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On January 5, 2010, the Internal Revenue Service ("IRS") issued Notice 2010-6 (the "Notice"), which provides methods that employers can use to voluntarily correct plan document failures under Section 409A of the Internal Revenue Code of 1986, as amended. The Notice also provides clarification of the correction of certain operational failures. This alert will focus on the correction of Section 409A plan document failures.
As discussed more fully below, the Notice provides long-term relief, but time is of the essence because certain document failures that are corrected before the end of 2010 generally are treated as if the failure never occurred.
The following chart highlights the type of plan document failures that can be corrected under the Notice.
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Failure
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Plan Correction
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Income Inclusion
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The plan provides that payment is to be made as soon as reasonably practicable following a Section 409A permissible payment event.
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The payment event will be treated as the payment date if the payment is made no later than December 31 or the 15th day of the third calendar month following the payment event.
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No.
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The plan designates a Section 409A permissible payment event (e.g., termination of employment), but does not define the event, or the definition is ambiguous such that the payment event can be interpreted to be Section 409A compliant or non-compliant.
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The plan is amended to either (i) add language requiring the terms to be interpreted in accordance with Section 409A, or (ii) set forth specific definitions that comply with Section 409A.
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No.
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The plan provides for payment upon the change in the employer-employee relationship (e.g., full-time to part-time, employee to independent contractor) that does not qualify as a separation from service under Section 409A.
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The plan is amended to provide for Section 409A payment events. The amendment may not have the effect of including a payment event that was not previously a payment event or eliminating a payment event, except as necessary to satisfy Section 409A.
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If, within one year following the date of correction, an event occurs that is not a separation from service under Section 409A but would have been under the pre-correction plan provision, 50 percent of the amount to which the pre-correction plan provisions would have applied must be included in income for the year in which the event occurs.
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The plan provides for payment upon a change in control, and the definition of change in control does not satisfy Section 409A.
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The plan is amended to provide for a change in control event that satisfies Section 409A, provided that the amendment may not have the effect of including a payment event that was not previously a payment event.
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If, within one year following the date of correction, a transaction occurs that is not a Section 409A change in control but would have been under the pre-correction plan provision, 25 percent of the amount deferred to which the pre-correction plan provisions would have applied must be included in income for the year in which the event occurs.
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This plan provides for a payment event that is related to the employee's illness or other incapacity, but that does not satisfy the definition of disability under Section 409A.
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The plan is amended to (i) remove the payment event, or (ii) define the payment event as a disability under Section 409A.
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No.
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The plan provides for a payment period that is later than 90 days and earlier than 366 days following a permissible payment event.
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The plan is amended either to (i) remove the non-compliant payment, or (ii) set forth a Section 409A payment period.
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If the plan is amended within a reasonable time after the occurrence of the payment event, 50 percent of the amount deferred under the plan to which the pre-correction plan provision would have applied is included in income for the year in which the event occurs.
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The plan provides for payment upon a permissible payment event but conditions the payment on an employment-related action of the employee, such as the execution and submission of a non-competition agreement, a non-solicitation agreement or a release of claims.
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The plan is amended to remove the ability of the employee to delay or accelerate the timing of payment. If the plan provides for payment (subject to the employee's action) within a Section 409A compliant period, payment must be made on the last day of such period. If not, payment will be made 60 or 90 days following the payment event.
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No.
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The plan provides for permissible and impermissible payment events under Section 409A.
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The plan is amended to remove the impermissible payment events.
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If, within one year following the date of the correction, one of the impermissible payment events occurs, 50 percent of the amount to which the pre-correction plan provisions would have applied must be included in income for the year in which the event occurs.
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The plan provides for only impermissible payment events.
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The plan is amended to remove the impermissible payment events and to provide that payment will be made upon the later of the employee's severance from service or the sixth anniversary of the date of the correction.
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The employee must include in income 50 percent of the amount to which the pre-correction plan provisions applied in the year in which the correction occurs.
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The plan provides for more than one time or form of payment related to the employee's voluntary and involuntary separation from service.
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The plan is amended to provide that the form of payment upon a voluntary separation from service will be the same form of payment that the pre-correction plan provision provided for upon an involuntary separation from service.
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If an employee has a voluntary separation from service within one year following the date of correction, and as a result of the amendment an amount is not paid, 50 percent of the amount that is not paid must be included in income for the year in which the event occurs.
