Section 409A Deadline LoomingSeptember 17, 2008
On October 22, 2007, in Notice 2007-86, the Internal Revenue Service extended the effective date of the final regulations of Section 409A of the Internal Revenue Code regarding deferred compensation from January 1, 2008 to January 1, 2009.
The IRS has informally indicated that it is highly unlikely that there will be any further extensions. Therefore, as of January 1, 2009, all Section 409A transition relief will expire and all plans or arrangements covered by Section 409A must be in compliance with the final regulations of Section 409A.
For an explanation of Section 409A, the requirements of the final regulations and the current transition relief, please see our prior updates from May 2007 and October 2007 at docs/409Ainfo.cfm.
What arrangements are potentially subject to Section 409A?
Section 409A covers "deferred compensation plans." The definition of "deferred compensation plans" is extremely broad and can include plans or arrangements of the following types:
• 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
What happens if a plan violates Section 409A of the Code?
A violation of Section 409A can accelerate the employee's inclusion of income and result in a 20% penalty tax for the employee 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 of the same employer, even if they comply with Section 409A.
Why should I focus on Section 409A now?
As of January 1, 2009, all deferred compensation plans must be compliant with the final regulations of Section 409A. In addition, to utilize the Section 409A transition relief discussed in Notice 2007-86, all deferred compensation plan amendments must be made by December 31, 2008.
What transition relief is still available?
The current transition relief provided for in Notice 2007-86 expires on December 31, 2008 and allows for the following:
Good Faith Compliance Standards Prior to January 1, 2009
For periods after December 31, 2007, and before January 1,2009, the "good faith compliance" standard will only be met if plans are operated under rules consistent with guidance found in Notice 2005-1 or the final regulations.
Payment Election Changes
Elections to change the time and form of payment of amounts not yet in pay status under nonqualified deferred compensation plans and arrangements can continue to be made until December 31, 2008. An election made in 2008 to change the time and form of payment may not affect amounts otherwise payable in 2008, nor can the election accelerate any payment into 2008.
"Linked" Payment Election Changes
Payment elections that have existed under nonqualified deferred compensation plans and arrangements since October 3, 2004 that are "linked" to qualified plans remain compliant with Section 409A through December 31, 2008. As of January 1, 2009, all payments under nonqualified deferred compensation plans and arrangements must be "de-linked" from qualified plans.
Discounted Stock Options or SARs
Discounted stock options or SARs that are subject to Section 409A must generally be modified to comply with the requirements of the final regulations by December 31, 2008. Discounted stock options or SARs are subject to Section 409A if they are granted, or vest (regardless of the date of grant), after December 31, 2004. The most common modifications are to change the discount exercise price to fair market value at the date of the grant, or to retain the discount exercise price, but substitute a fixed exercise date. If discount options or SARs that are subject to Section 409A are exercised before they are modified to comply, there is no way to avoid the penalty tax.
What should my company do now?
If you have not already, you, along with counsel, should confirm whether you have any plans or arrangements that may be subject to Section 409A. If you do, you should discuss with counsel what modifications, if any, are required to bring your plans into compliance with the final regulations and, where feasible, to take advantage of the current transition relief. Even though you may have previously reviewed and/or modified an arrangement in reliance on the proposed regulations or earlier guidance, we recommend that, if you have not already done so, all arrangements should be reviewed in light of the final regulations since all transition relief is scheduled to expire on December 31, 2008.
Given the volume of plans needing revisions, we cannot guarantee that we will be able to review your plans in a timely manner in advance of the rapidly approaching deadline of December 31, 2008, unless you speak with one of the G&K contacts set forth below or your regular contact at G&K regarding your plans prior to October 31, 2008.
IMPORTANT: All plans and arrangements must be reviewed and necessary modifications must be made prior to January 1, 2009.
Where can I obtain additional information about Section 409A?
Detailed information regarding Section 409A and the regulations and transition relief that has been issued since its enactment can be found on our website at docs/409Ainfo.cfm.
If you have any questions about Section 409A or require assistance, please contact Debra Koenig (email@example.com or 414-287-9476), Lecia Johnson (firstname.lastname@example.org or 414-287-9319), or Todd Cleary (email@example.com or 414-287-9433).
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The following is based on a summary of legal principles. It is not to be construed as legal advice. Individuals should consult with legal counsel before taking any action based on these principles to ensure their applicability in a given situation.