Legal Updates & Alerts

Are Your Employment, Consulting or Separation Pay Arrangements Subject to § 409A Tax Rules?

June 19, 2007
Action is required! The deadline for amending plans and agreements to comply with the new deferred compensation tax rules is December 31, 2007; companies that have not yet reviewed their arrangements in light of § 409A should do so now.

Section 409A of the Internal Revenue Code established new rules that govern all plans, agreements and other arrangements that provide for the deferral of compensation. Section 409A went into effect January 1, 2005, but the deadline for bringing the written terms of plan documents and agreements into compliance with § 409A was extended pending the issuance of final treasury regulations. On April 10, 2007 the IRS issued final regulations interpreting the deferred compensation rules under § 409A, which are effective January 1, 2008. All deferred compensation plans and arrangements must comply in writing with the final regulations by December 31, 2007. Failure to comply with § 409A may expose participants in deferred compensation arrangements to a 20% penalty tax and interest, as well as immediate taxation of amounts deferred under the arrangement.

Many agreements and arrangements that are not typically considered to be "deferred compensation arrangements" may, in fact, be covered by § 409A. Any agreement or arrangement (written or verbal) that provides for compensation to be earned in one year and paid in a later year is a "deferred compensation arrangement," unless it is one of the types of arrangements that is expressly exempted from coverage under § 409A. This can include employment agreements that have severance and/or change of control provisions, severance plans and arrangements, change of control plans and agreements, consulting or independent contractor agreements, bonus plans, long-term incentive plans and retention arrangements. Verbal arrangements that have the effect of deferring compensation are covered by § 409A, and the final regulations require that all such arrangements be put in writing, and comply with the requirements of § 409A, by the December 31, 2007 deadline.

In very general terms, § 409A imposes strict rules regarding the events that may trigger payments under deferred compensation arrangements, and when and how changes to the form or timing of payments may be made, including strict limitations on when the timing of payments may be accelerated.

Many severance arrangements, bonus and long-term incentive and retention plans are, or could be, drafted or amended to qualify for an exemption from § 409A. All plans and agreements that may be "deferred compensation agreements" should be reviewed in light of the final § 409A regulations soon, and amended as necessary by December 31, 2007 to either comply with § 409A, or bring the arrangement or agreement within one of the exceptions from coverage under § 409A.