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Announcement

Significant Transition Relief Provided for Section 409A

October 31, 2007

Introduction

On October 22, 2007, the Internal Revenue Service responded to complaints by taxpayers and their representatives that the timetable to comply with the voluminous final regulations under Section 409A of the Internal Revenue Code was unreasonable. In Notice 2007-86, the IRS extended the effective date of the final regulations from January 1, 2008 to January 1, 2009. It is unlikely that there will be any further extensions.

The relief in Notice 2007-86 is significant in that it continues to allow "good faith" compliance with Section 409A until December 31, 2008, rather than requiring full adherence to the final regulations by December 31, 2007. However, in order to meet this standard, a company must be cognizant of the requirements of Section 409A and how they affect its compensation plans, agreements and other arrangements. Therefore, we continue to recommend that companies review these with counsel in a timely manner so that irrevocable actions are not taken that could subject employees and certain independent contractors to accelerated taxation and a 20% penalty tax.

For an explanation of Section 409A and the requirements of the final regulations, please see our prior updates from May 2007 at docs/409Ainfo.cfm.

What does this extended transition relief under Notice 2007-86 mean?

Deadline for Plan Amendments

• Compliance with the final regulations issued in April 2007 is not required prior to January 1, 2009. All necessary amendments to nonqualified deferred compensation plans MUST be made by December 31, 2008.

Good Faith Compliance Standards Prior to January 1, 2009

• The "good faith compliance" standard, under which Section 409A plans must be operated prior to January 1, 2009, has been modified. For periods prior to January 1, 2008, the "good faith compliance" standard will be met if plans are operated under rules consistent with guidance found in Notice 2005-1, the proposed regulations or the final regulations. 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. Generally, compliance with the proposed regulations will not be sufficient after December 31, 2007.

Payment Election Changes- Transition Rules Extended

• Elections to change the time and form of payment of amounts under nonqualified deferred compensation plans and arrangements can continue to be made until December 31, 2008. Consistent with past transition guidance, an election made in either 2007 or 2008 to change the time and form of payment may not affect amounts otherwise payable in the year of the election, nor can the election accelerate any payment into the year of election.

PLANNING POINT: Any changes to the time and form of payments that would otherwise be payable in 2008 or that are intended to cause amounts to be payable in 2008 must be made by December 31, 2007.

"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 are my 2007 reporting obligations under Notice 2007-89?

On October 23, 2007, the IRS released Notice 2007-89, which addresses reporting and wage withholding issues under Section 409A for calendar year 2007.

2007 Annual Deferrals

• For calendar year 2007, your company is not required to report any amounts deferred under a nonqualified deferred compensation plan or arrangement in box 12 of Form W-2.

2007 Reporting and Withholding on Amounts Includible as Income Under Section 409A

• If a nonqualified deferred compensation plan or arrangement fails to meet the requirements under Section 409A, all previously deferred compensation for the current taxable year and all preceding taxable years that is not subject to a substantial risk of forfeiture is includible in gross income and is classified as "wages" for withholding purposes. Your company must report such amounts in box 12 of Form W-2 using "Code Z." Notice 2007-89 has clarified that withholding will not be necessary for the amount of the 409A penalty tax (20% and interest, where applicable), but is only required for regular income and employment taxes on the amount.

PLANNING POINT: Notice 2007-89 contains specific rules as to how to calculate the amounts includible in gross income under Section 409A and when employees are subject to wage withholding. Therefore, if your company will need to report Section 409A amounts in an employee's gross income, you should contact counsel as soon as possible.

What should my company do now?

You, along with counsel, should continue to determine if 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. Even though you may have previously reviewed and/or modified an arrangement in reliance on earlier guidance, we recommend that all arrangements be reviewed in light of the final regulations.

Where can I obtain additional information about Section 409A?

Detailed information regarding Section 409A and the regulations that have been issued since its enactment (both proposed and final) 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 (dkoenig@gklaw.com or (414) 287- 9476), Lecia Johnson (ljohnson@gklaw.com or (414) 287-9319), or another Godfrey & Kahn attorney.

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Milwaukee: Todd M. Cleary (tcleary@gklaw.com), John E. Donahue (jdonahue@gklaw.com), Lecia D. Johnson (ljohnson@gklaw.com), Debra Sadow Koenig (dkoenig@gklaw.com), Sarah E. McNally (smcnally@gklaw.com), Douglas J. Patch (dpatch@gklaw.com), James N. Phillips (jphillips@gklaw.com)

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.

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