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U.S. Issues Final Requirements for 'Nonqualified' Deferred Compensation Plans
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April 23, 2007
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By Benjamin I. Delancy
Thelen Reid Brown Raysman & Steiner LLP
Internal Revenue Code §409A imposes detailed requirements on "nonqualified deferred compensation plans," which are broadly defined to include such things as separation pay, certain stock rights and traditional deferral arrangements. Violating those rules causes immediate taxation plus a 20 percent penalty. Final §409A regulations were released on April 10, 2007, and were published in the Federal Register on April 17, 2007. The regulations generally are effective January 1, 2008. Before that, taxpayers generally may continue to rely on the existing transition guidance.
This report identifies many of the significant changes from the September 2005 proposed regulations, some transitional issues addressed in the final regulations and some of the documentation requirements contained in the final regulations.
Significant Changes from the Proposed Regulations
Stock Rights: The final regulations significantly expand the definition of service recipient stock and provide much greater flexibility for structuring stock options and stock appreciation rights to avoid §409A, for valuing stock that is not publicly traded, and for extending options without triggering §409A.
Separation Pay: The final regulations provide greater flexibility for separation pay arrangements, including amounts paid upon separation from service for good reason and the ability to rely on one or more of the exceptions from §409A while also paying amounts that are subject to and comply with §409A. There also are new rules addressing post-termination reimbursements and other fringe benefits.
Separation from Service: The final regulations liberalize the definition of separation from service, more clearly address the consequences of various leaves of absence, and provide significant flexibility for determining whether a separation from service occurs in the context of corporate transactions.
Six-month delay for specified employees: The final regulations provide more flexibility for identifying employees subject to the six-month delay. The new rules also significantly alter the identification of the specified employees following a corporate transaction.
Subsequent elections: The final regulations clarify when companies may add or delete payment events without satisfying the subsequent election rules.
Plan terminations: The final regulations change the rules applicable to plan terminations, both adding new restrictions and relaxing previously proposed restrictions.
Plan requirements: The final regulations clarify which provisions must be included in written plan documents and also clarify that terms of a plan may be provided in more than one document.
Transition from Good Faith Positions
The final regulations describe how plan sponsors can move from the "reasonable good faith" transition period to full compliance. These transition rules address issues such as:
 | The treatment of stock rights granted before April 10, 2007 (the publication date of the final regulations) that comply with earlier transition guidance but not the final regulations (e.g., fair market value exercise price, extensions, service recipient stock).
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| The continued effectiveness of initial deferral elections in effect before January 1, 2008, and deferral elections relating to performance-based compensation programs established before April 10, 2007.
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| The need for elections relating to the time and form of payment to comply fully by January 1, 2008.
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| The treatment of participants who either are in pay status before January 1, 2008, or who, according to the final regulations, should be in pay status before that date.
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| The extent to which companies may rely on a good faith application of the six-month delay for specified employees if a separation from service occurs before January 1, 2008.
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Documentation Requirements
The final regulations provide that plan documents must fully comply with §409A, effective January 1, 2008. To comply with §409A, plan documents generally must, on or before December 31, 2007, contain:
| The material terms, including the amount (or method or formula) of deferred compensation and the payment schedule or payment triggering events.
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| The six-month delay requirement (for public companies).
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| The conditions for electing deferrals.
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The final regulations do not require plan sponsors to amend plan documents to comply for periods before 2008. However, the taxpayer must be able to demonstrate that the plan was operated in compliance with the transition guidance, and this will be easier to do if the plan documents are amended to reflect actual operation. In addition, if a plan does not comply with §409A on or after January 1, 2008, that violation will not affect any amounts for any taxable year before January 1, 2008, if the taxpayer can demonstrate operational compliance with the transition guidance.
To view the final regulations and their preamble, click here.
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For more information about the issues covered in this report, please contact Benjamin I. Delancy in our Washington, D.C. office at 202-508-4081 or at bdelancy@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2007 Thelen Reid Brown Raysman & Steiner LLP
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