The IRS recently issued final regulations under Section 409A of the Internal Revenue Code that will require many employers to take prompt action.
Section 409A, enacted in reaction to the Enron and other corporate scandals, introduced comprehensive new rules governing deferred compensation plans. Section 409A applies to deferred compensation plans for employees, independent contractors, directors and partners. The consequences of violating section 409A are severe: all amounts (plus earnings) for all years become currently includible in the participant’s income, and the participant becomes subject to a penalty equal to 20% of the includible income and interest on underpayment of income.
The final regulations confirm that the IRS intends for Section 409A to cover a wide range of arrangements, many of which might not usually be considered “deferred compensation.” In addition to traditional deferred compensation plans, other arrangements that might be subject to 409A include:
If an arrangement is subject to Section 409A, the plan must be operated in “good faith compliance” until December 31, 2007 and in accordance with the final regulations after that date. By December 31, 2007, a written document must be drafted (if none currently exists), or the existing plan document must be amended to include certain required provisions.
To make sure that this deadline is met, employers should immediately take action to: (1) inventory their arrangements; (2) identify which arrangements are subject to Section 409A; (3) determine whether a plan document must be drafted or what revisions are required to the existing plan document; (4) have the new document or amendment drafted and adopted.