Recall that for 409a compliance, an independent company valuation is required for nonqualified deferred compensation nqdc plans that include stock options andor stock appreciation rights sars. What is section 409a deferred compensation 10 unless an exemption applies, all plans or arrangements that provide for the deferral of compensation are subject to, and must comply with, 409a. The final regulations clarify that a right to a benefit that is excludable from income will not be treated as a deferral of compensation for purposes of section 409a. Oct 11, 2007 while deferred compensation plans must operate in compliance with section 409a as of january 1, 2008, the deadline for written compliance of plan documents is december 31, 2008. Mar 07, 2018 such compensation is not guaranteed to be paid on or before march 15 of the following year section 409a was enacted, in part, in response to the practice of enron executives accelerating the payments under their deferred compensation plans in order to access the money before enrons bankruptcy, and also in part in response to a. Lazar may 17, 2007 on april 10, 2007, the internal revenue service irs issued the final rules on 409a 409a1 after a comment period during which groups as diverse as the national employment lawyers association and the american bar. Section 409a provides that payment from a nonqualified deferred compensation plan may be made only at a fixed date or pursuant to fixed schedule, or following. Items of general interest guidance under 409a of the internal. Internal revenue code section 409a and the hidden deferred. Except as otherwise provided in this paragraph a, the term nonqualified deferred 1. If a deferred compensation plan meets the section 409a requirements, an employee is taxed on the plan distributions when made. Such a payment normally would violate section 409a, which generally prohibits acceleration of payments. Section 409a of the internal revenue code establishes a complex.
The regulations provide a definition of a nonqualified deferred compensation plan subject to section 409a, including rules related to the statutory effective date, and rules governing initial and subsequent deferral elections, the establishment of the time and form of payment. Section 409a applies to deferred compensation arrangements of all employees. When a payment is contingent on an employee release or covenant, the employee may be able to manipulate the payments tax year by strategically timing his or her execution of the release or covenant. Payment of deferred compensation cannot be accelerated, subject to a few exceptions. This checklist highlights potential pitfalls under section 409a that can arise when granting and administering restricted stock units rsus and stock options and the methods for avoiding these pitfalls.
We would refer to this as imported deferred compensation. While payments under the partnershipllc interest should be outside of section 409a, earnout payments pursuant to the sale or extinguishment of the interest could be subject to section 409a if classified as compensation rather than as consideration for the interest. Taxation of deferred compensation under irc section 409a. Top 10 rules for compliant nonqualified deferred compensation lori jones july 28, 2016 internal revenue code section 409a regulates nonqualified deferred compensation nqdc plans and arrangements, which are commonly used to provide supplemental compensation to key executives. We often receive questions about whether different types of bonus plans and nonqualified deferred compensation plans nqdc plans are subject to erisa. Nonqualified deferred compensation plan a nonqualified deferred compensation plan is any plan that provides for the deferral of compensation. Jun 12, 20 deferred compensation benefits irc sect. Under section 409a, subject to limited exceptions, payments must have one payment schedule for any single payment event.
A frequently used exception to the definition of deferred compensation is for amounts that qualify as a shortterm deferral. Section 409a imposes new rules on elections and payouts under a nonqualified deferred compensation plan. Section 409a applies to compensation that workers earn in one year but that is not paid until a future year. The time and form of deferred compensation payments must be elected by. Jun 20, 2007 internal revenue code section 409a acceleration or delay of payments. If the arrangement fails to meet these requirements, an employee faces adverse tax consequences on the. However, special transition rules apply for 2005, 2006, 2007 and 2008. Highlights of final rules for nonqualified defined benefit.
An internal revenue code section 409a primer by tony ling and galen mason1 the american jobs creation act of 2004 was signed into law on october 22, 2004. Revenue code 409a, which now governs most nonqualified deferred compensation plans. Section 409a was a response to accounting abuses by enron. The final regulations also clarify that a separation pay plan for purposes of section 409a, including for purposes of the plan aggregation rules, refers only to plans providing for payments of amounts of deferred compensation disregarding the exceptions from the definition of deferred compensation for certain types of separation pay where one of the conditions to the right to the payment is a separation. The final regulations provide that a deferred compensation plan subject to section 457f may be a nonqualified deferred compensation plan for purposes of section 409a and that the rules of section 409a apply to deferred compensation plans separately and in addition to any requirements applicable to such plans under section 457f. Section 409a changeincontrol payment events a lexis practice advisor practice note by alan m. Section 409a and severance arrangements a lexis practice advisor practice note by alan m. Accordingly, for example, an arrangement to provide health coverage excludable from income under section 105 generally would not be subject to section 409a. Unfortunately, section 409a generally requires participants to make irrevocable by dec.
