Deferred Compensation Payments Tied To a Release

There is a potential Section 409A deadline this year that applies to certain arrangements that condition the payment of deferred compensation on the employee signing a release.

The Issue

If an employee terminates employment near the end of a calendar year, the IRS is concerned that the employee can manipulate the timing of when the severance benefits will be paid based upon when the employee signs the release. Under IRS guidelines, employers have until December 31, 2012 to revise any noncompliant provisions relating to severance benefits and releases.

The Correction

The IRS provides two alternative correction methods. The arrangement can be amended to provide for one of the following:

  • Payment will be made on a fixed date, such as the 60th day after the employee terminates employment, or
  • If the period to sign the release spans two calendar years, the severance benefit will be paid during the second calendar year.

Both of these accomplish the goal of ensuring that the delivery of the release does not affect the timing of payment.

Many Severance Pay Arrangements are Exempt

These requirements only apply to arrangements that are subject to Section 409A where no exception is applicable. Many, if not most, severance arrangements will be exempt. There is no need to amend arrangements that are exempt from Section 409A under either the “short-term deferral” exception, where the deferred compensation is paid shortly after it becomes payable, or the “severance pay” exception, where the amount and timing of the severance payments meet the limits set forth in Section 409A.

Action Steps

You should review any plan or agreement that provides severance pay coupled with a release to determine whether an amendment is necessary before the end of 2012. Any required amendment is likely to be short and simple. We are glad to assist with the document review and amendment preparation.