Public Companies Need to Amend Plans by December 31, 2007
May 21, 2007
R. Gregory Bailey- Washington
Maria D. Lumb- Washington
On April 10, 2007, the IRS issued the long awaited Final Regulations under Section 409A of the Internal Revenue Code. Section 409A affects all employers that provide nonqualified deferred compensation to employees and other service providers.
Deadline Quickly Approaching
Although Section 409A became effective January 1, 2005, the IRS permitted employers to delay the amendment of affected plans and agreements during a transition period, but required operational good faith compliance with the requirements of Section 409A during such period. This transition period is coming to an end. All affected plans and agreements must be amended to conform to the requirements of Section 409A by December 31, 2007.
Why Is This Deadline Especially Important for Public Companies?
Section 409A restricts certain distributions of nonqualified deferred compensation to specified “key” employees of public companies. This restriction must be enforced in the plan’s operation, and also must be expressly stated in each nonqualified deferred compensation plan or agreement sponsored by a public company that applies to specified “key” employees. The IRS has noted that purported “savings clauses” for Section 409A are not effective to bring plans into compliance if they contain noncompliant provisions.
Who Are Specified Key Employees?
Specified key employees are defined under the key employee rules applicable to 401(k) and other qualified retirement plans. The Final Regulations set forth the method of identifying such employees.
What is a Nonqualified Deferred Compensation Plan?
Deferred compensation is very broadly defined for purposes of Section 409A. Nonqualified deferred compensation plans can take various and surprising forms, such as stock option and other equity compensation plans, employment agreements, severance agreements, reimbursement arrangements, and bonus programs. Generally, any arrangement that provides payment in a future year for services performed in an earlier year potentially is subject to Section 409A and must be amended by December 31, 2007.
Failure to Comply May Result in Significant Consequences A violation of Section 409A results in the immediate taxation of the nonqualified deferred compensation, plus a 20 percent penalty tax and interest. Accordingly, companies with noncompliant plans may face liability to service providers and employees who incur adverse tax consequences as a result of noncompliant plans. In addition, noncompliant plans may affect the ability of companies to make representations relating to tax and employee benefits issues in corporate transaction agreements.
How to Proceed
All plans and arrangements that may provide deferred compensation should be reviewed as soon as possible to determine which 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 Maria Lumb at maria.lumb@hklaw.com or Greg Bailey at greg.bailey@hklaw.com or call toll free, 1-888-688-8500.