IRS Releases Final 409A Deferred Compensation Regulations- Time For Action

The following is a guest blog based on an Employment Law Update issued in June 2007 by the law firm of Nexsen Pruet Adams Kleemeier (NPAK). NPAK is a multi-specialty law firm headquartered in Columbia, South Carolina, with more than 170 attorneys and offices in Charlotte and Greensboro, NC and in Columbia, Charleston, Greenville, Hilton Head and Myrtle Beach, SC. The firm offers significant advantages to clients in terms of outstanding individual lawyers, a depth of talent, and extensive experience in many areas. If you have any questions about this post, please contact Suzanne Guitar Odom, an attorney with NPAK.

IRS Releases Final 409A Deferred Compensation Regulations- Time for Action

On April 20, 2007, the IRS issued final regulations interpreting the nonqualified deferred compensation requirements of Internal Revenue Code Section 409A. The 400 pages of regulations take effect on January 1, 2008. Employers should begin to plan for compliance by year-end because all plans and arrangements subject to Section 409A must be in full documentary and operational compliance by December 31, 2007.

Section 409A became effective on January 1, 2005, ushering in a new set of rules for the taxation of nonqualified deferred compensation plans. The new rules generally apply to any plan, program, or arrangement that defers compensation from one tax year to another, except for a qualified employer retirement plan (such as 401(k) plans), or a bona fide vacation leave, sick leave, compensatory time, disability pay or death benefit plan.

Nonqualified deferred compensation arrangements covered by Section 409A include:

· Nonqualified executive retirement plans (such as elective deferrals, Supplemental Executive Retirement Plans, and excess benefit plans)
· Post-retirement reimbursement arrangements and similar benefits
· Certain severance pay plans
· Certain stock option and other equity-based incentive awards (such as stock appreciation rights, restricted stock units, and phantom units)
· Certain other incentive compensation plans
· Some types of split dollar life insurance arrangements

Among the other types of employment-related arrangements that usually contain employer commitments governed by Section 409A are:

· Employment agreements
· Letters or other correspondence offering terms of employment
· Consulting agreements
· Change-of-control agreements
· Annual bonus programs
· Tax gross-up provisions
· Indemnification provisions
· Commission programs

A prudent employer should identify and inventory all plans and arrangements subject to Section 409A. By year-end, employers will need to review each plan or arrangement to determine what documents need to be amended and what administrative practices should be changed to be in full compliance.

There are a number of issues to be considered along the way, such as:

· How to preserve pre-40A “grandfathered benefits”?
· Do director pay plans (or pay plans relating to other contractors) need to be amended?
· Does a plan or arrangement qualify for a regulatory exception?
· How required changes impact compliance with contractual obligations?
· Will contractual provisions in plans or arrangements affect the amendment process?
· How should changes be communicated to affected individuals?
· Will service provider agreements need to be amended?

If a nonqualified deferred compensation plan fails to comply with any of the new requirements, then compensation deferred under the plan will become includible in the participant’s gross income for the taxable year in which the failure occurs, and interest along with a 20 percent penalty tax will be imposed.

The compliance and amendment process will take thoughtful and thorough planning. Most plan amendments will require appropriate approvals by a Board of Directors or the Board’s Compensation Committee. Employers should develop an action plan and compliance timeline to be completed by year-end.