United States: IRS Extends Section 409A Transition Relief To December 31, 2008

On October 22, 2007, the Internal Revenue Service ("IRS") issued Notice 2007-86, which extends to December 31, 2008 the transition relief under Internal Revenue Code Section 409A ("Section 409A") that was scheduled to expire on December 31, 2007. The newly issued guidance revokes and supersedes the limited expansion of transitional relief recently issued by the IRS under Notice 2007-78. Notice 2007-86 fully extends operational compliance to December 31, 2008.

General Rule. During 2008, taxpayers continue to be required to operate a nonqualified deferred compensation plan in compliance with the plan's terms, to the extent consistent with Section 409A and the applicable IRS guidance. However, full compliance with the final regulations issued earlier this year is not required until January 1, 2009. To the extent an issue is not addressed in the IRS guidance, taxpayers must apply a reasonable, good faith interpretation of Section 409A. Reliance upon the final regulations is treated as applying a reasonable, good faith interpretation of Section 409A. However, taxpayers will not be able to demonstrate a reasonable good faith interpretation of Section 409A by relying on the proposed regulations for periods after December 31, 2007.

Amendment and Operation of Plans Adopted on or Before December 31, 2008. A plan adopted on or before December 31, 2008 (including plans amended to comply with the final regulations during 2007) will not be treated as violating Section 409A if the plan is operated through December 31, 2008 in compliance with the provisions of Section 409A and applicable provisions of Notice 2005-1 and any other generally applicable guidance published with an effective date prior to January 1, 2008 (except for reliance on the proposed regulations after December 31, 2007), and the plan is amended on or before December 31, 2008 to conform to the provisions of section 409A and the final regulations under section 409A.

Change in Payment Elections. With respect to amounts subject to Section 409A, a plan may provide, or be amended to provide, for new payment elections on or before December 31, 2008, with respect to both the time and form of payment. The election or amendment will not be treated as a change in the time or form of payment or an acceleration of a payment provided that the plan is so amended and elections are made on or before December 31, 2008. As is presently the case for elections or changes made in 2007, elections or changes made in 2008 cannot apply to amounts that would otherwise be payable in 2008 and may not cause an amount to be paid in 2008 that would not otherwise be payable in 2008.

Payments Linked to Qualified Plans. The ability to continue to have the time and form of payment under a qualified plan or a broad-based foreign plan dictate the time and form of payment under a related nonqualified deferred compensation plan has also been extended through 2008, provided that the determination of the time and form of the payment is made in accordance with the terms of the nonqualified deferred compensation plan that governs payment elections, as in effect on October 3, 2004.

Substitutions of Non-Discounted Stock Options and Stock Appreciation Rights ("SARs"). It will not be a material modification of the stock option or SAR to replace a stock option or SAR otherwise providing for a deferral of compensation under Section 409A with a stock option or SAR that would not have constituted a deferral of compensation under Section 409A if it has been granted upon the original date of grant of the replaced stock option or SAR, provided that the cancellation and reissuance occurs on or before December 31, 2008. Notice 2007-86 generally extends to December 31, 2008 the ability to cancel a discounted stock option or SAR and substitute a non-discounted stock option or SAR not subject to Section 409A.

Conclusion. Notice 2007-86 provides employers and service providers with another year to thoroughly consider how best to restructure and document their deferred compensation programs to comply with the final Section 409A regulations. This will allow employers and service providers time to analyze all of their plans and make informed and reasoned decisions regarding the changes that may be necessary to bring existing arrangements into compliance with Section 409A. This extension by the IRS will likely be the final such extension and, therefore, employers and service providers should be proactive and begin the Section 409A compliance process as soon as possible. As we have previously discussed in other Alerts, non-compliance with Section 409A creates the potential for significant tax liability on behalf of the individual taxpayers and employer sponsors of plans and/or programs subject to Section 409A.

On a related note, on October 23, 2007, the IRS also issued Notice 2007-89, which once again suspends employers' and payers' reporting requirements for calendar year 2007 with respect to deferrals of compensation within the meaning of Section 409A.

If you have a question about this Alert or would like more information, please contact group chair W. Michael Gradisek, John A. Reader, Jr., Lawrence I. Davidson, or the attorney in the firm with whom you are regularly in contact.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

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