Excerpt:
Section 409A, which became effective January 1, 2005, is an extremely broad law that covers many arrangements not generally considered deferred compensation, such as stock options, severance pay, bonus arrangements, etc. In general, 409A governs any arrangement where an employee or consultant has a vested right to compensation in one year that will be paid in a later year. Such arrangements may be designed to fit into one of the exemptions to 409A. If not exempt, however, the arrangement must meet strict rules, including rules as to time and form of payment (that must be documented), and it is very difficult to make changes to the arrangement once it is in place. Any deferred compensation arrangement that is not exempt from 409A and does not comply with the rules of 409A will subject the employee or consultant to income tax liability at the time that the right to payment vests (even if there is no right to payment at that time and thus no money available to pay the tax liability), together with a 20% penalty tax on the deferred amount.
Under a transition period that has been in effect since adoption of the new law, it has been sufficient to be in “good faith” compliance with 409A, and certain changes to deferral arrangements have been permitted. That transition period will end as of December 31, 2008, and no further postponements of this deadline are expected. Beginning on January 1, 2009, the final regulations under 409A will be in effect, and all deferral arrangements must be in full compliance with 409A.
All employers, whether public or private companies, should take the following action prior to December 31, 2008:
- Review all arrangements for the payment of deferred compensation to confirm full compliance - both in form and operation - with Section 409A.
- Make any desired changes to the time or form of payment under existing arrangements.
- For public companies only, ensure that any arrangement for payment of deferred compensation to a “key employee” upon separation from service provides for a six month delay in such payment, as discussed below.
The following checklist provides some guidance for regularly-occurring 409A issues. Given the broad coverage of 409A and the complexity of the 409A guidance, however, a complete discussion is beyond the scope of this overview. We strongly recommend that all companies consult their legal advisers as soon as possible with respect to 409A compliance.
This update also covers:
- Stock Options
- Employment, Change in Control and Severance Agreements
- Traditional Deferral Arrangements and SERPs
Download the Foley Hoag Taxation Update - September 23, 2008