The Internal Revenue Service (IRS) recently announced that it
has started a formal audit initiative to evaluate compliance with
the rules for nonqualified deferred compensation under Section 409A
of the U.S. Internal Revenue Code (Code). Section 409A of the Code
imposes specific requirements on the timing of deferral elections
and the designation of the time and form of payment of amounts
under nonqualified deferred compensation plans. Severe tax
penalties are imposed on the employee if the requirements are not
satisfied. Under the first phase of the initiative, the IRS will
audit up to 50 large companies selected from a group of employers
previously identified for an employment tax audit. Following the
first phase of the initiative, the IRS will determine its next
The limited-scope audit will focus on compliance in three key
areas: (i) initial deferral elections; (ii) subsequent deferral
elections; and (iii) distributions in accordance with one of the
permitted payment events, including the requirement that certain
distributions to "specified employees" of public
companies be delayed for six months. As part of the audit, the IRS
is likely to review plan documents, election forms, and evidence of
payments to ensure compliance with Section 409A of the Code.
In light of the IRS audit initiative, companies should take the
opportunity to self-audit their deferred compensation plans for
documentary and operational compliance with Section 409A of the
Code. The IRS has correction programs under which many operational
or documentary issues can be corrected prior to audit. It is
important to note that once the company or the employee is under
IRS audit on these issues, the correction programs may no longer be
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