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Offer Deferred Compensation? Be Careful About Compliance

Congress enacted Section 409A (Sec. 409A) of the Internal Revenue Code more than 10 years ago in response to scandals involving Enron and other corporations. If you offer employees deferred compensation as a benefit, it is critical to stay familiar with Sec. 409A and its many requirements.

Applicable plans

Sec. 409A applies to most non-qualified deferred compensation arrangements, including bonus plans, supplemental executive retirement plans, certain severance pay plans, and equity-based incentive compensation plans such as stock options, stock appreciation rights (SARs), and phantom stock.

The requirements do not apply to qualified retirement plans, such as 401(k) plans. They also do not apply to most welfare benefit plans — for example, vacation, sick leave, compensatory time, disability, and death benefit plans.

Main requirements

For covered arrangements, Sec. 409A governs the timing of deferral elections and restricts the ability of participants to alter the form or timing of the payments. The law and regulations in this area are complex, but here is a quick summary of the main requirements:

  • Employees must make deferral elections before the beginning of the year in which they earn the compensation being deferred (except for certain performance-based compensation)
  • Benefits must be paid either: 1) on a specified date, 2) according to a fixed payment schedule, or 3) upon the occurrence of a specified event, such as death, disability, termination of employment, change in ownership or control of the employer, or an unforeseeable emergency
  • Sec. 409A prohibits plans under which the chief executive officer or board of directors has discretion over the timing or form of payment of vested benefits
  • Once compensation is deferred, payments can be delayed (by five years or more) but not accelerated; elections to delay benefits (or change the form of payment) must be made at least 12 months in advance

In addition, employers must maintain written plan documentation that is consistent with Sec. 409A’s requirements.

Documentation & operations

It is important to review your deferred compensation arrangement for Sec. 409A compliance regularly. Please call us for help evaluating your plan’s documentation and operations.

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