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Attention
Employers: Final 409A Regulations Impose December 31, 2007 Deadline
for Deferred Compensation
By Stuart
Harris, Jeff
Belfiglio, Holly
Wylam, Anne
Northrup, Sarah
Bhagwandin, Jason
Froggatt and Greg
Hitchcock
[June 2007]
On April 10, 2007, the IRS and the Treasury Department
issued long-awaited final regulations interpreting Section 409A
of the Internal Revenue Code (referred to hereafter as the “409A
Regulations” or “Final Regulations”). The
400-page document represents a two-year effort to apply the
rules of Section 409A to the many compensatory programs that
involve a deferral of compensation. It is essential that employers
note the Dec. 31, 2007 deadline and take any
needed steps to avoid the harsh consequences of noncompliance—i.e.,
plan participants suffering accelerated income tax, plus a 20
percent penalty tax and interest.
What follows is a brief summary of Section 409A, a list
of action steps for employers to take before Dec. 31, 2007,
and links to expanded discussions of key topics under Section 409A.
Introduction to Code Section 409A and
Regulations
Code Section 409A applies to most arrangements
that involve a deferral of compensation into a future tax year.
Common examples include supplemental executive retirement programs,
incentive bonus programs, stock options, stock appreciation
rights, and severance agreements. All arrangements that are
potentially subject to Section 409A must either fit an exemption
(of which there are many) or comply with Section 409A for
periods beginning on or after Jan. 1, 2005. However, the
IRS has agreed to be lenient for periods prior to the effective
date of the Final Regulations. Specifically, for the period
between Jan. 1, 2005 and Dec. 31, 2007, an employer’s
efforts to comply with Section 409A will be judged based
on a standard of whether the employer has made a reasonable,
good faith attempt to comply. In addition, prior to Dec. 31,
2007, plan documents need not be amended or updated to reflect
Code Section 409A.
Now that Final Regulations have been issued, all deferred compensation
arrangements that do not qualify for an exception must be in
full operational and documentary compliance with Section 409A
and the Final Regulations after Dec. 31, 2007. For arrangements
that must embrace full compliance, this means plan documents
must specify the amounts being deferred, the time and form of
payment, and the conditions under which initial or subsequent
deferral elections may be made.
Action Steps in Preparation for Dec. 31,
2007 Compliance Deadline
In order to meet the Dec. 31, 2007 deadline
for compliance, employers should take the following steps:
1) Inventory plans and arrangements
Identify potentially affected plans and
arrangements by reviewing not only traditional nonqualified
retirement plans such as supplemental executive retirement
plans (SERPs), but also annual bonus plans, executive employment
agreements, severance arrangements, stock options, restricted
stock units, equity compensation awards, post-retirement reimbursements,
and long-term incentive plans. Note that Section 409A
applies not only to plans for employees, but also arrangements
covering non-employee directors and certain other independent
contractors.
2) Identify grandfathered benefits
Benefits that were accrued and vested by the end of 2004
and that have not been “materially modified” are
grandfathered and exempt from Section 409A. Employers
should identify whether any deferred compensation arrangements
(or portions of deferred compensation arrangements) qualify
for grandfathering. Where a portion of a plan’s benefit
qualifies for grandfathering, employers should assess whether
the advantages of avoiding Section 409A on that portion
outweighs the administrative burden of separately accounting
for the grandfathered portion.
3) Determine if any exemptions apply
The 409A Regulations provide various exemptions
for short-term deferrals, severance arrangements, equity compensation
awards, etc. Employers should determine whether current deferred
compensation arrangements qualify for an exemption.
4) Amend covered plans
Plan documents subject to Section 409A
must be modified by Dec. 31, 2007 to comply with the 409A
Regulations. For example, plan documents must reflect the
new rules controlling deferral elections, the timing and form
of distributions, and subsequent changes to earlier elections.
5) Take appropriate board action
Amendments to plan documents should be
approved by the board of directors (or another appropriate
body) by Dec. 31, 2007. To avoid emergency year-end meetings
and holiday scheduling problems, board approval should be
sought well in advance of the end of the year.
Click on any of the following topics for a more in-depth
discussion of the key elements of the new Code Section 409A
regulations, changes from the proposed regulations, and detailed
action steps:
If you have questions
or would like more information, please contact:
Stuart
Harris, Portland, (503) 241-2300, stuartharris@dwt.com
Jeff Belfiglio, Bellevue, (425) 646-6100, jeffbelfiglio@dwt.com
Holly Wylam, Seattle, (206) 622-3150, hollywylam@dwt.com
Anne
Northrup, Seattle, (206) 622-3150, annenorthrup@dwt.com
Sarah
Bhagwandin, Seattle, (206) 622-3150, sarahbhagwandin@dwt.com
Jason Froggatt, Seattle, (206) 622-3150, jasonfroggatt@dwt.com
Greg
Hitchcock, Portland, (503) 241-2300, greghitchcock@dwt.com
Davis Wright Tremaine has employment and labor lawyers in Alaska,
Oregon, Washington state, California and Washington, D.C. We
represent many clients nationally. For a specific referral for
a DWT employment and labor attorney in your state, please contact
the above attorney. Thank you.
This
advisory
is a publication of the Employer Services Department of Davis
Wright Tremaine LLP. Our purpose in publishing this advisory
is to inform our clients and friends of recent developments
in employment law. It is not intended, nor should it be used,
as a substitute for specific legal advice as legal counsel may
be given only in response to inquiries regarding particular
situations.
Copyright
© 2007, Davis Wright Tremaine LLP.
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