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On October 22, 2007, the IRS released Notice 2007-86, providing broad relief from the documentary compliance requirements for deferred compensation arrangements subject to Internal Revenue Code Section 409A through December 31, 2008. Notice 2007-86 supersedes IRS Notice 2007-78 released just six weeks earlier, which had provided more limited relief. The new notice was issued in response to a barrage of complaints that the limited relief provided under the September notice was insufficient to prevent widespread compliance problems given the difficulty of satisfying even its minimal requirements.
The prior notice required that plans specify in writing, before the end of 2007, Section 409A-compliant provisions for the time and form of payment of deferred compensation, though plan documents would not otherwise have had to comply with Section 409A until the end of next year. Under the new notice, however, plan documents are not required to provide even compliant time and form of payment provisions until the end of 2008. Importantly, while under the new guidance, plan documents do not have to be amended before December 31, 2008 to comply with Section 409A, plans must operationally comply with the statute currently. Therefore, extreme caution is advised because operating a plan strictly in accordance with its existing terms may result in violations of Section 409A.
Virtually any type of compensation arrangement, including one embodied in an ordinary employment contract, may be subject to the stringent requirements and potentially punitive sanctions of Section 409A. If the arrangement fails to comply, the compensation will be presently includible in income (whether or not it has been paid) and will be subject to an additional excise tax of 20 percent, plus interest on the amount involved from the date the arrangement first failed to comply with the statute. In addition to employment contracts, affected arrangements may include change in control agreements; bonus, severance and supplemental executive retirement plans; stock option and other equity-based compensation programs; consulting agreements; split-dollar life insurance; and other programs under which an employee or other service provider is deemed to have a deferral of taxable income.
The statute prescribes specific time frames for making elections to defer income and provides that both the time and form of payment must be specified at the time of the deferral or be stated in the governing plan document. The arrangement cannot provide for distributions prior to the earliest of (i) employment termination; (ii) disability; (iii) death; (iv) a change in control of the entity; (v) occurrence of an unforeseeable emergency; or (vi) a specified date (or pursuant to a fixed schedule set forth in the plan). With limited exceptions (e.g., to the extent required by a domestic relations order), any acceleration of payments is prohibited.
Final regulations under Section 409A were published in April of this year. The regulations run 397 pages and cover innumerable aspects of compensation arrangements involving myriad complexities of interpretation and application. The issuance of Notice 2007-86 provides some welcome relief to plan sponsors and their advisors attempting to bring plan documents into compliance with all of the applicable regulatory requirements.
It remains crucial, however, to keep in mind that the extension applicable to documentary compliance does not alter the requirement for current and ongoing operational compliance with the statute, which in many cases will necessitate disregarding existing plan provisions and implementing procedures not specified in the documents. Notice 2007-86 also extends through 2008 certain transition relief that allows plan participants to change existing payment elections, subject to various limitations. Due to the complexities involved in the application of Section 409A to even the simplest of deferred compensation plans, it is advised that qualified tax counsel be consulted concerning these arrangements.
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