Tax News

CCH (cch.taxgroup.com) reports:

The IRS has extended the January 1, 2008, deadline for compliance with the written plan requirements in the final nonqualified deferred compensation regulations under Code Sec. 409A (TAXDAY, 2007/04/11, I.1). Employers will now have until December 31, 2008, to bring plan documents into compliance with the regulations. Employers will have to operate their plans in compliance with the final regulations during 2008 and have their documents in place by December 31, 2008, in order to take advantage of this relief. The IRS has also released additional guidance on how the final regulations shall be applied.
CCH Comment. This will come as welcome news to the employee benefits community. Under Reg. §1.409A-1(c)(3), written plan documents for nonqualified deferred compensation plans are required for the first time. For some employers, that means documents have to be created from scratch. None of the operational requirements of the regulations are postponed nor is any of the prior transition relief extended. Even the written plan deadline extension requires plan documents to be retroactive to the original effective date of the regulations January 1, 2008.
Transition Relief
Retroactive amendment period. A nonqualified deferred compensation plan will not violate the requirements of Code Sec. 409A merely because the written provisions of the plan fail to meet the requirements of Code Sec. 409A guidance (including the final regulations and transition guidance) provided (1) the plan is in operational compliance, and (2) is amended on or before December 31, 2008, to comply retroactively to January 1, 2008. A plan is in compliance on or after January 1, 2008, if the written plan as amended (1) contains all of the written provisions required by the final regulations, and (2) accurately reflects the operation of the plan on and after January 1, 2008, through the date of amendment.
CCH Comment. It is worth repeating that the written plan must accurately reflect the new regulations and must reflect how the plan actually operated up until the time of the amendment.
Compliant time and form of payment. Unless a later date is permitted under the final regulations, if there have been deferrals of compensation under a plan as of January 1, 2008, but the deferred compensation has not been paid, the plan will not comply with Code Sec. 409A after December 31, 2007, unless the plan designates in writing before January 1, 2008, a compliant time and form of payment of such deferred compensation. Amounts deferred after December 31, 2007, and before January 1, 2009, will not comply with Code Sec. 409A unless the plan designates in writing a compliant time and form of payment of such amounts on or before the applicable deadline under the final regulations. For these purposes, a plan can designate a compliant time and form of payment even if some written plan provisions are not in compliance. For example, suppose the plan includes a "haircut" provision in the event of separation from service (i.e., the employee can elect an immediate lump sum payment subject to forfeiture of a specified portion). Even though such a provision is not allowed under the final regulations, as long as the plan does not use the provision, and the provision is removed by December 31, 2008, the plan is in compliance.
Designating a compliant time and form of payment. Under the notice, a plan will provide for a compliant time and form of payment for a deferred amount if the plan provides for an objectively determinable form of payment payable upon: (1) a separation from service; (2) a change in control event; (3) an unforeseeable emergency; (4) a specified date or fixed schedule of payments; (5) death; or (6) disability. For example, a plan may provide that an amount deferred under the plan will be paid in the form of a life annuity commencing on the later of the employee's separation from service or attaining age 65, but it may not provide that an amount deferred under the plan will be paid during the three years following the employee's separation from service (with the exact timing determined at the discretion of the employee).
Retroactive adoption of permissible payment event definitions. The plan may retroactively adopt permissible payment event definitions. Permissible payment events under the final regulations include separation from service, change in control events, unforeseeable emergencies, and disability. During 2008, the plan must operationally comply with those definitions. However, written provisions that do not reflect the regulatory definitions do not render the plan noncompliant as long as the written plan is amended prior to December 31, 2008, to accurately and retroactively reflect the regulatory provisions. For example, a plan providing that a payment will be made upon the employee's disability may be treated as providing for a payment upon a disability as defined in Reg. §1.409A-3(i)(4). The plan must actually be operated in accordance with the final regulations, so that a payment due upon the employee's disability could only be made upon a disability that met the requirements of the definition of disability set forth in the regulation. Furthermore, the plan must be amended by December 31, 2008, to accurately reflect the application of the provision during 2008 and to fully comply with the requirements of the final regulations.
If a payment event has been timely designated, a later adoption of an alternative definition of the designated payment event, as applicable on or before December 31, 2008, will not be treated as a change in the time or form of payment. However, once an event has occurred in 2008 and been treated as a payment event (or as not qualifying as a payment event), the employee and employer may not retroactively alter the definition of the payment event.
