As we first reported in the April 2007 issue of Benefits in Brief, a complicated set of final rules governing nonqualified deferred compensation arrangements under Code Section 409A becomes effective on January 1, 2008. This month the IRS delayed the effective date of one small piece of those rules. Employers now will have until January 1, 2009, to incorporate most of the new rules into their deferred compensation plan documents. Many other documents must be modified, however, and virtually all of the important decisions must be made, by the end of this year.
The final Section 409A regulations came on the heels of transitional relief granted by the IRS in each of the two preceding years. That relief was intended to ease the burden of complying with these complex new rules. Responding to renewed calls from practitioners for a delay in the looming compliance deadline, the IRS issued on September 10, 2007, another round of limited transitional relief, in the form of Notice 2007-78. Unlike prior transitional relief, however, Notice 2007-78 provides very little help to employers.
END OF YEAR DEADLINES STILL SIGNIFICANT
Even after the issuance of this relief, employers will have much to do before the end of 2007. For instance:
DOCUMENTARY COMPLIANCE DEADLINE DELAYED
- By December 31, employers must identify each plan or arrangement (including employment agreements) that may be subject to Section 409A;
- Employers must fully comply in operation with Section 409A beginning on January 1, 2008;
- By the end of 2007, employers must specify times and forms of distribution that comply with Section 409A;
- Employers that wish to take advantage of the special transitional relief that permits them to add or change distribution options and solicit new participant payment elections for existing deferrals must do so by the end of 2007;
- Nonqualified plans that “link” the time and form of distribution to qualified plan distributions must be “de-linked” by December 31, 2007; and
- Changes to the definition of “good reason” terminations in employment agreements must be made by December 31, 2007.
The primary purpose of Notice 2007-78 is to give employers 12 additional months to incorporate all of Section 409A’s technical details into their plan documents. The final regulations still become effective on January 1, 2008. That means that employers must administer their deferred compensation arrangements in full compliance with the new rules beginning on that date. And bringing plans into operational compliance with Section 409A will in many cases require that employers finalize plan design decisions before the end of 2007.
Even the documentary compliance relief granted by the Notice is limited. Although plans need not be amended to include many of the new provisions until the end of 2008, they must designate – in writing – a Section 409A-compliant time and form of payment by December 31, 2007. That designation may be made in a separate document, such as a deferral election form. Plan terms that are inconsistent with Section 409A may be disregarded through the end of next year, but only if those terms are disregarded in operation, as well.
For example, a plan provision that allows participants to accelerate a distribution date if they accept a 10% reduction in the amount distributed (e.g., a “haircut” provision, which is prohibited under Section 409A) will be ignored through the end of 2008, so long as no participant is allowed to elect such an accelerated distribution in operation and the plan is amended to remove the provision by December 31, 2008. (Leaving such a provision in the document could, however, open an employer to a breach of contract claim if it refuses to honor a participant’s request for this form of payment.)
MORE GUIDANCE FOR EMPLOYMENT CONTRACTS
The Notice also provides some additional guidance concerning the application of Section 409A to employment agreements. For instance, the IRS clarified that employers may change the definition of “good reason” termination events in such agreements in order to qualify for certain exceptions to the new rules, without running afoul of Section 409A. (For a more comprehensive discussion of the “good reason” rules, see the article titled “Good Reason” to Read Final 409A Regulations in the May 2007 issue of Benefits in Brief.) Such changes must be made, however, by December 31, 2007.
The IRS announced that it intends to create a limited voluntary compliance program through which taxpayers may correct unintentional operational violations of Section 409A. Guidance concerning that program is expected in the near future. In the meantime, however, employers should not assume that they can safely put Section 409A in a corner until next year.