Deferred Compensation 409A Compliance Deadline is December 31, 2008

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The Internal Revenue Service has given until December 31, 2008, for all covered deferred compensation plans to come into written  compliance with the IRS Section 409A regulations. Noncompliance with Section 409A by this deadline will result in severe tax  consequences for the employee or other service provider, including a 20% tax penalty and full taxation of the deferred amounts on the date of deferral. This alert reminds employers and other service recipients of the upcoming deadline, explains the general background of Section   409A and  outlines what steps should be taken now to comply.

What is Section 409 A?

In general, Section 409A provides that “non-qualified” deferred compensation is currently includable in taxable income if it is not subject to a substantial risk of forfeiture unless the arrangement  complies with the operational and documentary requirements of Section 409A. In April 2007, the IRS issued its final regulations on Section 409A. The IRS, through Notice 2007-86, extended the deadline to December 31, 2008, to bring plans fully into compliance.

In order for existing covered deferred compensation arrangements to  comply, there must be a legally binding written plan that meets all the  rules and requirements of 409A. In most cases, this means that an   amendment or restatement will be required. Unwritten arrangements will be required to be documented.

The definition of covered deferred compensation under 409A is expansive. It can include arrangements that cover only one person, or those that cover a group and includes:

1) Discounted stock options
2) Discounted stock appreciation rights
3) Salary continuation arrangements
4) Supplemental executive retirement plans
5) Employment agreements or offer letters providing for deferral of  compensation
6) Phantom stock arrangements
7) Other forms of equity-based compensation
8) Separation pay plans
9) Change in control agreements
10) Multiyear bonus plans or other incentive plans providing for deferred payment

What You Should Do.

Employers and other service recipients should review all their compensation arrangements (written and unwritten) to identify which ones may be subject to 409A. Action steps need to be outlined to bring the arrangement into compliance by the end of this year, so that  unwritten plans are documented and written plans are compliant with the Section 409A rules and regulations. Failure to correctly identify covered plans or take corrective measures subjects the employee or other service provider to having the deferred income immediately includable in their taxable income and triggers the 20 % penalty. In addition to requiring documentary compliance for all covered plans, additional transition relief rules pertaining to specified arrangements must also be completed by December 31, 2008. The transition relief rules include:

  • New payment elections regarding the time and form of payment. With respect to amounts subject to 409A, a plan may provide or be amended to provide for new payment elections on or before December 31, 2008, and will not be treated as a change or an acceleration of a payment in violation of 409A, provided the plan is amended and the elections are made on or before December 31, 2008. However, an election or amendment to change a time and form of payment made in 2008 would only apply to delay or accelerate amounts not otherwise payable in 2008.
  • Substitution of non-discounted stock option and stock appreciation rights. Plans may be amended on or before December 31, 2008, to provide for replacement of discounted stock option or stock appreciation rights (“SAR”) otherwise providing for a deferral of compensation under 409A, with a stock option or SARs that would not have constituted a deferral of compensation under 409A  (non-discounted) if it had been granted upon the original date of grant of the replaced stock or SAR. Certain limitations apply, including that the cancellation and re-issuance does not result in the cancellation of a deferral in exchange for cash or vested property in the same year. The transition relief does not apply to discounted stock options subject to 409A held by individuals subject to Section 16(A) of the SEC Act of 1934 at the time of grant as the deadline to substitute those awards passed on December 31, 2006.
  • Modification of separation pay plans to comply with “Good Reason” Exception. Certain separation pay plans that provide for involuntary termination upon “good reason” by the employee or service provider may be exempt from 409A. The deadline to make modifications to comply with the exemption is December 31,2008.

For More Information.

This Alert is a general summary only. For more information contact your attorney at Karr Tuttle Campbell or the following attorneys:

Medora A. Marisseau
Email: moc.elttutrraknull@uaessiramm
Telephone: (206) 224-8045
Tracy M. Miller
Email: moc.elttutrraknull@rellimt
Telephone: (206) 224-8097
 

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