ERISA Update: Deadline for 409A Compliance Fast Approaching

July 10th, 2008

In October 2004, the American Jobs Creation Act enacted Section 409A of the Internal Revenue Code (Code).  This Code Section made significant changes to how nonqualified deferred compensation (NQDC) plans must be structured.  In October 2007, the IRS extended the deadline for 409A compliance to December 31, 2008.  Employers with NQDC plans must have their NQDC plans amended to be compliant in design, administration and operation by this date.

Section 409A defines NQDC plans very broadly.  According to the final regulations, “nonqualified deferred compensation plan means any plan … that provides for the deferral of compensation”.  This definition means that Section 409A potentially impacts any arrangement that provides an employee with an enforceable right in one tax year to compensation that is payable in a subsequent tax year.  Examples of plans that could be impacted include:

Bonus plans with deferred payments

  • Employment agreements
  • Supplemental Executive Retirement Plans (SERPs)
  • Incentive pay plans
  • Stock appreciation rights (SARs)/Discounted stock options
  • Phantom stock plans
  • Severance arrangements
  • Change-in-control agreements
  • Excess benefit plans

Section 409A provides numerous requirements for NQDC plans, including:

  • Plans must be in writing
  • Plans must set deadlines for election of deferrals
  • Plans must require that the time and form of payment be designated at the time of the deferral
  • Plans must restrict the ability to make changes to designated time and form of payment
  • Plans must define the permitted distribution events
  • Plans may not provide for the acceleration of payments

The cost for non-compliance with Section 409A can be very high.  NQDC plans that do not comply with Section 409A are subject to the immediate taxation of all vested amounts deferred, including earnings, for all years in all similar plans plus interest plus a 20% penalty tax.  Additionally, Section 409A does not provide any exceptions to this penalty calculation for de minimus violations.

Employers should audit all of their compensation arrangements to identify any written or unwritten agreements, arrangements or programs that may fall under the Section 409A definition of a NQDC plan and then review them with benefits counsel to determine whether any need to be amended to comply with Section 409A.  Please contact our office for additional information on Section 409A compliance.

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