United States: The Importance Of Fixing Section 409A Compliance Failures Sooner Rather Than Later

A recent Memorandum issued by the Office of Chief Counsel within the Internal Revenue Service demonstrates yet again the perils of failing to comply with Section 409A of the Internal Revenue Code.1 The Memorandum takes the position that Section 409A penalties may apply even when a non-complying provision in a deferred compensation arrangement is corrected before the amounts subject to deferral become substantially vested.


A company entered into a retention agreement with one of its executives. The agreement provided for the executive to vest in his right to a retention bonus if he remained continuously employed until the third anniversary of the execution date of the agreement. The bonus was to be paid in two equal installments on the first and second anniversaries of the vesting date.

As the Office of Chief Counsel acknowledged, if the agreement had stopped there, there would have been no Section 409A violation. Unfortunately for the company and the executive, the agreement also afforded the company discretion to pay the entire retention bonus in a lump sum on the first anniversary of the vesting date. Such discretion violated Section 409A's general prohibition on accelerating payment of deferred amounts.

During the third year following execution of the retention agreement, but before the vesting date, the company amended the agreement to remove its discretion to accelerate payment of the retention bonus. The Office of Chief Counsel was asked to advise whether, notwithstanding the amendment, the executive would be required to include the amount of the retention bonus as income under Section 409A during the year the amendment was made. The Chief Counsel advised that he would.

Analysis and Implications

The retention agreement at issue provided for a deferral of compensation subject to Section 409A, since the executive acquired a legally binding right to the retention bonus in one year (when the retention agreement was signed) but would not receive the bonus until a subsequent year, and the arrangement did not meet the requirements of any exception from treatment as deferred compensation under Section 409A. Nevertheless, an agreement that provides for a fixed payment schedule triggered by vesting of the right to the deferred amount generally will satisfy Section 409A's rules relating to time and form of payment. The agreement in question provided for an appropriate fixed payment schedule, but included, in violation of Section 409A, discretion for the company to accelerate payment. An amendment to the agreement to remove the discretion was intended to correct this formal Section 409A failure.

The Chief Counsel's view was that the correction was not made soon enough. Based on a narrow reading of the statute and proposed regulations relating to income inclusion under Section 409A2, the Chief Counsel concluded that if a Section 409A failure exists at any time during a taxable year, the taxpayer (here, the executive) is required to recognize income under Section 409A in the amount that remains deferred at the end of the taxable year, reduced by any amounts that remain subject to forfeiture at the end of the taxable year. Applying this principle, the Chief Counsel expressed the view that the full amount of the retention bonus would be included in the executive's income under Section 409A – and presumably would be subject not just to standard income tax but to the 20% additional tax imposed under Section 409A – during the third year following execution of the retention agreement.3

The result advocated by the Office of Chief Counsel seems harsh. The "failure" under consideration was purely formal. It had no effect on how the retention bonus was actually paid. The offending provision, moreover, was removed at a time when the executive's right remained subject to substantial risk of forfeiture, and more than a year before the first installment of the retention bonus was scheduled to be paid. While the Chief Counsel's position finds some support in the statutory and regulatory texts analyzed in the Memorandum, the Chief Counsel acknowledged that the situation under consideration was not explicitly addressed. It is difficult to perceive a convincing tax policy justification for subjecting the executive to early income recognition and a 20% penalty under these circumstances.

We note that if the failure had been corrected during the second year following execution of the agreement – that is, during the year before vesting – then the executive would have escaped adverse consequences Section 409A. While there would have been a Section 409A failure during the year, under the proposed regulations no amount would have been taken into income for that year, as the entire amount remained subject to forfeiture at the end of the year.

Correction Procedure

On January 5, 2010, the IRS issued Notice 2010-6, which enables taxpayers to correct certain failures of nonqualified deferred compensation plans in order to comply with the document requirements of Section 409A. Notice 2010-6 allows a plan sponsor to remove impermissible discretion to accelerate payment events from a plan, provided that the amendment is made before discretion to accelerate has been irrevocably exercised and before any payment has been made under the plan. Both conditions appear to have been satisfied in the situation considered in the Office of Chief Counsel Memorandum. Notice 2010-6 imposes additional general conditions for relief – including that the plan sponsor identify and correct any other nonqualified deferred compensation plan documents that contain a similar failure, that it attach a statement to its tax return for the year of correction and that it provide the service provider with a statement to be attached to its tax return for that year – but these conditions generally can be met without significant cost or burden to either the plan sponsor or the affected employees.

Interestingly, the Memorandum from the Office of Chief Counsel makes no reference to Notice 2010-6. One is left to speculate whether the company and the executive who entered into the retention agreement might have mooted the issue considered by the Office of Chief Counsel by following the correction procedure of Notice 2010-6. One can also question whether the potential availability of a correction procedure might have made the Office of Chief Counsel less willing than it otherwise might have been to issue a taxpayer favorable interpretation.


Memoranda from the Office of Chief Counsel may not be used or cited as precedent, and it remains to be seen how zealously individual IRS agents will pursue formal Section 409A violations that are corrected while deferred amounts remain unvested. The Memorandum nevertheless serves as a reminder that the documentation for arrangements that provide for a deferral of compensation subject to Section 409A need to be drafted with care, and that when mistakes are made, it is important to catch them, and correct them, as early as possible.


1 Internal Revenue Service Office of Chief Counsel Memorandum No. 201518013 (April 14, 2015).

2 Proposed Treas. Reg. 1.409A-4 (published in the Federal Register on December 8, 2008).

3 Amounts included in income under Section 409A are not required to be included in income at any other time. Under the position advocated by the Office of Chief Counsel in the Memorandum, this rule would effectively allow the company to accelerate payment of the retention bonus to the third year following execution of the agreement, as the bonus will already be includible in income for that year and subject both to income tax at the executive's marginal rate and to the 20% additional tax imposed under Section 409A.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.