IRS Issues Final 409A Regulations – Immediate Action May Be Required!
 
May 31, 2007
 
David O'Leary - Chicago

On April 10, 2007, the Internal Revenue Service issued the long awaited Final Regulations under Section 409A of the Internal Revenue Code. Section 409A, which became effective January 1, 2005, is the most significant legislation affecting nonqualified deferred compensation plans and arrangements in the last 50 years. It affects all employers, whether public, private or tax-exempt.

Amendments Must Be Adopted Prior to December 31, 2007

Although Section 409A became effective January 1, 2005, the IRS permitted employers and other plan sponsors to delay the amendment of the plan or arrangement until issuance of the Final Regulations, provided that they administer the plan or arrangement in good faith compliance with the requirements of Section 409A during the interim period. Now that the Final Regulations have been issued, all affected plans and agreements must be amended to conform to the requirements of Section 409A prior to December 31, 2007.

Which Plans and Arrangements Should Be Reviewed for Compliance?

Section 409A applies to all plans and arrangements under which services are rendered in one tax year and payment for the services is made in a subsequent tax year, unless such plans and arrangements are specifically exempted. The types of plans or arrangements that typically require a review for Section 409A compliance or exemption include:

• equity-based compensation plans, such as those granting qualified and nonqualified stock options, phantom stock, restricted stock, stock appreciation rights

• unfunded deferred compensation plans

• “top hat” and excess benefit plans

• supplemental executive retirement benefits (SERPs)

• arrangements that cover only one person, such as employment and severance agreements

Failure to Comply May Result in Significant Adverse Tax Consequences to Employees and Other Service Providers

All deferred compliance plans and arrangements should be immediately reviewed to determine if they qualify under one of the exemptions in Section 409A. If not, the plans or arrangements should be carefully reviewed to determine what amendments, if any, are necessary. Because the final regulations include modifications and clarifications of some rules contained in previous guidance, plans and arrangements that were amended for Section 409A compliance in 2005 or 2006 also should be reviewed.

For more information, e-mail David O’Leary at david.oleary@hklaw.com or call toll free, 1-888-688-8500.