By Mary Ellen Schill
December 2, 2008
Really, we mean it this time! The deadline for amending deferred compensation agreements to comply with Section 409A of the Internal Revenue Code is December 31, 2008, and there is no indication that the IRS will grant another extension. So, add reviewing deferred compensation, employment, and severance agreements to your list of things to do before year?end. Section 409A was enacted in 2004, and both the statute itself and subsequent IRS guidance make it clear that in order to avoid the harsh consequences of a noncompliant nonqualified deferred compensation plan (accelerated income taxes and a 20% excise tax for starters) the words in the plan document do matter, and those words must satisfy the IRS final regulations on or before December 31, 2008.
409A became effective January 1, 2005, and perhaps the most significant impact on deferred compensation was the requirement that any agreement which grants deferred compensation must be in writing prior to the time the executive has a legally enforceable right to the deferred compensation. In addition, on their face, the written words must comply with 409A, and the words cannot be fixed after the fact, i.e. after the agreement is effective, or, for existing agreements, after the December 31, 2008 deadline. This means existing agreements must be actually amended prior to the end of 2008 to comply. The actions to amend the agreements must be taken prior to December 31, 2008, it is not sufficient to just amend agreements later with an effective date prior to December 31, 2008!
What does this mean for clients with existing nonqualified deferred compensation plans and those desiring to adopt new plans? Ruder Ware has worked closely with those clients since the end of 2004 and continued in 2008 to:
Document previously granted but undocumented executive deferred compensation.
Review existing nonqualified deferred compensation documents and update where necessary to comply with the new rules.
Identify benefits provided to executives that fall within the new definition of deferred compensation subject to 409A and therefore now require written documentation.
Ensure that any new deferred compensation granted is documented with fully compliant deferred compensation plan documents.
Our work on behalf of clients has demonstrated that it is rare to find a nonqualified deferred compensation plan document drafted prior to the enactment of 409A that fully complies with 409A and the subsequent guidance issued by the IRS. This is because the inflexibility that 409A now imposes on these plans would have never been built into a pre-409A plan document. There was little reason, for example, to require an executive to select a form of payment for his or her deferred compensation years in advance of retirement, yet 409A now requires just that. Also, we have found hidden “deferred compensation” subject to 409A in executive employment agreements and severance agreements.
We stand ready to help you review existing agreements for compliance with 409A prior to year end, and adopt any necessary amendments on time. Please contact Mary Ellen Schill, who prepared this article, or any of the attorneys in the Employment, Benefits & Labor Relations Practice Group of Ruder Ware to get the process started and check one more thing off your list.
This document provides information of a general nature regarding legislative or other legal developments, and is based on the state of the law at the time of the original publication of this article. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations, or issues, and additional facts and information or future developments may affect the subjects addressed. You should not act upon the information in this document without discussing your specific situation with legal counsel.
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