PAYMENT OF COMPENSATION IS NOT AS EASY AS IT ONCE WAS

Just when you thought the tax code couldn't get any more complicated, Congress added Section 409A which contains extensive new rules addressing deferred compensation. Congress designed the new rules to "fix" abuses it saw with deferred compensation during the collapse of Enron and WorldCom several years ago. These rules affect most nonqualified compensation plans and arrangements in which compensation is paid in a year later than the year in which the services were performed. This means most employers (public and private) need to carefully review their compensation arrangements to ensure compliance with Section 409A or the availability of an exemption. The penalties for noncompliance are significant and include immediate taxation of all of an individual's vested deferred compensation, a 20% penalty, as well as interest for the period of any prior deferral.

Section 409A has been effective since 2005. The IRS issued final regulations on Section 409A which were to be effective January 1, 2008; but in October, the IRS extended the date for document compliance with the final regulations to January 1, 2009. This gives employers more time to address these issues and make any necessary changes in their compensation plans and agreements. While employers have additional time to amend their documents to comply with the specific rules contained in the regulations, they are required to operate their arrangements in compliance with the general Section 409A rules now.

Section 409A is broad in its application, potentially covering a wide array of arrangements including the following:

• Traditional" non-qualified deferred compensation arrangements
  • Salary reductions, matching and/or profit sharing
  • SERPs (Supplemental employee retirement plans)
• Employment agreements and offer letters
• Bonus arrangements - including individual or group performance bonuses
• Commission arrangements
• Severance payments & "good reason" termination payments
• Salary continuation agreements
• Disability payments
• "Window" or downsizing plans
• Settlement agreements
• Indemnification and reimbursement arrangements
• Split dollar life insurance
• Equity arrangements or incentive plans - ISOs, NQSOs, SARs, Phantom plans
• Retention and change in control agreements
• Buy/Sell arrangements - e.g. buy outs of A/R or goodwill
• Operating/Partnership agreements
  

Employers should conduct an internal review of all agreements and company policies that contain provisions that defer compensation to evaluate whether those arrangements are subject to Section 409A. Each subject arrangement must then be analyzed to determine whether it currently complies with Section 409A, or whether amendments are necessary before the new compliance deadline. Again, the new extended compliance deadline applies only to compliance with the documentation requirements. Good-faith operational compliance has always been required.

While action may be necessary to comply with Section 409A, employers need to proceed with caution. Actions taken may adversely impact entitlement to certain grandfather rules or other relief or worse yet, cause a violation of Section 409A.

As things stand currently, for periods prior to 2008, a company will be considered in "good faith compliance" if it meets various pronouncements issued under Section 409A. After 2007, reliance on the proposed regulations will not be treated as reasonable good faith compliance in most instances. To the degree that the announced guidance does not address a matter, one must still comply with a reasonable good faith interpretation of the statute. In short, employers (and employees) cannot take a position inconsistent with the statute after 2004.

Since final regulations address most Section 409A issues, now is the time to revisit and address compensation plans and arrangements, while some transitional rules and relief are still available. Considering the potential consequences of noncompliance under these rules and the complexity of the statues, we recommend you discuss this issue with Bob Winger, a partner specializing in employee benefits or Randy Duncan, head of the Closely Held Business Team at Dunn Carney.

Closely Held
Business Team

The Closely Held Business Team - Dunn Carney is dedicated to assisting business owners in navigating through the opportunities and challenges the law presents to advance each owner’s success in business. They understand the multifaceted issues business owners face each day and the need for responsive and proactive legal counsel.

Team members include:
Randy Duncan, Team leader
Bob Allen
John Barhoum
Merrill Baumann
David Buono
Brian Cable
Jack Cooper
Ken Davis
Tim Hering
Frank Hilton
Elizabeth Howard
Scott Jonsson
Robert Kerr
JoDee Keegan
Tamsen Leachman
Kelly Martin
David Rossmiller
Tony Sayess
Kyle Stinchfield
Dan Vidas
Matt Wilmot
Bob Winger
David Zehntbauer