Client Alert: Deferred Compensation Under Section 409A
January 1, 1900
New rules regarding the taxation of deferred compensation will be effective beginning January 1, 2009. Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”) imposes severe penalties for certain compensation arrangements that do not comply with the new requirements. All plans and other compensation arrangements should be reviewed to determine compliance with the final rules under Section 409A. Taxpayers have until December 31, 2008, to amend their plans and other compensation arrangements to comply with the new rules (and may rely on the transition relief under Section 409A until then).
Scope of Section 409A
Section 409A requires that any award of deferred compensation must conform to the new rules, or the recipient of the compensation may be subject to immediate taxation of the amount that was deferred, plus an additional 20% penalty tax. Deferred compensation is defined as any agreement that provides for compensation to be paid after the year the recipient has a right to the compensation (even if the right is subject to vesting or a risk of forfeiture). Deferred compensation includes common arrangements such as stock options, stock appreciation rights, restricted stock awards, phantom stock, settlement agreements, severance agreements, and split-dollar life insurance arrangements. Section 409A does not apply to “grandfathered” arrangements in which the right to receive deferred compensation was fixed as of October 3, 2004.
Compliance with Section 409A
Section 409A generally requires that any election to defer compensation be made prior to the year in which the service provider earns the compensation. In addition, deferred compensation must be payable only upon
• separation from service (six-month delay for “specified employees” of public companies);
• disability (as defined);
• specified time or schedule set forth on the deferral date;
• change in control (as defined); and
• unforeseeable emergency (as defined).
In addition, a payment will be exempt from taxation under Section 409A if it is paid within 2½ months after the end of the taxable year in which the right to the payment “vests” (the so-called “short-term deferral” rule). The application of these rules under Section 409A are technical and require case-by-case analysis of each arrangement.
Strategies for Compliance
We will be pleased to work with you to identify all plans and arrangements subject to Section 409A. At your request, we will determine which modifications or amendments are needed to bring the documents into compliance. Please contact Rick Aderman at 312-836-4104 or the attorney at our firm with whom you usually work if you wish to discuss this further.
Circular 230 Notice
Pursuant to regulations governing practice before the Internal Revenue Service, unless expressly stated otherwise, any tax advice contained herein or in any attachment hereto cannot be used, and is not intended to be used, by a taxpayer for (i) the purpose of avoiding tax penalties that may be imposed on the taxpayer under the Internal Revenue Code or (ii) the promotion or marketing of any tax-related matter or program.