Sweeping Deferred Compensation Reform

Although Congress added Section 409A to the Internal Revenue Code over one year ago (new law which significantly changes the taxation and operation of “nonqualified” deferred compensation plans), the overwhelming majority of companies who offer deferred compensation plans are still not in compliance. This presents an immediate concern for employers and employees utilizing such plans because failing to comply with 409A may cause all previously deferred and vested compensation to become immediately taxable, in addition to triggering a 20% penalty.

Under Section 409A, compensation deferrals for services to be performed
in an upcoming taxable year, must generally be made prior to the end of
the current taxable year, subject to very limited exceptions apply. As far
as distributions go, Section 409A only permits deferred compensation plans
to make distributions upon separation from service, death, disability, a specified time (such as attaining a specific age) or pursuant to a fixed schedule, a change in control or an unforeseeable financial emergency. Moreover, employers and participants are prohibited from accelerating the time or schedule of any payment, again, subject to very limited circumstances.

The issues facing may employers and plan participants is that many existing plans permit employees to make or change their deferral elections at any time and/or allow distributions, acceleration of payments and hardship withdrawals contrary to Section 409A. If such plans are not amended prior to the end of this year, the Section 409A immediate tax and penalty provisions are triggered. What should employers do now? First, employers must identify all deferred compensation arrangements (including employment agreements and bonus plans, severance plans and change in control agreements) and review them for compliance with the provisions of Section 409A. Second, employers should not amend or modify existing plans without first consulting with their attorneys because certain modifications will cause the plan to automatically violate Section 409A.

This article is intended to only alert you to the impact of Section 409A and is by no means a comprehensive analysis nor does it constitute legal advice.

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