Spring 2008
George L. Whitfield
Code Section 409A was enacted in late 2004 to bring an abrupt halt to actual and perceived abuses in delayed payment of compensation.
Motivated in part by the Enron debacle, it imposes strict requirements on the deferral and ultimate payment of "deferred compensation," a term that is very broadly defined in the law.
Compliance in the operation of plans and agreements has been required from the initial effective date, January 1, 2005. After a series of extensions, however, the 2008 calendar year is the final deadline for documentary compliance and for taking advantage of certain transition opportunities that expire at the end of the year.
Under the transition rules, the time and form of payment of any type of deferred compensation generally can be changed to be earlier or later than currently provided. At the stroke of midnight on December 31, 2008, however, the time and form of payment specified in the plan, employment agreement, severance arrangement, bonus program or other documentation will become frozen and difficult or impossible to change. Once fully effective, Section 409A, with some exceptions, prohibits any acceleration of the time of payment and any delay of the time of payment unless elected at least a year in advance and delaying payment for five years or more. These rules also impact any change in the form of payment.
Following a series of notices and the issuance of proposed regulations in late 2005, final regulations were published in April 2007, to be effective at the beginning of 2008. Based on the complexity of the final guidance and the potential consequences of any compliance failure under Section 409A, there was an outcry for an extension of the compliance deadline and transition rules beyond the end of 2007. After a September misstep labeled by one publication as "half a loaf" and another as "the relief that isn’t," the IRS announced, on October 22, an extension of the documentary compliance deadline and transition rules to the end of 2008. There will be no further extension. And, following the early December publication of extremely limited correction opportunities, no more compliance guidance will be provided.
ACTION NOW REQUIRED
It is difficult and time consuming to analyze the impact of Section 409A on arrangements such as supplemental executive retirement plans (SERPs), employment agreements, severance arrangements, stock option plans, and many other programs that may include some deferral of compensation. If you haven’t already done so, now is the time to give Section 409A compliance your complete attention.
If you have questions about Section 409A or need help with a compliance review, please contact me by e-mail at gwhitfield@wnj.com or by phone (616) 752-2102, or contact any other member of our Section 409A Task Force.
CORRECTION PROGRAM
The very limited correction program announced by the IRS on December 3, 2007, allows correction of unintentional operational failures (e.g., deferral of the wrong amount or deferral for the wrong person). The program does not allow correction of document failures. Full relief from Section 409A is available for correction within the same taxable year. Correction is also allowed (but with only partial relief) for unintentional operational failures occurring before the end of 2010, even if not made in the same year, if they involve only relatively small amounts. In addition to the permitted correction, the employer must take commercially reasonably steps to prevent a recurrence of the compliance failure and must comply with other requirements such as reporting the correction to the IRS.
Corrections that are permitted within the same taxable year include erroneous payment of an amount that should have been deferred or continued in deferral during the year, deferral or continued deferral of an amount that should have been paid, payment of an amount to a specified employee of a public company that should have been delayed for six months, and grant of a stock option or other stock right with an exercise price below fair market value on the grant date.
Failures that occur prior to the end of 2010 may be corrected by the end of the second taxable year following the year of the failure, if the amount involved does not exceed a dollar amount tied to the limit on pre-tax elective contributions ($15,500 for 2007 and 2008, $15,000 for 2006 and $14,000 for 2005). For failures that are not corrected in the same year, the taxpayer will be required to pay the additional 20 percent income tax imposed by Section 409A but not the additional interest penalty otherwise applicable.
The correction guidance ends with a request for comments on the possibility of an expanded correction program for the future that would be similar to the current program but would apply beyond 2010 and would allow correction of failures involving larger monetary amounts. At a recent conference, an IRS attorney closely involved with development of the Section 409A regulations commented that he does not expect that there will ever be a comprehensive correction program under Section 409A comparable to that available for qualified retirement plan compliance failures.
THE TIME IS NOW
Neither the current nor any anticipated future correction program under Section 409A will allow correction of documentary failures. Therefore, as we have advocated in prior newsletters and alerts and other communications, if you have not previously done so, now is the time to contact us concerning Section 409A compliance. We will be pleased to work with you to review your arrangements that may be subject to Section 409A and to provide guidance on compliance steps that may be needed.