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The plan provides for more than one time or form of payment not related to the employee's voluntary and involuntary separation from service.
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The plan is amended to remove the forms of payment such that the remaining form of payment is the form resulting in, or potentially resulting in, the latest final payment date.
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If, within one year following the date of the correction, a payment event occurs, 50 percent of the amount to which the pre-correction plan provision would have applied must be included in income for the year in which the event occurs.
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The plan provides the employee or employer with discretion to change the time or form of payment following a permissible payment event, which is not otherwise permitted under Section 409A.
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If a plan has a default time or form of payment that would be in effect if the employee or employer did not exercise discretion, the plan may be amended to remove the discretion. If a plan does not have a default time or form of payment, the plan may be amended to remove the discretion and to apply the potential time or form of payment under the terms of the plan in place immediately prior to the amendment that would result in the latest final payment date.
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If, within one year following the correction date, a payment event occurs, 50 percent of the amount to which the pre-correction plan provision would have applied must be included in income for the year in which the event occurs.
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The plan provides the employer with the discretion to accelerate and make a payment regardless of whether a Section 409A payment event has occurred.
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The plan is amended either to (i) remove the employer's discretion to accelerate the payment, or (ii) otherwise make the acceleration compliant under Section 409A.
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No.
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The plan provides for reimbursements or in-kind benefits subject to Section 409A that do not comply with Section 409A.
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The plan is amended to provide for reimbursements or in-kind benefits that satisfy Section 409A, provided that the amendment causes the amount eligible for reimbursement or in-kind benefits to be allocated pro-rata to the number of years during which the employee may be eligible to receive the reimbursements or in-kind benefits (which may not be amended as part of the plan correction).
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If, within one year following the correction date, an event occurs that would have made the employee eligible for payment of reimbursements or in-kind benefits, and as a result of the amendment the availability or payment of reimbursements or in-kind benefits was removed or reduced, 50 percent of the amount deferred to which the pre-correction plan provision would have applied must be included in income for the year in which the event occurs.
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The plan provides the employee or employer with discretion to change the time or form of payment following a permissible payment event, which is not otherwise permitted under Section 409A.
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If a plan has a default time or form of payment that would be in effect if the employee or employer did not exercise discretion, the plan may be amended to remove the discretion. If a plan does not have a default time or form of payment, the plan may be amended to remove the discretion and to apply the potential time or form of payment under the terms of the plan in place immediately prior to the amendment that would result in the latest final payment date.
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If, within one year following the correction date, a payment event occurs, 50 percent of the amount to which the pre-correction plan provision would have applied must be included in income for the year in which the event occurs.
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The plan fails to include the six-month delay of payment for specified employees.
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The plan is amended to add the delay language and to provide that an amount payable under the plan that is subject to the delay may not be paid before the later of (i) 18 months following the date of correction, or (ii) six months following the date of the payment event.
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If a specified employee separates from service within one year following the date of correction, 50 percent of the amount deferred under the plan to which the pre-correction plan provision would have applied (and that thus is delayed because of the amendment) must be included in income for the year in which the separation from service occurs.
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The plan provides for an initial election to defer compensation that does not comply with Section 409A (plan provisions providing elections to defer compensation that would not otherwise be deferred compensation, and not elections as to the time and form of payment of a deferred amount).
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The plan is amended to remove the ability to make the impermissible initial deferral election, provided that any amounts that were not paid during one or more years due to the impermissible initial deferral election are corrected in accordance with the provisions of Notice 2008-113.
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To the extent income inclusion is required under Notice 2008-113.
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If an employer corrects a plan document failure, it must take all reasonable steps to identify and correct substantially similar failures under all its non-qualified deferred compensation arrangements. The relief provided under the Notice is not available if the employee or the employer is under examination with respect to non-qualified deferred compensation for any taxable year in which the failure existed. Finally, the above chart does not address excise tax issues or timing issues.
Employers should review their non-qualified deferred compensation arrangements early in 2010 to verify that the written documents comply with Section 409A. If the plan is corrected in accordance with the Notice on or before December 31, 2010, the plan generally may be treated as having been corrected on January 1, 2009.
If you have any questions regarding Section 409A plan document corrections or would like us to assist in the review of your non-qualified deferred compensation arrangements, feel free to call a member of the firm's Employee Benefits and Executive Compensation group.
