IRS Extends Code Sec. 409A Document Compliance For One More Year; But Otherwise Keeps Year-End Deadline

by Brant Goldwyn
October, 2007

IR-2007-157, Notice 2007-78

In a surprise move, the IRS has extended the document compliance deadline under the Code Sec. 409A nonqualified deferred compensation regs for one year, to December 31, 2008. It also has provided transitional relief on certain other requirements and promises a voluntary compliance program for the correction of unintentional operational violations.

Nevertheless, the January 1, 2008 effective date for compliance with the final regs otherwise stays firm. The IRS is remaining firm that employers will have to operate their plans in compliance with the final regs during 2008.

CCH Take Away. "It's an important development; this is very welcome relief," Andrew Liazos, partner at McDermott Will & Emery LLP, Boston, told CCH. Liazos cautioned, however, that "there is no more good faith compliance, as of January 1, 2008. Plans must comply with the final regs. Just because you have a delay of the plan document deadline ... people have to be careful not to interpret this too broadly. There's still work to do."

Fred Oliphant and Gary Quintiere, partners at Miller and Chevalier, LLP, Washington, also advised approaching this "relief" with caution, telling CCH, "At most it's half a loaf, no more. This may not do much for employers. They still have to go to plan participants by the end of 2007 to determine elections. Employers cannot sit back and wait until 2008 to decide how the plan works."

Background

Code Sec. 409A provides strict, broad-brush rules for the taxation of nonqualified deferred compensation arrangements. Although Code Sec. 409A has been officially on the books and effective because of the American Jobs Creation Act of 2004 since January 1, 2005, Code Sec. 409A itself is not sufficiently complete or inclusive. To fill in the gaps, IRS regulations and other directive guidance have been necessary. Promulgating these rules has been an arduous process; final regs were only finally published this past April.

Starting in mid-summer, practitioners launched an intense lobbying effort against the current January 1, 2008 effective date. It culminated in a letter sent in late August to Acting IRS Commissioner Kevin Brown on behalf of 92 law firms that stated that the rules were too complex and the task of bringing documents into conformity too daunting to make the December 31, 2007 deadline.

Retroactive amendment period

Under the new guidance, a nonqualified deferred compensation plan will not violate Code Sec. 409A merely because the written provisions of the plan fail to meet the requirements of the final Code Sec. 409A regs 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.

Compliant time and form of payment

Unless an exception in the final regs applies, the new guidance provides that 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. Further, 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 regs. Rules on how to designate a "compliant time and form of payment" are set forth in the new guidance.

Comment:

The IRS also took this opportunity to issue guidance and additional relief to address certain issues raised by practitioners involving application of the final regs to certain employment agreements (including good-reason provisions and the substitution rule) and predetermined cashout features.

Voluntary compliance program

The IRS announced that it expects "in the near future" to establish a limited voluntary compliance program that will allow certain unintentional operational failures to be corrected in the same tax year and avoid application of Code Sec. 409A taxes and penalties. It also anticipates that the program will permit other correction methods that will result in only limited amounts becoming included in income and subject to penalties.

No offshore trust relief

The new guidance makes it clear that the grace period provided to offshore trusts in Notice 2006-33 is not being extended beyond its December 31, 2007 deadline. For such grace period assets, a nonqualified deferred comp plan must be in conformity with a reasonable, good faith interpretation of Code Sec. 409A on or after December 31, 2007.