Public companies should take steps to determine whether any amendments may be required to new and outstanding compensatory arrangements in light of Section 162(m) of the Internal Revenue Code and certain transition relief under Revenue Ruling 2008-13. All organizations should consider taking advantage of transition relief that may be available pursuant to the Section 409A correction program of Notice 2008-113. This update summarizes key highlights and offers practical guidance.

Amending Compensatory Arrangements by December 31, 2009 to Comply With Section 162(m) Performance-Based Compensation Limitations

Section 162(m) generally limits a publicly held company's ability to deduct applicable compensation with respect to any "covered employee" to the extent that the amount of the employee's compensation for the taxable year exceeds $1 million, subject to certain exceptions, including an exception for performance-based compensation.

Revenue Ruling 2008-13 reversed an important IRS ruling position under Section 162(m) and ruled that compensation will not qualify as performance-based compensation under Section 162(m) if a compensatory arrangement provides that the compensation will be paid, without regard to whether the applicable performance goal is attained, in the event of a covered employee's (i) involuntary termination without cause, (ii) termination for good reason, or (iii) retirement.

Transition relief under Revenue Ruling 2008-13 provides that the rulings therein will not apply to
(i) compensatory arrangements with a performance period (i.e., the service period to which the performance goal relates) beginning on or before January 1, 2009, or (ii) compensation paid pursuant to the terms of a contract as in effect (without regard to any future renewals or extensions, including renewals or extensions that occur automatically) on February 21, 2008. This generally means that for performance periods beginning on or after January 1, 2010, Revenue Ruling 2008-13 will apply and that governing documents must properly conform to the holdings therein in order to preserve a position that the exception for performance-based compensation under Section 162(m) applies.

For more information on Revenue Ruling 2008-13 and Section 162(m), see our March 21, 2008 update. For more information on identifying "covered employees" for purposes of Section 162(m), read our June 7, 2007 update.

Correcting Section 409A Operational Failures Under Notice 2008-113 and
2009 Transition Relief

Notice 2008-113 created a correction program that can reduce or even eliminate penalties upon prompt correction of operational failures (not document failures) of nonqualified deferred compensation arrangements subject to the requirements of Section 409A. Relief is most generous when failures are corrected in the same taxable year in which they occur and where the affected individual is treated as a "non-insider," and other relief is available only in the next or second tax year following the year in which the failure occurs. Other requirements also apply.

Notice 2008-113 also contains potentially helpful transition relief allowing correction of certain operational failures, described in Section V of Notice 2008-113, involving non-insiders for periods prior to 2008. The failures eligible for transition relief extend to the following operational failures:
(1) payments that should not have been made in a taxable year of the employee (or other service provider); (2) payments that should not have been made until later in the taxable year of the employee; and (3) amounts that should have been paid to the employee in a taxable year but were erroneously credited to the employee's plan account or otherwise treated as deferred compensation. If these failures are corrected under the transition relief provided by
Notice 2008-113, the employee's tax year ending in 2009 will be treated as the taxable year next following the taxable year in which the failure occurred. This relief generally expires on December 31, 2009.


Practical Tips

Start Now! Organizations Should Review Compensatory Arrangements Prior to December 31, 2009. Organizations should take steps to determine whether any amendments may be required to new and prior compensation plans, agreements and other arrangements in light of Section 409A compliance and Revenue Ruling 2008-13. Any operational failures under Section 409A should be corrected immediately to take advantage of the current correction program under Notice 2008-113 and its more generous relief for timely corrections. Public companies should identify all new and outstanding compensation plans, agreements and other arrangements involving their "covered employees" (within the meaning of Section 162(m)), with a particular focus on identifying whether these arrangements include termination of employment or retirement as a permitted payment event, and determine whether any amendments may be required in light of Revenue Ruling 2008-13.

Evaluate and Manage Section 409A Compliance. To the extent an employer has identified operational failures under Section 409A in 2009 or prior years, consideration should be given to correcting under Notice 2008-113 by the end of 2009 and taking full advantage of the transition relief available for certain operational failures this year. This is also an opportune time to consider internal control and responsibility for Section 409A reviews of applicable plans and agreements, including with respect to properly managing Section 409A requirements implicated by any new documents or amendments in the future.

Consider Amending Section 162(m) Arrangements. Public companies should consider amending the governing documents for their Section 162(m) arrangements in response to Revenue Ruling 2008-13. Public companies should also address their governance and public disclosure planning in connection with needs in response to any such amendments. Management should keep in mind all applicable shareholder approval and reporting and disclosure obligations, including for current and periodic reports (Forms 8-K, 10-Q and 10‑K) and in proxy statements.

You can read the full text of Notice 2008-113 and Revenue Ruling 2008-13 at the IRS Web site.

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.