The IRS recently issued final regulations interpreting the requirements imposed on nonqualified deferred compensation arrangements by Section 409A of the Internal Revenue Code. The final regulations are effective January 1, 2008. All nonqualified deferred compensation arrangements must be in written compliance with the final regulations by December 31, 2007.

All employers may be subject to Section 409A, including small businesses, public companies, private companies, non-profit entities, and governments and governmental units.

Common types of arrangements that may be subject to Section 409A include:

  • Traditional nonqualified deferred compensation plans
  • Phantom stock
  • Employment agreements
  • Restricted stock units
  • Offer letters
  • Performance units
  • Reimbursement arrangements
  • Change in control agreements
  • Severance arrangements
  • Split-dollar life insurance arrangements
  • Bonus/incentive plans
  • Supplemental executive retirement plans (SERPs)
  • Stock options
  • Excess benefit plans
  • Stock appreciation rights
  • Tax-gross up provisions
  • Equity incentive plans and award agreements
  • Section 457(f ) plans
  • Post-retirement benefits
  • Director deferred compensation arrangements

409A Recommended "To Do" List:

  1. Identify all arrangements, agreements, plans and policies that may constitute deferred compensation. In general, arrangements under which an employee or other service provider has a legally binding right during a taxable year to receive compensation that is (or may be) payable in a later taxable year may be subject to Section 409A.
  2. Do not overlook older arrangements. For example, an employment agreement entered into before January 1, 2005 and still in existence would need to be reviewed (particularly the severance provisions).

  3. Have legal counsel review each arrangement and, if necessary, amend the arrangement or, for an arrangement not in writing, prepare a written document to comply with Section 409A by December 31, 2007.
  4. If necessary, obtain approval from the board of directors or the compensation committee for new arrangements or amendments to existing arrangements. You may need to obtain approval from employees, officers, directors, or independent contractors to modify existing arrangements. In some cases, negotiations may be necessary.

  5. Communicate to employees, officers, directors, or independent contractors, as applicable, any changes in the terms of the arrangements that have been or need to be made.
  6. Have legal counsel review and revise employee communications, enrollment forms, election forms, etc. so that they comply with Section 409A and are consistent with the corresponding arrangement.
  7. Consider whether Securities and Exchange Commission ("SEC") reporting requirements apply to new or modified plans or agreements and make any necessary filings. If a plan is registered under a Form S-8 with the SEC, have legal counsel amend the plan prospectus, if necessary.

Penalties for Non-Compliance

The failure to comply with the applicable requirements of Section 409A can result in significant income tax consequences. Generally, vested deferred amounts of the employee or independent contractor will be immediately taxable and will be subject to an additional 20% tax, plus interest. The employer providing the deferred compensation could be subject to penalties if it fails to withhold taxes or report the income.

For an in-depth review of various provisions of Section 409A, click on the following link to view "409A: Redefining the Approach to Compensation," a seminar presented by the Powell Goldstein Employee Benefits and Executive Compensation Group.

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.