September 29, 2010

Section 409A Correction Program - Action Required Before Year End

In January 2010, the Internal Revenue Service (the “IRS”) issued Notice 2010-6 (the “Notice”), which allows taxpayers to correct plan documents of non-qualified deferred compensation arrangements that do not strictly comply with the requirements of Section 409A of the Internal Revenue Code, as amended, (the “Code”).  If the necessary amendments are adopted in 2010, employees covered under the non-qualified deferred compensation arrangements would be able to avoid Section 409A tax penalties, including acceleration of income recognition, an additional 20% federal tax and interest penalties. 

In light of the correction procedures provided under the Notice, all employers should undertake a review of their non-qualified deferred compensation arrangements and employment agreements now.  This should be done even if these arrangements had been updated for compliance with Section 409A in 2008.  In the Notice, the IRS for the first time took an official position that certain common language in employment agreements, such as conditioning severance on the execution of a release, may constitute a violation of Section 409A unless the agreement provides for payments to commence at a fixed date that is unaffected by the timing of the execution of the release. 

Under the Notice, employers may voluntarily amend their non-qualified deferred compensation plan documents to correct non-compliance with Section 409A including:

  • Payment events that are dependent on an employee completing certain actions (such as executing a release of claims)
  • Problematic definitions of plan terms that do not meet the definitional requirements of Section 409A
  • Plans which allow for payments to be made more than 90 days after a permissible payment event
  • Impermissible payment events (such as an initial public offering that does not constitute a change in control as defined in Section 409A)
  • Impermissible employer or employee discretion to set payment schedules or accelerate payment events
  • Failure to include a six-month delay of payments to specified employees of public companies

The Notice generally allows employers to correct such problems by amending non-complaint plan documents by December 31, 2010 without the covered employees incurring any Section 409A penalties, subject to certain conditions set forth in the Notice, including additional tax reporting by both the employers and the covered employees.  Amendments may be adopted after December 31, 2010, but in that instance the covered employees cannot fully avoid these penalties.  It is important to note that in many cases, the relief provided under the Notice is limited to documentation non-compliance and certain penalties will continue to apply to operational non-compliance, even if amendments to plan documents are made before year end. 

We recommend that our clients undertake a review of their non-qualified deferred compensation arrangements and employment agreements now, in light of the December 31, 2010 expiration date of the transition relief under the Notice.  If you would like us to assist in your review of your compensation arrangements or have questions regarding this Notice, please contact Scott Webster or Lynda Galligan, or your regular Goodwin Procter attorney.