Tax Alert

Revise Non-Qualified Deferred Compensation Arrangements to Avoid Section 409A Penalties for Non-Compliance

November 9, 2010

Action Required by December 31, 2010

In 2004, the then newly enacted Section 409A of the Internal Revenue Code changed the tax rules applicable to non-qualified deferred compensation arrangements and imposed strict and complex requirements relating to election, distribution and acceleration provisions of such arrangements. Plans and arrangements that do not meet the Section 409A requirements are subject to immediate taxation upon vesting and the imposition of a 20% penalty and interest.

Over the years, the IRS has periodically issued guidance relating to Section 409A in the form of Notices and Proposed and Final Regulations. The guidance makes clear that Section 409A has wide applicability and requires a significant departure from many past practices. For example, a variety of typical compensation arrangements are now subject to Section 409A including:

  • severance agreements;
  • non-qualified stock options with an exercise price that is below fair market value as of the date of grant;
  • stock appreciation rights;
  • performance-based compensation and other bonus arrangements;
  • salary deferral plans; and
  • commission programs.

The IRS has extended the time within which to amend non-qualified deferred compensation plans and arrangements to comply with Section 409A without penalty to December 31, 2010. Because IRS guidance has evolved since Section 409A was enacted, Morse recommends that all non-qualified deferred compensation plans and arrangements (including plans and arrangements that have been previously reviewed) be reviewed for compliance with the latest guidance. Amendments to comply with Section 409A may be made after December 31, 2010, but penalties may apply.

For more information on tax issues for your business, please contact Chip Wry.

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