While most nonqualified deferred compensation plan ndcp sponsors will be. For an nqdc plan, being subject to erisa may be a good thing. Section 409a s definition of nonqualified deferred compensation appears simple, but in practice it is extremely broad, with the result that it applies to many compensation arrangements that were not traditionally viewed as providing a deferral of compensation, such as severance benefits,retention or incentive bonus agreements, or other. On the positive side, section 409a resolves decades of uncertainty created by conflicts between irs positions and federal court authority. Any change in form or timing must be made at least 12 months in advance of scheduled payment and must defer the scheduled payment by at least 5 years. Rules on deferred compensation, severance pay by wendi s. The key advantage of these arrangements to the executives is that they generally do not have to pay taxes on the compensation until it is actually paid i. When a nonresident alien nra earns deferred compensation for work outside u. Also, it appears to confirm that a deferred compensation obligation could be settled on the otherwise applicable payment date by delivery of vested property, such as a partnership profits interest. Levine, morrison cohen llp this practice note discusses the changeincontrol events that can be used to trigger payment under a nonqualified deferred compensation nqdc arrangement that is subject to i.
Section 409a section 409a is a provision of the tax law imposing significant penalties on employees1 who participate in a nonqualified deferred compensation plan that fail to comply with its requirements. On june 21, 2016, the irs proposed clarifying regulations under section 409a on which taxpayers may immediately rely. Income inclusion and correction january 30, 2009 be payable at more than one time or in more than one form of payment e. Excluded plans the final regulations exclude the types of plans described in section 409a d1 from the definition of a nonqualified deferred compensation plan, as well as certain other arrangements that were also set forth in the proposed regulations. The proposed regulations are subject to a 90day notice and comment period, al. Corrections of document failures january, 2010 background all nonqualified deferred compensation plans are required to be in documentary and operational compliance with section 409a as of january 1, 2009 or their later inception. Whats new under the final regulations time of determination. Nonqualified deferred compensation plans and section 409a.
The valuation establishes the strike price at which the options and sars can be exercised. Section 409a has strict payment timing rules and generally prohibits acceleration of payment. But compliance will require a document, or combination of documents, that contain certain provisions required by the final regulations. The final regulations also clarify that a separation pay plan for purposes of section 409a, including for purposes of the plan aggregation rules, refers only to plans providing for payments of amounts of deferred compensation disregarding the exceptions from the definition of deferred compensation for certain types of separation pay where one of the conditions to the right to the payment is a separation from service. Levine, morrison cohen llp this practice note discusses how the nonqualified deferred compensation nqdc rules of i. Teachers salaries are nonqualified compensation plans that meet the requirements of irc section 409a. Failure to comply with section 409a results in full taxation of all deferred compensation of the same type, plus a 20% penalty tax, plus interest if compensation was deferred in a year before the year of the violation. We explain that being subject to erisa may be a good thing for an nqdc plan, particularly with respect to resolving disputes and claims for benefits. Highlights of final rules for nonqualified defined benefit plans transition relief extended the code section 409a provisions generally apply to compensation deferred under nonqualified plans after december 31, 2004. In general, stock options are treated as nonqualified deferred compensation under section 409a if the stock options have an exercise price that is less than the fair market value of the underlying stock on the date of the grant. Service recipients are generally employers, but those who hire independent contractors are also service recipients.
It created a new section 409a of the internal revenue code 409a and the code respectively. Section 409a of the united states internal revenue code regulates nonqualified deferred compensation paid by a service recipient to a service provider by generally imposing a 20% excise tax when certain design or operational rules contained in the section are violated. Compensation clawbacks and code section 409a acceleration. Sep 06, 2017 partyear compensation is not subject to section 409a if it meets certain requirements.
He says there are five permissible times the deferred compensation can be paid. Thus, these options are in the money when they are granted. References in this notice to amounts deferred under a plan in the context of a dollar amount deferred for example, a requirement to include in income under 409a a a specified percentage of the amount deferred under the plan refer to the dollar amount determined under applicable guidance. September 6, 2017 earlier this summer, the office of the chief counsel of the internal revenue service irs released a. Final regulations set forth guidance on the application of section 409a to nonqualified deferred compensation plans. Distributions to employees from nonqualified deferred compensation plans are considered wages subject to income tax upon distribution. The timing of payments must be established when the deferral election is made or the right to deferred compensation is granted. Income inclusion and correction january 30, 2009 to illustrate further, assume that, in year 1, all of an employees deferred amounts under a nonqualified deferred compensation plan are nonvested i. Under the new rules, an election to defer pay must. In order to keep a plan compliant with 409a, fogleman says, the basic rules are first, the plan has to be in writing. Deferred compensation rules section 409a of the tax code on september 29, 2005, the treasury department and the irs issued proposed regulations interpreting the deferred compensation rules under section 409a of the internal revenue code, which were part of the american jobs creation act of 2004 enacted in october of 2004.
