October 2007

On April 10, 2007, the Department of Treasury issued final regulations implementing section 409A that was added to the Internal Revenue Code in October, 2004 (the “Final 409A Regulations”). On September 10, 2007, the IRS issued Notice 2007-78 that extended the deadline for documenting amendments of deferred compensation arrangement in existence after December 31, 2004 for compliance with section 409A. This Notice extended only the deadline by which final amendments must be documented and adopted. The Notice does not, however, change:

• The requirement that plans in existence prior to January 1, 2005 must be complying with the good faith transition guidance of IRS Notice 2005-1, the preamble to the proposed regulations under section 409A, or IRS Notice 2006-79 for all periods after December 31, 2004 (collectively the “Interim Guidance”), including initial elections as to the time and form of payment, subsequent changes in those election, and limiting payment to the six payment events permissible under section 409A.
   
• The requirements that plans in existence on December 31, 2007 must have designated in writing, either in a plan document or a separate written instruments, the time and form of payment that are compliant with section 409A no later than December 31, 2007 with respect to amounts accrued before 2008. The writing must designate the time and form of payment as well as the event triggering payment.
   
• The requirement that employment and other agreements, including plan documents, in existence after December 31, 2004 containing definitions of involuntary separation, including separation for good reason, that will be relied for creating a substantial risk of forfeiture for purpose of section 409A must be modified to comply with the requirements of the Final 409A Regulations not later than December 31, 2007.
   
• The requirements that deferred compensation arrangements must comply in good faith with the requirements for eliminating provisions allowing transfer of assets to off-shore trusts or restricting use of employer assets solely for purpose of paying deferred compensation because of changes in the employer’s financial health in violation of section 409A(b).

The biggest change in the Final 409A regulations for most taxpayers will result from the plan aggregation rules requiring aggregation of like kinds of plan. Despite these new rules, we are recommending generally that:

• Not later than December 31, 2007 clients amend deferred compensation arrangement in existence at any time after December 31, 2004 to be compliant, to the full extent possible, with the final 409A Regulations; and
   
• During 2008, but not later than December 31, 2008, clients review the extent that their deferred compensation arrangements are in compliance with the final 409A Regulations, including the plan aggregation rules.

Because section 409A defines deferred compensation so broadly and because the penalties to employees for noncompliance is so draconian, we recommend that employers and employees have any form of arrangement that may constitute a deferral of compensation other than pursuant to a qualified retirement plan be reviewed by tax counsel or advisers familiar with section 409A. These include arrangement for severance pay, supplemental retirement benefits or SERPs, stock appreciation rights, restricted stock, restricted stock units, and non-qualified stock options.