What is 409A?

Internal Revenue Code Section 409A was enacted in 2004 to require that a wide variety of deferred compensation arrangements be more specifically written to control an executive’s ability to manipulate income tax deferral. It also restricts the prompt payout of deferred compensation to certain executives of publicly traded companies.

Authority

The statute is broadly written to cover starting in 2005 a wide range of situations. Employers need to evaluate what arrangements, including many previously unregulated common business practices, are now subject to higher standards and substantial penalties for noncompliance.

The IRS has recently extended the deadline for all plan provisions to be adopted until the end of 2008. In the meantime, employers still need to operate their plans in compliance with final regulations and may need to make some changes to their plan regarding time and form of payments before the end of 2007. Immediate action is still required.

Examples of Arrangements Covered include:

• Salary and bonus deferral arrangements;
  
  
• Supplemental Executive Retirement Plans (“SERPs”);
  
  
• Discounted non-statutory stock options;
  
  
• One person arrangements even if that person is not an employee (an independent contractor service provider).

Some Common Exceptions from 409A include:

• Limited Involuntary Separation Agreements
  
  Involuntary Separation Agreements where the total payment does not exceed the lesser of two times (i) the qualified Plan annual limit (e.g. 2007, $225,000), or (ii) the employee’s average annual salary, if the payments are completed by no later than the end of the second calendar year following the year of separation.
  
  
• Collectively Bargained Plans
  
  Severance payments made as a result of collective bargaining agreements.
  
  
• Short Term Deferral
  
  Amounts paid within two and one-half months after the calendar year in which the right to payment has vested.
  
  
• Reimbursement of Expenses
  
  Reimbursements or direct payment by the employer of certain business, or unreimbursed non-taxable medical expenses.
  
  
• De Minimis
  
  All payments, reimbursements and benefits under a separation pay arrangement that do not exceed $15,500 (for 2007).

Sanctions for Violating 409A

The employee is hit with an additional 20% income tax penalty on any payments from plans that are not 409A compliant.

Please contact Tom Hughes or Ruth Marcott, Attorneys at Felhaber, Larson, Fenlon, and Vogt, PA should you have further questions. They can be reached at 1-800-989-6321.