Section 409A in a Nutshell

Onus of Section 409A -- Compensation subject to Section 409A may result in additional tax and interest to the employee, including an obligation on the part of the employer to report that the compensation is subject to such additional tax and interest, unless (i) the compensation does not constitute, or is excepted from the definition of, a "deferral of compensation" or (ii) payment of the compensation complies with Section 409A

Definition of Deferral -- the service provider has a legally binding right during a taxable year to compensation that is or may be payable to (or on behalf of) the service provider in a later taxable year [Final Treasury Regulations §1.409A-1(b)(1), all citations hereafter are to the Final Treasury Regulations], i.e., compensation for service performed during one taxable year payable in a later taxable year, subject to the following exceptions:

Customary pay practice exception --first pay period after the last day of the taxable year [§1.409A-1(b)(3)]

Short-term deferral exception -- payment is actually or constructive received on or before the last day of the 2-1/2-month period following the end of the service provider's, or service recipient's, taxable year [§1.409A-1(b)(4)]

Severance pay exceptions --

Separation pay exception --

Involuntary separation -- independent exercise of the unilateral authority of the service recipient to terminate the service provider's services [as defined §1.409A-1(n)]

For separation pay not exceeding two times the lesser of (i) annualized compensation based upon the annual rate of pay for the preceding taxable year (adjusted for any subsequent expected increase) or (ii) the §401(a)(17) limit on compensation that can be taken into account for qualified plans, and

Must be paid no later than the last day of the 2nd taxable year after the year of separation [§1.409A-1(b)(9)(iii)]

Collective bargaining agreement exception -- a collectively bargained separation pay plan that provides for separation pay only upon an involuntary separation (as defined above) from service or pursuant to a window program [§1.409A-1(b)(9)(ii)]

Window program exception -- separation made available for acceptance for a limited period of time no longer than 12 months [§1.409A-1(b)(9)(vi)]

Other Exceptions -- the following arrangements are not subject to section 409A

Any qualified plan under sections 401(a), 403(a), 403(b), 408(k), 408(b), 415(m), or 501(c)(18) [§1.409A-1(a)(2)]

Any section 457(b) plan [§1.409A-1(a)(2)(vii)]

Any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan [§1.409A-1(a)(5)]

Requirements to Comply with Section 409A --

Arrangement must be in writing [§1.409A-1(c)(3)]

Any elections by the service provider must be made and become irrevocable not later than --

General rule: Not later than the close of the service provider's taxable year next preceding the service year [§1.409A-2(a)(1) and (3)]

Service recipient rule: may provide that elections regarding fiscal year compensation may be made not later than the close of the service recipient's taxable year immediately preceding the first taxable year of the service recipient in which any services are performed [§1.409A-2(a)(6]

First year eligibility rule: in the case of the first year in which a service provider becomes eligible, may provide that election can be made within 30 days after the date the service provider becomes eligible with respect to compensation paid for services to be performed after the election

Part-year service period deferral rule: in the case of service for a recurring period (the "service period") less than 12 consecutive months, an election may be made to annualize compensation for such service if (i) the election is made before the services period begins, (ii) the election does not defer payment beyond the last day of the 13th month following the first date of the service period, and (iii) both the service recipient and the service provider reasonably anticipate the part-year service will continue in subsequent years [§1.409A-2(a)(14)]

Time and form of payment must be fixed from by no later than the later of the time the service provider first has a legally binding right [§1.409A-2(a)(2)]

Payments must be limited to one of six permissible events -- the relevant events being separation from service, becoming disabled, and death [§1.409A-3(a)]

No acceleration is permitted of the time or schedule of any payment or amount scheduled to be paid except under limited circumstances (such as separation from service) [§1.409A-3(a)]

Effective Dates and Extent of Compliance Required

The General Rule:

1. For periods prior to December 31, 2004, no compliance is required.

2. For periods beginning January 1, 2005 through December 31, 2008, there must be compliance with "a reasonable, good faith interpretation of the [statutory language of section 409A]" and that interpretation may not be inconsistent with the applicable guidance of IRS Notice 2005-1. Complying with a provision of the Final Regulations is deemed reasonable, good faith compliance.

3. For periods after December 31, 2008, there must be compliance with the Final 409A Treasury Regulations (which were issued on March 20, 2007).

Special Rule for Deferrals Pursuant to Collective Bargaining Agreements:

No compliance is required if the deferral is pursuant to a collective bargaining agreement in existence as of October 3, 2004 until the earlier of (i) termination of that bargaining agreement or (ii) December 31, 2009, after which time there must be compliance with the General Rule stated above