On Nov. 30, 2010, the IRS released Notice 2010-80, providing additional relief under which nonqualified deferred compensation plan documents which fail to comply with Section 409A of the Internal Revenue Code (Section 409A) may be amended to comply.
Nonqualified deferred compensation plans that are subject to Section 409A must comply with Section 409A in both form and operation. Under the statute and final 409A regulations, any failure to comply with Section 409A in form or in operation, regardless of materiality, generally subjects any employee or other service provider affected by the failure to immediate income inclusion (or income inclusion at the time of vesting, if later), a 20% additional income tax, and an additional interest tax on any compensation deferred under the plan or under any similar plan.
Certain operational failures may be corrected under Notice 2008-113 and, prior to the new guidance, certain document failures could be corrected under Notice 2010-6, in each case without adverse tax consequences to affected service providers, or with limited adverse tax consequences.
The new guidance expands the correction program for document failures and provides relief from certain information reporting requirements under both correction programs. Specifically, the new guidance:
- Permits two types of previously uncorrectable plan designs to be corrected under the 409A document correction program: (i) stock rights intended to comply with Section 409A and (ii) nonqualified deferred compensation plans where the benefit is linked to or offset by the benefit payable under another nonqualified deferred compensation plan or a qualified plan. Notably, nonqualified deferred compensation plans where the time or form of payment is linked to or determined by the time or form of payment under another nonqualified deferred compensation plan or qualified plan remain uncorrectable.
Example – Employer Y maintains a SERP under which plan benefits are determined by offsetting participants’ accrued benefits under Employer Y’s defined benefit pension plan. Employer Y’s shares are publicly traded, and therefore those SERP participants who are “specified employees” for purposes of Section 409A are subject to a six-month delay for any payments made from the SERP on account of their retirement or other separation from service. The SERP was not timely amended to include language requiring the six-month payment delay for specified employees. Employer Y may now utilize the document correction program to fix this error in the SERP.
- Provides an additional correction method under the 409A document correction program for failures relating to the timing of a deferred compensation payment being dependent on the service provider’s execution of a release or other similar document (a “release timing failure”). Namely, a release timing failure may be corrected by amending the plan to provide that, if the period in which the employee is required to sign the release (or other similar document) spans two taxable years, the payment will automatically be made in the later of the two years, regardless of the year in which the release (or other similar document) is signed. Previously, a plan with a release timing failure could only be corrected by being amended to provide for payment on a fixed date (either the 60th or 90th day following the payment triggering event).
Example – the SERP described above provides that benefit payments will commence on the first day of the month after a participant signs and does not revoke a release of claims against Employer Y. The SERP requires that the release be signed and not revoked within 60 days after a participant’s retirement or other separation from service. If the 60-day period spans two tax years or ends shortly before end of a tax year, a participant could affect which tax year in which payments begin by when they sign and return the release to Employer Y. The correction program would now permit Employer Y to correct the SERP document by adding a provision that requires that payments commence in the later of the two tax years in which payments could begin based on when the release was signed during the 60 day release consideration period.
- Provides a new transition rule under the 409A document correction program for release timing failures existing on Dec. 31, 2010, under which no document or operational failure is deemed to occur if either (i) payments are completed by March 31, 2011, or (ii) any payments made after March 31, 2011, where the release consideration period spans two taxable years, are made in the later of the two years (or, if made in the earlier of the two years, are treated as an operational failure and corrected under the 409A operational correction program). Under this transition rule, a plan with a release timing failure existing on Dec. 31, 2010 only needs to be amended to correct the failure if any payments under the plan occur after Dec. 31, 2012.
Example – Employer Y made a lump sum payment under the SERP in 2010 to a non-specified employee. Even though the SERP did not include release timing provisions that complied with the guidelines in the correction program, no special correction needs to be made with respect to this payment because it was completed before March 31, 2011. The same result would apply even if the payments had been made in the form of an annuity or periodic installments spanning beyond March 31, 2011, so long as the SERP did not treat each annuity or installment payment as a separate payment.
- Relieves a service recipient from having to provide an affected service provider with an information statement relating to any of the following corrections: a document correction for corrections made under the 409A document correction program prior to Dec. 31, 2010;a document correction for corrections made under the new transition rule described above for release timing failures;an operational correction for corrections made under the 409A operational correction program in the same taxable year in which the operational failure occurred.
- a document correction for corrections made under the 409A document correction program prior to Dec. 31, 2010;
- a document correction for corrections made under the new transition rule described above for release timing failures;
- an operational correction for corrections made under the 409A operational correction program in the same taxable year in which the operational failure occurred.
- Relieves the service provider from having to attach an information statement relating to any of the corrections described above to his or her individual income tax return. However, the new guidance does not relieve the service recipient from having to attach the required information statement to the service recipient’s own income tax return for the year of the failure.
Example – Employer Y takes action before Dec. 31, 2010 to amend the SERP to correct the absence of a six-month delay provision and the release timing issue. Employer Y meets the eligibility requirements of the correction program and makes the two corrections in accordance with the specific requirements of the correction program (including the special rule for correcting six-month payment delay errors which requires delay for the later of 18 months following the date of the correction or six months from the date of retirement/separation from service). By taking these actions before the end of 2010, Employer Y is not required to send correction notices to participants in the SERP but must still attach a correction notice to its own tax return for the 2010 tax year.