At the start of this year, the IRS issued Notice 2010-6, which provides methods for employers to correct documentary failures under section 409A of the Internal Revenue Code. The Notice provides additional transition relief for this year which allows an employer to correct certain documentary failures without penalty under section 409A. Because this relief is available, employers should review or have reviewed for them their severance, change-in-control (or CIC), executive health care and employment agreements, and nonqualified plans that are subject to section 409A (“section 409A arrangements”).
Brief Overview of Notice 2010-6
Notice 2010-6, 2010-3 I.R.B. 275 (Jan. 19, 2010), allows employers to correct a number of documentary failures under section 409A arrangements. These include:
- Correction of impermissible definitions of otherwise permissible payment events, including:
- Impermissible definition of separation from service
- Impermissible definition of change-in-control event
- Impermissible definition of disability
- Correction of impermissible payment periods following a permissible payment event, including:
- Impermissible payment periods of longer than 90 days following an event
- Impermissible conditioning of severance payments upon signing a release
- Correction of impermissible payment events and payment schedules, including:
- Impermissible payment events
- Impermissible alternative payment schedules
- Impermissible discretion following a payment event
- Impermissible discretion to accelerate payment
- Impermissible reimbursement or in-kind benefits
- Correction for failure to include a six-month delay for specified employees
- Correction for provisions on impermissible initial deferral elections
In addition to providing guidance on correcting these document failures, the Notice also provides guidance and cause for concern. For example:
- Termination of employment. The Notice indicates that the phrase “termination of employment” may violate section 409A if it leads to payments in situations not permitted under section 409A (for example, where an employee reduces their hours or is re-hired as an independent contractor providing significant services after termination of employment). Note that not all terminations of employment are a separation from service for purposes of section 409A. It is possible to have a separation from service that is not a termination (or a termination that is not a separation from service). Only a separation from service is an acceptable payment trigger under section 409A. Prior to the Notice, the IRS had informally indicated that the term “termination” was acceptable in agreements. Now employers should review agreements to see if it needs to be clarified. See Notice 2010-6, Section IV.B.
- Severance payment timing. The Notice states that severance payments contingent on a release of claims or the end of a rescission period may violate section 409A (if the compensation to be paid is subject to section 409A). See Notice 2010-6, Section VI.B.
The correction of a document failure requires several steps, including amending the section 409A arrangement, attaching a statement regarding the correction to the employer’s federal income tax return, and providing a statement regarding the correction to affected participants who are to attach it to their federal income tax returns. In addition, to be effective an employer must correct the failure in all of its section 409A arrangements that have a similar failure. Thus, although the Notice provides relief, there are burdens on employers and affected participants.
Transition Relief Available in 2010
The Notice provides that if a document failure is corrected by December 31, 2010, then the document is deemed to have been corrected as of January 1, 2009, the date on which plan documents were to be in a form that complied with section 409A. If a payment has been made that would not have occurred under the corrected document, then that payment is to be corrected using the operational failure guidance found in Notice 2008-113 by December 31, 2010.
There is also transition relief for linked plans that extends through December 31, 2011. The Notice requires that the linked plans must have identical time and form of payment. This transitional relief is important because it is not available once the transition period expires on December 31, 2011.
Employers should consider having severance, CIC, executive health care and employment agreements, nonqualified deferred compensation plans, restricted stock unit and other arrangements subject to section 409A reviewed again before the end of 2010 for potential documentary failures. Although the Notice allow correction in subsequent years, the transition relief available in 2010 offers a chance to correct a number of such failures on a penalty-free basis.