On January 5, 2010, the Internal Revenue Service (“IRS”) issued Notice 2010-6 (the “Notice”), which establishes a document corrections program under Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”).The Notice provides important and timely guidance on correcting Section 409A documentary failures of nonqualified deferred compensation plans and arrangements.
A nonqualified deferred compensation plan or arrangement must comply with the requirements of Section 409A both in form and in operation. Many employers do not realize that Section 409A generally applies to (with some specific exceptions) any plan or arrangement that defers the receipt of compensation from one tax year to another. As a reminder, the following plans and arrangements are generally subject to Section 409A’s requirements: (1) severance, (2) termination provisions, (3) signing and annual bonuses, (4) long-term incentives, (5) some equity incentives, (6) reimbursements, (7) tax gross-ups, (8) post-employment extended welfare benefits, (9) consulting arrangements, (10) director compensation, (11) earn outs, and (12) transactional-based payments.
Generally, failure to comply with Section 409A’s requirements results in accelerated taxation of the amounts deferred under the nonqualified deferred compensation plan and excise and other tax penalties on the service provider (i.e., the employee or independent contractor), as well as withholding and reporting requirements on the service recipient (i.e., the employer). The IRS, in Notice 2008-113, previously provided relief and guidance permitting the correction of some operational compliance failures. Documentation of existing arrangements, however, had to have been completed by the end of 2008. During 2009, many plans and arrangements subject to Section 409A were found to be noncompliant with some, or all, of the documentary requirements. However, until now, there was no fix.
The stated purpose of this new IRS relief is to provide a manner in which employers can voluntarily correct certain documentary compliance failures and thus avoid, or reduce, current income inclusion and additional taxes. Specifically, the Notice permits employers to correct certain Section 409A documentary failures if such failures are corrected by December 31, 2010 (and, if any operational failures resulting from the documentary failure are also corrected). Relief, however, is not available if: (1) the employer’s or the employee’s federal tax return is under examination, (2) the failure is intentional, or (3) the failure is related to an IRS listed transaction.
We recommend that employers review their nonqualified deferred compensation plans now to identify and correct provisions that fail to comply with Section 409A’s requirements.
For more information, contact your SGR Executive Compensation and Employee Benefits counsel.