One-Year Extension of Section 409A Deadlines for Nonqualified Deferred Compensation

On October 4, 2006, the Internal Revenue Service (IRS) and the Department of the Treasury issued Notice 2006-79,¹ which pushes back many of the formal compliance deadlines for nonqualified deferred compensation programs under Section 409A of the Internal Revenue Code (IRC) until December 31, 2007 (from the December 31, 2006 extended deadline set in earlier guidance.²)

BRIEF BACKGROUND

IRC §409A, which was added in 2004 as part of the American Jobs Creation Act,³ superimposes a comprehensive new set of rules on nonqualified deferred compensation arrangements. Among the changes are new documentation requirements and tougher restrictions on employees' control over the timing and format of distributions. The definition of nonqualified deferred compensation under §409A is broad, encompassing such elements as stock options and severance payments. Violations of §409A will result in severe tax penalties on individuals covered by the programs.

Given the dramatic changes in established practices, the breadth of the law's reach and the tremendous variety of private-sector arrangements that now must be reshaped to comply, it has taken longer for the Treasury and IRS to craft appropriate regulations than Congress may have contemplated. While the agencies say that final regulations should be released before the end of 2006, in Notice 2006-79 they gave the private sector extra lead time to bring their programs into compliance.

THE NEW GUIDANCE

Notice 2006-79 includes the following:

• Extended transition relief (which is discussed in more detail below).
• Extension of the deadline for adopting the necessary documentation, and
• Extension of the period during which companies are treated as complying with the law if they satisfy a reasonable, good faith interpretation of those requirements, even if the final regulations set a stricter standard for the period after they take effect.

A plan sponsor will satisfy the reasonable, good faith standard if it follows (1) previously issued guidance in Notice 2005-14⁴; (2) the proposed regulations, which were published last October⁵; or (3) the final regulations, which the IRS and the Treasury Department expect to publish by the end of this year. However, the final regulations will not officially take effect until January 1, 2008.

The Transition Relief Provisions
The transition relief provisions under Notice 2006-79 answer the following questions:

• Do the §409A anti-acceleration and five-year re-deferral rules apply to new payment elections? No: New payment elections are allowed without regard to the §409A anti-acceleration and five-year re-deferral rules. However, any such election must be made before the year in which the original payment would have been made and cannot cause the payment to be made in the calendar year of the election.
• Can plan sponsors still link payments from supplemental executive retirement plans (SERPs) and qualified plans? Yes: SERP payments can continue to be linked to the timing and form of a payment under a qualified plan, for distributions in 2007.
• How is constructive receipt affected? Constructive receipt is not waived. In other words, the transition rule does not allow election of a new payment date for nonqualified deferred compensation in the same tax year that the nonqualified deferred compensation would be payable.
• What is the compliance deadline if the deferred compensation arrangement is maintained under a collective bargaining agreement? A deferred compensation arrangement maintained under a collective bargaining agreement in effect on October 3, 2004, is not required to comply with §409A before the earlier of (1) the date the last collective bargaining agreement in effect on that date terminated or (2) January 1, 2009.

Important: Notice 2006-79 does not provide transition relief for certain discounted stock options or stock appreciation rights issued by public companies. Under Notice 2006-79 these options or rights cannot be modified after December 31, 2006 to conform the exercise price to the fair market value price of the stock on the initial grant date, if the company expects to have to report an additional expense due to the grant of the options or rights that were not timely reported. (This includes, for example, backdated options.) However, the transition relief will be extended until December 31, 2007 if the expense for the discounted options or rights were reported in time or the company's securities are not publicly traded.

IMPLICATIONS

In light of this latest guidance, employers that offer nonqualified deferred compensation should continue:

• Identifying plans that are subject to §409A,
• Determining the impact of §409A on employees and others who receive nonqualified deferred compensation (e.g., directors), and
• Make sure that they are complying in operation with a reasonable, good faith interpretation of the law.

Segal/Sibson consultants can be retained to work with employers that offer nonqualified deferred compensation and their attorneys on strategies to adapt their programs to IRC §409A.

1	To see the Notice, click here. (To return to the Compliance Alert text, click here.)
2	IRS Notice 2005-1 (12/20/2004) made transition relief available through 12/31/2005, and the Preamble to the 2005 proposed regulations extended most of it, including certain delayed deadlines, through 12/31/2006. (To return to the Compliance Alert text, click here.)
3	To see Public Law No. 108-357, click here. (To return to the Compliance Alert text, click here.)
4	To see Notice 2005-1, click here. (To return to the Compliance Alert text, click here.)
5	To see the proposed regulations, which were published in the Federal Register on October 4, 2005, click here. (To return to the Compliance Alert text, click here.)

Compliance Alert, The Segal Company’s periodic electronic newsletter summarizing important developments affecting benefit plan compliance, is for informational purposes only. It is not intended to provide authoritative guidance. On all issues involving the interpretation or application of laws and regulations, plan sponsors should rely on their attorneys for legal advice.

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