Section 409A in 2009 and Beyond...

Posted by Seth I. Corbin, Fox Rothschild LLP

Now that the rush to amend all existing deferred compensation plans to comply with Section 409A has passed, the buzz surrounding Section 409A has quieted significantly. Although the transition period to bring documents into compliance ended on December 31, 2008, the same Section 409A issues employers and employees have struggled with for the past several months extend into 2009 and are likely here for many years to come. Namely, deferred compensation plans must continue to comply with the onerous Section 409A requirements, in both form and operation, in order to avoid the tax and penalties associated with any violation.

 

Section 409A implicates a variety of deferred compensation arrangements, including severance pay agreements and employment agreements that provide for severance, salary continuation, separation pay, and even bonuses. As many businesses are forced to consider workforce reductions in 2009, it is imperative that employers remain mindful of Section 409A. A failure to comply with Section 409A could result in the immediate recognition of income to the employee, a 20% excise tax penalty, and IRS interest. Additionally, employers have enhanced reporting and withholding responsibilities.

 

The final regulations under Section 409A apply to severance plans and refer to such plans as “separation pay plans.” Although the Section 409A regulations exclude certain separation pay plans from coverage under Section 409A, each separation pay plan must be carefully examined on a case-by-case basis to determine whether Section 409A applies and, if so, whether the plan should be revised to comply with its requirements.

 

Section 409A generally prohibits the acceleration of payments, the discretion to alter a payment schedule, and limits offsets against payments under a separation pay plan. These prohibitions can often be avoided with careful drafting of separation pay plans and without disrupting the original business intent of the parties involved. Additionally, reimbursements under a separation pay plan of an employee’s deductible medical expenses are excluded from Section 409A to the extent the right to reimbursement applies during the period when the employee would be entitled (or would, but for such plan, be entitled) to COBRA continuation coverage if the service provider elected the coverage and paid the applicable premiums.

 

In a bit of good news, the IRS recently announced a limited correction program for inadvertent and unintentional Section 409A operational failures. The correction program permits self-correction with reduced penalties for such operational failures as erroneous payments of deferred compensation and impermissible acceleration of payments. While not all failures may be corrected using this program, it remains a valuable option if and when Section 409A errors are discovered.

 

For more detailed on the status of 409A see our recent Alert: www.foxrothschild.com/uploadedFiles/alert_feb
09_empBenefits409ADeadline.pdf

 

 

 

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