Immediate Action Required for
Section 409A Compliance
All "nonqualified deferred compensation
plans" subject to Section 409A of the Internal Revenue Code must comply with
new rules by December 31, 2008. Any
failure to do so will expose executives, employees and others (including
directors and other independent contractors) who are the intended beneficiaries
of these arrangements to accelerated income tax, interest charges and a 20
percent excise tax.
The first step is the identification of subject "plans," which is defined to include contracts with individual
"service
providers" (that is, employees and certain independent contractors).
Any existing employment agreement or consulting agreement, bonus
arrangement or policy, equity incentive plan, excess benefit or supplemental
retirement plan (SERP), employment termination arrangement, and severance plan
as well as any conventional deferred compensation plan or agreement should be
reviewed to determine whether it is subject to Section 409A.
If any such arrangement grants a service provider a legally binding right
to compensation that is not currently received but is payable in a later taxable
year, the arrangement will have to comply with Section 409A or establish an
exception to Section 409A compliance. Exceptions
from Section 409A compliance cover:
-
qualified
retirement plans,
-
Section
403(b) tax-deferred annuities,
-
Section
457(b) eligible deferred compensation plans,
-
SEPs
and SIMPLE individual retirement accounts,
-
tax-exempt
welfare benefits such as group medical plans,
-
stock
options that have an exercise price that is not less than fair market value
on the date of grant,
-
severance
pay provided in the event of an involuntary separation from service under a
collective bargaining agreement,
-
severance
benefits payable only on an involuntary separation from service that meet
the "separation pay" exemption (benefits limited to twice the
employee’s annual rate of pay or twice the annual compensation limit for
qualified retirement plans, currently $230,000, whichever is less) or the
short-term deferral exemption (benefits expressly required to be paid within
two and one-half months of the close of the year in which the benefits
vest).
Even if an exception to Section 409A is
available, language changes may be appropriate to reflect specific Section 409A
terminology. For example, the
Section 409A regulations provide very specific definitions for terms such as "involuntary separation from service,"
"separation from service," "termination of employment," termination for "good reason,"
"change in
control," and "disability." These
terms are important for Section 409A compliance, which permits the payment of
benefits under subject arrangements only
upon death, disability, separation from service, change in control,
unforeseeable emergency or a payment date or schedule of payments that is fixed
in advance. Also note that Section
409A definitions will apply to establish the availability of certain Section
409A exemptions, such as the separation pay and short-term deferral exemptions
referred to above.
Section 409A also imposes restrictions on plans
which allow participants to make elections to defer a portion of their
compensation, a six-month delay on payment of benefits to specified employees of
public companies, and limits on the acceleration and postponement of the payment
of benefits (see "New Deferred Compensation Rules" at www.benefitslawgroupofchicago.com/HTML/new-deferred-compensation-rules-2005.htm
for details.
Remember, document compliance is required under
Section 409A (including any subject arrangements that have not yet been reduced
to writing, such as informal severance pay policies) by December 31, 2008.
General amendments that simply recite that the subject arrangement is to
be interpreted in accordance with Section 409A will not
be recognized by the IRS as a valid approach for document compliance.
Also bear in mind that retroactive amendments are not permitted.
The December 31, 2008 deadline will apply with only limited exceptions
available under an Internal Revenue Service correction procedure that has not
yet been fleshed out with definitive regulations.
Andrew S. Williams
Aronberg Goldgehn Davis & Garmisa
One IBM Plaza, Suite 3000
Chicago, Illinois 60611
312/755-3145
awilliams@agdglaw.com
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