Section 409A Timeline:

2004 - Congress enacted Code Section 409A to curb perceived abuses by taxpayers in nonqualified deferred compensation programs.

2005 - 2008 - Treasury developed guidance for Section 409A nonqualified deferred compensation programs and required "good faith compliance" with the guidance available. Taxpayers were required to amend plan documents for technical compliance with Section 409A by December 31, 2008 in accordance with the final regulations.

2009 - Final regulations under Section 409A became effective as of January 1. Taxpayers who discover certain operational failures with respect to their deferred compensation arrangements may benefit from participation in the IRS's Voluntary Compliance Program to correct such errors.

Section 409A Voluntary Compliance Program
While 2008 was the final year to amend nonqualified deferred compensation plans and agreements for Section 409A compliance, the focus for companies in 2009 has been on ensuring "operational" (administrative) compliance with these amended plans. In particular, where inadvertent errors in plan administration have been discovered and are corrected, the IRS has provided for a limited number of opportunities for Section 409A relief.

Late in 2008, the IRS issued Notice 2008-113, offering a voluntary compliance program (the "Program") that gives taxpayers the opportunity to correct certain "operational failures" under Section 409A (generally, errors in plan administration with respect to plan payments and deferrals). While not overly generous to taxpayers, the Program does allow for a number of errors to be corrected depending on which year they are discovered. The Program's structure emphasizes the importance of a year to year analysis of nonqualified deferred compensation programs. Accordingly, the Program is more likely to benefit taxpayers if errors are found sooner rather than later. Therefore, prior to year-end, if you have not done so already, we strongly encourage you to perform a self-audit with respect to the plan administration of all nonqualified deferred compensation arrangements at your company that are subject to Section 409A.

When Does Section 409A Apply?
Examples of arrangements that may be subject to Section 409A include:

• Elective deferred compensation plans (e.g., salary and bonus deferral programs)
• Non-elective deferred compensation plans (e.g., SERPs)
• Employment and change in control agreements
• Salary continuation plans
• Section 457(f) arrangements (for non-profit organizations or governmental entities)
• Restricted stock units (RSUs) and phantom stock
• Discounted stock options
• Certain stock appreciation rights (SARs)
• Severance plans
• Certain bonus or incentive plans
• Certain split dollar insurance arrangements

As a reminder, a violation of Section 409A accelerates the participant's inclusion of all income deferred under the arrangement and results in a 20% penalty tax for the participant over and above the income tax owed, as well as interest on such amounts if the tax is not paid in the proper tax year. In addition, these consequences may apply not only to the offending plan or arrangement, but also to similar plans or arrangements subject to Section 409A to which the participant is a party, even if those arrangements comply with Section 409A. Further information regarding Section 409A and its requirements can be found in our prior updates.

What Corrections Procedures Are Available Under the Voluntary Compliance Program?
Generally, the following operational failures can be corrected under the Program:

• Early or late payments of deferred compenstaion that are corrected in the same calendar year or within the two calendar years following the failure;
• Improper deferrals (including a failure to defer) of compensation that are corrected in the same calendar year or within the two calendar years following the failure; and
• Corrections of certain stock rights in order to qualify for the exemption from Section 409A.

The Program provides broader relief available for errors which are corrected in the same calendar year of the failure, as opposed to errors which are corrected in one of the two calendar years following the year of the failure. The Program does not provide for relief with respect to "insiders" (i.e., officers, directors, and certain beneficial owners, as determined in accordance with certain securities laws) unless the error is corrected in the same year as the failure. In addition, there is enhanced relief available under the Program where the error involves only limited amounts (for 2009, $16,500 or less). In some cases, where a failure is due to a company making an inadvertent acceleration of a payment, participation in the Program may require the participant to return the accelerated payments to the company for a period of time.

Once a company discovers a Section 409A operational failure that can be corrected, it is important to determine whether the company is eligible to participate in the Program. First, the operational failure must have been inadvertent and unintentional. Second, if the error relates to an erroneous payment, the company must not have been experiencing a "significant financial downturn" during the year in which the erroneous payment was made (on the theory that such downturn is indicative of a significant risk that the company would not be able to the pay the amount when it otherwise would become due). Third, the company must take steps to avoid any reoccurrence of the failure. In addition, certain notifications must be made to the IRS, including attaching a statement containing specific information regarding the failure and the correction to the company's tax return and in some cases, to the participant's tax return. Finally, there are specific reporting requirements under the Program with respect to the affected employee's W-2.

What Is the Benefit Of Using the Voluntary Compliance Program?
While the Program rarely eliminates the 20% penalty tax and interest on the affected amount of deferred compensation, the Program is most valuable where it can be used to remove the "Section 409A taint" that would otherwise apply to the remaining portion of deferred compensation payable to the participant under the arrangement in later years. For example, if an employer inadvertently accelerated a payment to an employee for $100,000 of deferred compensation in 2009 out of a total balance of $500,000 owed to the same employee under that arrangement or any similar arrangement, the Program would generally require that the 20% penalty be paid on the $100,000 distributed too soon, but would allow the remaining $400,000 to avoid immediate taxation in the year of the violation (2009), as well as the 20% penalty otherwise owed on that $400,000. Also, participating in the Program will be helpful to companies in removing any applicable withholding and/or reporting liabilities that might otherwise arise in connection with a Section 409A violation. For instance, in the above example, absent participation in the Program, as a result of the erroneous payment, the company would be required to withhold income and employment taxes on the full $500,000 in 2009.

Note on Voluntary Compliance with Respect to Section 409A Documentary Failures:
The Program discussed above is only available to correct certain operational failures that occur during the administration of a plan or arrangement. To date, the IRS has not offered any type of program to cure inadvertent "documentary" errors in Section 409A plans or arrangements (i.e., having a provision in a written plan that does not comply with the timing requirements of Section 409A). However, on an informal basis, the IRS has recently indicated that it may unveil such a program as early as this month. We will separately provide information on any such program as soon as it is available.

Next Steps
If you have not done so already, a self-audit should be done prior to year-end on all nonqualified deferred compensation arrangements at your company that are subject to Section 409A to discover whether any administrative errors were made with respect to distributions or deferrals.

To see if you can take advantage of the voluntary compliance program or if you have any questions about Section 409A in general, please contact Lecia Johnson, Debra Koenig or Sven Skillrud at 414-273-3500.