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8/8/2019 A Documentary Compliance

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Correcting 409A Documentary Failures underIRS Notice 2010-6: The Price you Pay for Delay

Brenda Berg and Jane FrancisMay 19, 2010


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409A Recap: How did we get

here? Internal Revenue Code Section 409A imposes strict rules on

nonqualified deferred compensation plans and other deferredcompensation arrangements. A NQDC plan is required to complywith 409A in both form (document) and operation.

Various guidance was issued between 2005 and 2007, culminatingwith final regulations in April 2007. Reasonable good faithstandard.

Deferred compensation plans were required to be in documentarycompliance with Section 409A by December 31, 2008.

The IRS provided an opportunity to correct certain limited 409Aoperational failures under Notice 2007-100 and later expanded inNotice 2008-113; however, until the issuance of Notice 2010-6,there was no method for correcting document failures.


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409A Recap: Why do we care?

Failure to comply with Section 409A results in a

tax imposed on each affected participant basedon the entire value of his or her nonqualifieddeferred compensation plus a 20% penalty andinterest.

Correcting under Notice 2010-6 can avoid orreduce these drastic consequences.

The relief coincides with an audit initiativelaunched by the IRS regarding 409Acompliance.


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Overview of Notice 2010-6

New correction program is intended to

encourage taxpayers to review their nonqualifieddeferred compensation plans to identifyprovisions that fail to comply with the

requirements of Section 409A, and to correctthose plan provisions promptly.

Early correction is important not only becausethe relief is generally not available once thetaxpayer is under audit, but also because someof the relief under the Notice is time sensitive.


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Why Notice 2010-6 is helpful

If NQDC arrangement is subject to 409A, then a

written document is required. Notice 2010-6 canbe used as a checklist for designing a compliantdocument.

If taxpayer reasonably believed plan was agrandfathered plan exempt from 409A and nowdetermines that it does not meet grandfatheredstatus, can correct now.

If correction made does not affect operation ofthe NQDC arrangement, no inclusion of income

required.


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Special Transition Rule

Taxpayers can avoid 409A income inclusion

otherwise required for the correction relief, suchas the type described above due to theimpermissible event occurring within one yearafter the correction, if the document failure iscorrected by December 31, 2010.

BUT if an improper payment was made (orshould have been made, if the amendeddefinition applied) by December 31, 2010, thereis also an operational failure that must becorrected under Notice 2008-113.


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Eligibility for Correction Under

Notice 2010-6 Relief is only available for failures that are

inadvertent and unintentional. Neither the service provider nor the

service recipient can be underexamination for a year in which the failureexisted.

Must take commercially reasonable stepsto correct all plans with substantiallysimilar document failures.


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Eligibility for Correction Under

Notice 2010-6 Cant be a plan linked to a tax-qualified plan

such as a pension plan, or a plan granting stockrights. Failure cant be related to a listed transaction

under Section 1.6011-4(b)(2) (abusivetransactions identified by the IRS from time totime).

Must be one of the failures specifically identified in the Notice and you have to do all of the thingsrequired for correction under the Notice.


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Essential 409A Compliance

Elements Written plan.

Timely deferral elections. Must elect time and form of distribution

when legally binding right to compensationis obtained.

No acceleration of distribution.

Required delay for specified employees. Extremely limited ability to further defer

payment.


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Failures Eligible for Relief

An otherwise permissible payment event such as termination ofemployment, disability, separation from service, change incontrol, or acquisition that is not defined in the document, or isimproperly defined.

A payment period that is more than 90 days following a permissible

payment event, or a payment period that is dependent upon theparticipant executing a non-compete or non-solicitation agreementor a release of claims.

An impermissible payment event, such as an initial public offering(that does not otherwise constitute a change in control as defined inthe 409A regulations) or enrollment of a child in college.


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Impermissible alternative payment schedules that apply dependingon which payment trigger occurs, for example, a lump sum if theparticipant has an involuntary separation from service versus tenannual installments if the participant has a voluntary separation fromservice.

Employer or participant discretion to change the time or form of apayment that is due, such as the discretion to pay in a lump sum orannual installments, discretion to delay payments if certain cash flowtargets are not met, or discretion to make subsequent deferralelections.

Employer discretion to accelerate payments events, such asdiscretion to pay before the participant separates from service eventhough the plan provides for payment upon separation from service.


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Impermissible reimbursements, like country club dues,after separation from service.

Failing to include the six-month delay for payments to

specified employees.

Provisions that dont comply with 409As initial deferralelection timing rules, such as applying the electiondeadline for performance-based compensation to abonus that does not qualify as performance-based

compensation.


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Creation of New Failures under

Notice Notice expands potential violations.

Timing of written document requirement Regulations provide no document failure can occur until thewritten plan deadline has expired. Notice indicatesdocumentary failure at time NQDC arrangement reduced towritingcould be much earlier.

Releases? Notice allows correction where payment is contingent upon

execution of a non-compete agreement, a non-solicitation

agreement, or a release following a permitted 409A paymentevent such as separation from service. It is permissible to forfeit a payment if a release is not signed

within the required period, but there is a 90-day limit.


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Possible Actions Required for

Correction Amendment of NQDC arrangement AND

all other arrangements. Current or future inclusion of amounts in

income and payment of tax. Information and reporting requirements,

even without inclusion in income.


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Information and Reporting

Requirements Service Recipient- attaches to its federal income

tax return for taxable year in which it corrects thefailure AND in taxable year subsequent to theyear in which correction occurred IF serviceprovider required to include amount in income.

