan;

# All payments are made within 24 months of the date the employer takes all necessary actions to irrevocably terminate and liquidate the plan; and

# The employer does not adopt a similar plan within the three-year period following the date the employer takes all necessary actions to terminate and liquidate the plan. (Note: under the Proposed Regulations, an employer was prohibited from adopting a similar plan within the five-year period following the termination and liquidation.)

Employers may also make accelerated distributions upon a termination and liquidation of a plan if they have approval of a bankruptcy court pursuant to 11 U.S.C. §503(b)(1)(A) or upon a corporate liquidation taxable under Code Section 331. Distributions are permitted in the year of termination or, if later, the year in which workers’ interests become vested. Distributions may be delayed if payment is not administratively feasible.

Termination Upon Change in Control Event. An employer may accelerate payments upon the termination of a plan as a result of a change of control. If the employer terminates and liquidates the plan pursuant to an irrevocable action taken by the employer within 30 days preceding or 12 months following a change in control event, then distributions can be accelerated if made within 12 months of the date the employer irrevocably takes all necessary action to terminate and liquidate the plan. All like plans must be aggregated, terminated, and liquidated. Further, the change of control must satisfy the Final Regulations’ definition of a change in control.

Cancellation of Deferral Elections Due to Disability. NEW—An employer has the discretion to cancel a worker’s deferral election upon a showing of the worker’s disability. Unlike disabilities for general distributions, a “disability” that will support a cancellation must relate to a medically determinable physical or mental impairment resulting in the worker’s inability to perform the duties of his or her position or any substantially similar position, where such impairment can be expected to result in death or can be expected to last for a continuous period of not less than six months. The cancellation may not occur later than the end of the worker’s taxable year or the 15th day of the third month following the date worker incurs the disability.

De Minimis Plan Offsets. NEW—A plan may make a payment as satisfaction of a debt of a worker, which is incurred in the ordinary course of the service relationship with the employer, provided the payment is not greater than $5,000 and the payment is made at the same time and in the same amount as the debt otherwise would have been due and collected from the worker.

Bona Fide Disputed Payments. NEW—A plan may make a payment as part of a disputed settlement between an employer and a worker. The payment must be for a substantially reduced value in relation to the amount that would have been payable without the dispute. If a payment is made proximate to a downturn in the financial health of the employer, the payment will be presumed not to meet this acceleration exception.

Changes in Elections Under a Cafeteria Plan. NEW—A change in an amount deferred under a plan will not result in an impermissible acceleration if that change is solely due to a change in the amount of compensation that can be deferred under the plan’s benefit formula, which is a direct result of an election change made under a cafeteria plan. The change must apply in the same manner as any other increase or decrease in compensation would apply to the plan’s benefit formula.

Delay of Payments – Exceptions to 409A’s General Distribution Rules

Distribution of amounts payable under a plan generally cannot be delayed or they will result in a violation of Code Section 409A because such delays will be deemed to provide for an impermissible additional deferral of compensation. The Final Regulations provide employers greater flexibility to delay payments that are otherwise due under the terms of the plan without triggering a Code Section 409A violation. Although these delay provisions are not required to be explicitly provided for in the plan document, employers should consider whether inclusion makes good practical sense from an operational perspective.

Permissible Delayed Payments

The following are circumstances under which employers may delay payments to workers, beyond a specified payment date of amounts deferred under a plan, without triggering a Code Section 409A violation:

Compensation Deduction Limits. If an employer reasonably anticipates that the payments would reduce or eliminate its deduction for compensation to the worker because of the compensation limits imposed on certain executives of publicly traded companies (162(m)), the payment can be delayed (to the extent of such reduction or elimination) until the earliest of (1) the worker’s first taxable year in which the employer reasonably anticipates (or should anticipate) that the payment will not be so limited and the employer’s compensation deduction will no longer be reduced or eliminated; or (2) the period beginning with the date on which the worker separates from service and ending on the later of the end of the employer’s tax year in which the separation occurs or the 15th day of the third month following the separation. Any payments delayed until the separation date will be subjected to the general distribution rules under Code Section 409A, so that any “specified employee” may have to wait six months for his or her distribution.

Federal Securities Laws, Other Federal Statutes or Other Agreements. A payment may be delayed if an employer reasonably anticipates that the payment would violate federal securities or other applicable laws, as long as the payment is made at the earliest date on which the employer reasonably anticipates the payment will not cause a violation. This does not include payments that would result in income inclusion or application of a penalty tax under the Code.

Going Concern. NEW—If at the time of the payment date the payment would jeopardize the ability of the employer to continue as a “going concern,” the employer may delay making the payment until the worker’s first taxable year in which the payment would not jeopardize the employer’s ability to continue as a going concern. The Proposed Regulations had specifically provided that a payment could be delayed if the payment would result in a violation of a loan covenant or other contractual obligation. While this specific delay of payment provision was not adopted by the Final Regulations, the ability to delay a payment if it jeopardizes the ability of the employer to continue as a “going concern” arguably encompasses such instances.

Disputed Payments or Refusal to Pay. A worker will not be assessed a penalty for having violated Code Section 409A if the employer intentionally or unintentionally refuses to pay all or a part of the amounts owed to the worker under a plan. The worker must not have implicitly consented to the delay and he or she must make reasonable, good faith efforts to collect the amounts, including providing the employer with a notice that the amounts are due no later than 90 days after the payment could have been timely made, and taking further enforcement measures at least 180 days after the latest payment is due.

Action Needed

All plans, programs, arrangements, and agreements that have a compensation component should be inventoried now to determine whether such plans, programs, arrangements, and agreements provide for a deferral of compensation and to assess the effect of Code Section 409A. All deferred compensation arrangements must be amended to comply with Code Section 409A no later than December 31, 2007.