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- Last Call for 409A Amendments to Deferred Compensation Arrangements
Last Call for 409A Amendments to Deferred Compensation Arrangements
This is one last reminder for companies that have not yet amended their deferred compensation arrangements with employees and/or other service providers to comply with Internal Revenue Code Section 409A. The deadline for making such amendments is December 31, 2008, and there is no indication that the Internal Revenue Service will postpone the deadline as it did in the past.
As we have previously written,* Section 409A of the Internal Revenue Code imposes an additional income tax on taxpayers who receive deferred compensation under arrangements that do not conform to the election, distribution and other requirements of Section 409A. In broad strokes, the 409A principles are as follows:
- Elections to defer compensation must be made not later than the close of the year preceding the calendar year in which the compensation is earned. However, when a taxpayer first becomes eligible to participate in a deferred compensation arrangement, he or she may make an election to defer within 30 days of such eligibility.
- Distributions of deferred compensation may be made only on account of (i) the attainment of a date or time specified under the arrangement (or under a valid election under the arrangement), (ii) a change of control of the entity sponsoring the plan, or the taxpayer’s (iii) separation from service (or 6 months following a separation from service if the taxpayer is a “specified” employee), (iv) death, (v) disability or (vi) unforeseeable emergency. Each of the distribution events is defined in detail in the applicable regulations issued under 409A.
- The date of distribution of the deferred compensation, as established by the terms of the plan, may not be accelerated, subject to limited exceptions, such as domestic relations orders, plan termination, and the payment of employment taxes.
What’s at stake is the imposition of an additional 20% tax on the deferred compensation, in addition to the ordinary income tax on such compensation, both of which are imposed at vesting. Typically, the taxpayer receiving the deferred compensation is at risk if the plan fails to conform to the 409A requirements; however, some arrangements commit the sponsor to maintain the arrangements to avoid the application of 409A or pay the applicable taxes for the executive recipients.
The common types of arrangements covered by these rules include, but are not limited to, deferred compensation plans, supplemental executive pension plans, certain severance arrangements, stock option agreements that provide a discounted exercise price, restricted stock unit plans, as well as arrangements, such as employment agreements, that contain provisions for post-employment payments of compensation. Note, too, that the array of plans subject to 409A is not limited to arrangements with employees - director and service provider contracts are also covered.
Plans, agreements and arrangements have been required to be in operational conformity with 409A since 2005. Sponsors were given until the end of 2008 to be in documentary compliance. So-called “grandfathered plans,” that is, those under which the compensation was deferred prior to 2005, are not generally subject to 409A, unless the plan is materially modified. The Internal Revenue Service also offered limited transition relief for certain operational failures occurring before 2010 and is expected to make the relief program permanent. There is no relief for documentary failures and none is anticipated in the near future.
If you wish assistance with plan amendments, or advice whether a particular arrangement is covered by Section 409A, please contact us.
*See CL&M’s Client Advisories: New Tax Law Makes Significant Changes to Deferred Compensation Rules (October 29, 2004), Code Section 409A Compliance: What to Do Before Year End (October 1, 2007), and Code Section 409A: Limited Relief from Documentary Compliance this Year (November 5, 2007).
Questions regarding this advisory should be addressed to Patricia Matzye (212-238-8730, firstname.lastname@example.org), Howard J. Barnet (212-238-8608, email@example.com) or Dan Pittman (212-238-8854, firstname.lastname@example.org).
Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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