Service Provider-receives statement thatprovider entitled to relief under Notice forreporting of income (if applicable); W-2 or 1099coded with 409A failure noted if required toinclude in income. Possible repaymentobligations.


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What is NOT a Failure

According to the Notice? Term providing payment as soon as reasonably

practicable following the permissible paymentevent, or under conditions substantially similar. Unless there is a pattern or practice of making late

payments, counting permissible payment event as thetrigger for required payment date. Could still have an operational violation if dont pay in

accordance with the document terms.


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Do You Have to Use the Notice

to Correct? Non-vested Amounts: Proposed

regulations for 409A income inclusiononly tax vested amounts so there is nofailure until then.

Is it a reasonable interpretation that you donot have a violation?

Are you within written document deadline? Other tax and contract correction doctrines(rescission, scriveners error)?


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General Correction Principles

Must amend before problem arises and makeamendment effective immediately.

Must correct with most restrictive interpretation to serviceprovider. Date of correction is latest of date on which

amendment adopted, is effective, or is set forth inwriting. NOTE: under transition rule, date of correction isretroactive to January 1, 2009.

Look-forward period: Generally, if impermissible eventoccurs within one year of the date of correction, serviceprovider must include into income 50% (or 25%) ofamount deferred (subject to 20% penalty, but nointerest).


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Examples: Undefined Payment

Term Plan provides for payment upon termination of

employment, which is not defined. Does plan have a 409A savings clause? Then

interpret this to comply if possible (if hasnt beeninterpreted otherwise before). Then no correctionrequired (not a 409A violation).

If no savings clause but wasnt interpreted wronglybefore, then can amend the plan to comply (either

with savings clause or correct definition). If was interpreted wrongly before, can treat as anoperational correction, fix under Notice 2008-113, andamend the plan.


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Examples: Bad Definition of a

Payment Term Plan provides for payment upon termination of

employment, which is defined to mean the datethat the employer no longer considers theindividual to be an employee of the employer If the incorrect payment event already occurred

(either under bad definition, or under a correct 409Adefinition), its too late! Amend the plan to make definition comply, effective

immediately.

One-year look-forward period (if past 2010): 50% ofthe deferred amount must be included in income andis subject to 20% 409A penalty.

IRS reporting required.


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Examples: Impermissible

Payment Period Plan provides for payment after 409A

Separation from Service, to be paid within 6months after separation occurs, in employersdiscretion Amend the plan to remove the payment period or limit

the period to 90 days (and no service providerdiscretion).

If the separation has already occurred, can still

amend if its done within a reasonable time afterseparation, IF paid within 90 days of separation, AND50% of deferral is included in income & penalty.

IRS reporting is required.


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Examples: Discretion Regarding

Payment Schedule Plan provides for service provider (employee)

discretion to elect a lump sum or 10 annualinstallments upon distribution event, with lumpsum as a default. Must remove discretionary language.

If default time or form in NQDC arrangement, mustuse default, so in this case, lump sum is payable. If no default, must use time/form that would result in

latest final payment date. One-year look-forward period (if past 2010): If an

event that was corrected occurs, 50% incomeinclusion rule applies.



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Examples: Impermissible

Payment Event Plan provides for payment upon a childs

entrance to college. Must amend to remove event before event selected

by service provider. One-year look-forward period (if past 2010): If any of

the impermissible payment events would haverequired payment, 50% income inclusion rule applies.

If ONLY impermissible payment events before

amendment, also must replace with provisionproviding payment on later of separation from serviceand 6 th anniversary of date of correction.



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Examples: Initial Deferral

Election Plan allows deferral of 2012 annual bonus (to be

otherwise paid March 15, 2013) up to June 30, 2012, butannual bonus doesnt qualify as performance-basedcompensation. If election was made by December 31, 2011 (correct election

deadline), then no amounts are included in income. If election was revoked by December 31, 2011, then no 409A

violation (and no deferral either).

Correction (amendment) must be made by end of

second taxable year following taxable year in whichapplicable initial deferral election was required (2013). IRS reporting is required.


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Examples: Failure to Include

Six-Month Delay Rule Plan does not contain restriction for specified

employees that requires a six-month delay of adistribution in the event of separation fromservice or change in control. Correct before event occurs by amending NQDC

arrangement to add restriction. Further, the amount may not be paid before later of18 months following date of correction or 6 monthsfollowing date of payment event.

One-year look-forward period (if past 2010): Ifpayment event occurs, 50% income inclusion ruleapplies.



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Where Do We Go From Here?

ABA Comments issued April 30, 2010.

Requests include: tighter definition of under audit;broader ability to use Notice based on reasonable,good faith effort to comply; expansion to stock rightsissues and short-term deferral failures; elimination oflinked plan carve-out; deletion of reportingrequirement where no income inclusion; clarificationof release requirements and forgiveness failures priorto the date of the release

IRS signaled intent to combine Notices 2008-113 and 2010-6 into single Revenue Procedure.


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Now is the Time

If you get nothing else out of this

presentation, remember this: the windowfor possible tax-free correction closes onDecember 31, 2010.


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Q & A

Brenda R. Berg (303) [email protected]

Jane O. Francis (303) 295-8599

[email protected]

Holland & Hart LLP

P.O. Box 8749Denver, Co 80201-8749
mailto:[email protected]:[email protected]:[email protected]:[email protected]

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