Designating specified payment date or fixed schedule of payments. The designation of a specified payment date or a fixed schedule of payments is governed by Reg. §1.409A-3(i)(1) of the final regulations. The regulation provides requirements for tax gross-up payments to qualify as fixed payments. A payment that would otherwise qualify under that regulation, except that the arrangement does not require that the payment be made by the end of the employee's tax year next following the employer's tax year in which the employer remits the related taxes, will be treated as designating a fixed schedule of payments if the plan is amended on or before December 31, 2008, to provide for such a requirement, and the plan is operated in compliance with such requirements for the period after December 31, 2007, through the date of amendment. Also, for a specified payment date or a fixed schedule of payments, the addition or deletion of a designated payment provision is not treated as a change in the time and form of payment if the addition or deletion is made on or before December 31, 2008, it meets the final regulatory requirements for designation of payment upon a permissible payment event or specified time or fixed schedule, and does not affect the tax year in which the payment will be made.
Retroactive Amendments and the six-month delay on payments to specified employees. The six-month delay requirement on payments to specified employees must be included in the written plan documents under Reg. §1.409A-1(c)(3)(v) of the final regulations. However, as long as payment is actually delayed, a plan will not be treated as failing this requirement as long as it is amended by December 31, 2008, to contain this requirement retroactively to January 1, 2008. The written plan provision must accurately reflect the operation of the plan through the amendment date, and taxpayers must demonstrate that the required delay was applied to affected payments. Taxpayers may have to demonstrate the method by which the employer identified any specified employees, and that such method was applied consistently to all plans and employees.
Application of Final Regulations and Additional Guidance
Good reason provisions of employment agreements.
The final regulations liberalized the rules regarding the treatment of separation from service payments under good reason terminations and provide a safe harbor in Reg. §1.409A-1(n)(2)(ii) for good cause conditions. Taxpayers may want to conform existing good reason conditions to meet the regulatory requirements, though modification of these arrangements may raise issues regarding whether a substantial risk of forfeiture condition has been added or modified in a manner that would not be respected under the final regulations or earlier guidance. This notice provides that taxpayers may make these modifications on or before December 31, 2007, without the modifications being treated as the extension of a substantial risk of forfeiture.
Application of substitution rule to employment agreements. Under Reg. §1.409A-3(f), payment made as a substitution for deferred compensation is treated as deferred compensation. Under the new guidance, if a right to deferred compensation payable only upon an involuntary separation from service would automatically be forfeited at the end of the term of the employment agreement, the grant of a right to deferred compensation in an extended, renewed, or renegotiated agreement will not be treated as a substitute for the forfeited right at the termination of the prior employment agreement.
Predetermined cashouts. Under Reg. §1.409A-2(b)(2)(ii), taxpayers have only a limited ability to provide for the cashout of remaining annuity or installment payments when the present value of the remaining payments falls below the predetermined threshold. Under the new guidance, a taxpayer may treat a cashout provision as part of an objectively determinable and nondiscretionary payment schedule if the payment schedule would otherwise meet the requirements of the regulations (including that the cashout threshold be fixed at the time the permissible payment is designated), if the taxpayer can demonstrate that the provision operated in an objective, nondiscretionary manner and did not operate so as to provide either the employer or the employee with the rights having substantially the effect of a right to a late elections to the time and form of payment.
Anticipated Voluntary Compliance Program
The IRS anticipates issuing guidance in the near future establishing a limited voluntary compliance program that will apply to certain unintentional operational failures to comply with Code Sec. 409A so that such failures can be corrected in the same tax year in which they occur.
Application of Restrictions on Certain Trusts
Restrictions apply under Code Sec. 409A(b) to the use of offshore trusts for nonqualified deferred compensation plans, to the ability of a plan to restrict trust assets to protect the payment of benefits in the event of an employer's change in financial health, and to the transfer of assets to a trust to pay nonqualifed deferred compensation during a period in which the plan is in high risk status, the employer is in bankruptcy, and the plan is underfunded. Until further guidance is issued, taxpayers may continue to rely on a reasonable, good faith interpretation of these provisions.
IR-2007-157, 2007FED ¶46,627
Treasury Department News Release, TDNR HP-551, 2007FED ¶46,628
Notice 2007-78, 2007FED ¶46,629
Other References:
Code Sec. 409A
CCH Reference - 2007FED ¶18,960.22
Tax Research Consultant
CCH Reference - TRC COMPEN: 15,066