By december 31, 2012, all deferred compensation arrangements in which payment is contingent on employee action, such as execution of a release of claims, must either include payment timing restrictions that comport to irs notice 201080 or satisfy an exemption from section 409a of the internal revenue code the code. Section 409a imposes significant requirements on deferred compensation arrangements, which are defined very broadly as described below. Internal revenue code section 409a acceleration or delay. Early distributions from plans unforeseeable emergencies. Lawsuit settlements permit qualified acceleration qualifying under section 409a. Deferred compensation under 409a does not include compensation whose payment is delayed or deferred until a substantial risk of forfeiture lapses, but then the compensation is paid immediately. Section 409a and deferred compensation arrangements for u. Nonqualified deferred compensation nqdc plan a plan, agreement, or arrangement between an employer and an employee or service recipient and service provider to pay compensation. Section 409a covers deferred compensation arrangements, whether they appear in formal plan documents, board resolutions, individual employment agreements, or unwritten practices.
The latter month or months of an option or futures contract. Structuring equity compensation for partnerships and llcs. Mar 15, 20 in general, stock options are treated as nonqualified deferred compensation under section 409a if the stock options have an exercise price that is less than the fair market value of the underlying. In general, guaranteed payments are payments made to a partner in his capacity as a partner without regard to the partnerships income the preambles to the proposed final regulations provide that section 409a applies to guaranteed payments described in section 707c and the rights. However, section 409a does not apply to qualified plans such as a section 401k plan or to a section 403b plan or a section 457b plan. Since 2005, section 409a of the internal revenue code of 1986, as amended the code, has prescribed strict rules governing the timing of deferral and payment of nonqualified deferred compensation, which may include incentive compensation that is deferred.
If an employer has never adopted a nonqualified deferred compensation plan that permits employees to defer compensation andor an employee had not previously been eligible to participate in the employers nonqualified deferred compensation plan, section 409a permits a newly eligible employee to make an initial deferral election during the. The final word under the new section 409a rules paul hastings. Section 409a of the internal revenue code mandates employer reporting of certain information related to deferred compensation plans. Where such measures directly affect employee compensation and benefits, section 409a of the internal revenue code of 1986, as amended section 409a, may be implicated. The current final regulations generally provide that a payment made under an ndcp is considered a shortterm deferral and not deferred compensation subject to section 409a if the payment by its terms is not permitted to be made later than, and actually is made no later than, the 15th day of the third month following the later of the end of.
For purposes of clause i, the interest determined under this clause for any taxable year is the amount of interest at the underpayment rate plus 1 percentage point on the underpayments that would have occurred had the deferred compensation been includible in gross income for the taxable year in which first deferred or, if later, the first taxable year in which such deferred compensation is. For example, when considering a threemonth option at the time of purchase months two and three could be thought. Internal revenue code section 409a acceleration or delay of. An executiveos election to defer compensation generally must be made before the start of the calendar year in which the compensation is earned. Irs clarifies numerous 409a issues groom law group. For an overview of the application of section 409a to equity awards, see practice note, section 409a. Eighteen topics were addressed under the comprehensive final section 409a regulations issued in 2007, and one issue was addressed under the proposed section 409a regulations on the impact of 409a violations issued in 2008. Shortterm deferral on or before 15th day of third month of year after vesting exemption. The plan must specify how much compensation will be deferred, when it will be paid and the form of payment. The shortterm deferral rule can mitigate the impact of section 409a i. Deferred compensation plans of taxexempt employers that. In order to qualify these payment amounts as shortterm deferrals and not deferred compensation under section 409a. Overview of deferred compensation arrangements under section 409a page1 i.
Wsgr alert new proposed regulations issued under section. The provision permitting payments upon the termination and liquidation of a plan in connection with bankruptcy is revised to address a previously erroneous cross reference. Under section 409a, employers are required to report the amount of compensation deferred for each plan participant and also report any amounts deferred that are in violation section 409a. If the arrangement does not meet the requirements of section 409a or is not properly administered in accordance with section 409a, the compensation is subject to. Deferred compensation rules section 409a of the tax code. Background section 409a of the internal revenue code the code, enacted in 2004 to regulate nonqualified deferred compensation plans, includes detailed rules that govern when the election. Added to the tax code in october of 2004, section 409a has created a new body of law governing deferred compensation. If a deferred compensation plan meets the section 409a requirements, an employee is taxed on the.
Deferred compensation atlantic planning group, llc. Timing is everything for nonqualified deferred compensation plans. This generally requires that a payment made on various types of. Definition of nonqualified deferred compensation plan a. A legally binding right to compensation arises in one taxable year. The shortterm deferral rule can mitigate the impact of. Nonqualified deferred compensation nqdc plan a plan, agreement, or arrangement between an employer and an employee or service recipient and service provider to pay compensation in the future. Foreign deferred compensation arrangements and foreign. Section 409a principally regulates timing with re spect to nonqualified deferred compensation timing in regard to elections to defer payment. This is referred to as nonqualified deferred compensation.
Are 409a issues lurking in your compensation arrangements. Yesterday, the irs issued proposed regulations clarifying 19 fairly narrow issues under existing code section 409a regulations. Section 409a restricts the timing of contingent deferred compensation payments. If the teacher is paid for only the months she worked, she is paid.
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