Employee Benefits & Executive Compensation Benefits Alert – Spring 2006
Deadline for 409A Compliance Approaching
The December 31, 2006 deadline for employers to update employment agreements and plan documents providing nonqualified deferred compensation arrangements in compliance with the new rules under Code section 409A is quickly approaching. In addition, payroll systems must be in place to comply with the new reporting requirements.
Consequences of Failure to Comply with New Requirements
The consequences to employees covered under these arrangements for failure to comply with section 409A are significant. Indeed, one Department of Treasury attorney has described the consequences as “catastrophic.”
If a nonqualified deferred compensation arrangement does not comply with section 409A, the affected employee will be subject to:
- income tax on the deferred amounts,
- an additional tax of 20 percent on that amount, and
- interest at the underpayment rate (currently 7 percent) plus one percent from the later of the taxable year the amount was first deferred or when it vested.
Updating Employment Agreements and Plan Documents
While the taxes and interest fall on the employee, it is the employer who is primarily responsible for keeping such arrangements in compliance with changing tax laws. The burden will generally fall on general counsel and human resource professionals to raise the issue and put in motion the processes to ensure compliance. Since the affected employees will often be the employer’s most valued employees, such amendments should have a high priority.
Most nonqualified deferred compensation arrangements will be easily identified. Other amounts that may be subject to 409A include certain stock appreciation rights, discounted stock options, separation pay arrangements (severance pay plans and certain reimbursement arrangements), performance-based compensation, and bonus plans.
Beginning in 2006, all deferrals for the year under a nonqualified deferred compensation plan must be separately reported on Form W-2. Annual reporting of all compensation deferred under a plan for the year is required regardless of whether such compensation is includible in gross income pursuant to 409A. The Internal Revenue Service will be issuing additional guidance this year to assist employers in determining the deferral amount for various types of plans.
Action Plan for Compliance
The employer’s representative responsible for ensuring that nonqualified deferred compensation arrangements comply with applicable laws, including tax laws, should take steps as soon as possible to ensure that all arrangements are 409A-compliant. The following steps should be a part of that process:
- Develop a comprehensive list of all employment agreements and nonqualified deferred compensation arrangements.
- Have all existing employment agreements reviewed to determine if the terms provide for nonqualified deferred compensation.
- Review existing nonqualified deferred compensation arrangements to determine if they are subject to 409A and comply with the new rules.
- Consolidate plan provisions into a single comprehensive document to the extent possible to simplify the review and amendment process.
- Be mindful and proactive with respect to these rules for all new employment agreements.
- Consult with payroll service provider to prepare for new reporting requirements.
The Employee Benefits team at Kaufman & Canoles is available to assist you with reviewing and updating these arrangements. Click here to request more information regarding this Benefits Alert.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.