Many readers of this notice will be aware that § 409A imposes new federal income tax rules for nonqualified deferred compensation. Final § 409A regulations were published in 2007, but the effective date for full compliance was postponed by Notice 2007-86 to January 1, 2009. This notice highlights some of the key features of § 409A and outlines several steps that companies must take before January 1, 2009 in order to ensure compliance with the new rules. Up until the deadline, taxpayers are generally entitled to rely for compliance with § 409A on a “reasonable good faith” interpretation of the provisions of § 409A, Notice 2005-1, and other generally applicable guidance.

Section 409A applies to all plans and arrangements, with a few exceptions, that result or may result in a person receiving compensation for services in a calendar year after the calendar year in which the services are performed. For purposes of § 409A, nonqualified deferred compensation plans can include:

• Employment and management agreements
• Particularly discounted) stock options, stock appreciation rights, phantom stock units, certain restricted stock, and other equity-based compensation
• Severance agreements and noncompete agreements
• Change-in-control agreements and parachute payments
• Section 457(f) plans
• Split-dollar life insurance arrangements
• Multi-year bonus arrangements, performance-based plans, and long-term incentive plans
• Certain post-employment welfare benefits, fringe benefits, and reimbursements
• Independent contractor arrangements which defer compensation
• Supplemental or excess benefit plans
• Executor or trustee fees
• Taxable post-retirement benefits (including in-kind benefits for retired executives

Failure to comply with § 409A, either in documentation or operation, may result in the employee having: (i) immediate income tax inclusion of all amounts deferred for the current and preceding years; (ii) an additional 20% tax on the deferred amounts; (iii) interest on the deferred amounts; and (iv) additional tax at the state and local level. The employer is responsible for related reporting and withholding requirements.

Although we use the terms “employee” and “organization,” § 409A covers all deferrals of compensation between “service recipients” (including public and private, for-profit and non-profit, incorporated and unincorporated entities (including partnerships, limited liability companies, trusts, and sole proprietorships)), and “service providers” (whether rank-and-file employees, directors, key executives, third-party vendors, or independent contractors (both individual independent contractors or in corporate or unincorporated form)). Further, although the term “plans and arrangements” might imply formal plans covering a group of employees, § 409A applies also to individual deferral arrangements. “Full compliance” generally means that a nonqualified deferred compensation plan or arrangement be operated in accordance with a legally binding written document that subjects the plan or arrangement to all the applicable rules set forth in the § 409A final regulations. In most cases, this will require amendments to, or restatements of, existing plan documents or contracts; in some cases it will require documenting previously unwritten arrangements.

To avoid the imposition of severe tax penalties, every organization needs to take the following steps:

• Step 1: Determine who within the organization is responsible for ensuring § 409A compliance.
• Step 2: Conduct an inventory of all nonqualified deferred compensation plans and arrangements, including arrangements that may be included in employment agreements, severance arrangements, bonus and incentive plans, and stock-based compensation programs.
• Step 3: Determine how the requirements of the § 409A final regulations will apply beginning January 1, 2009 to the nonqualified deferred compensation plans and arrangements identified in Step 2.
• Step 4: To the extent applicable, determine the strategy for preserving the “grandfathering” of pre-2005 deferrals against application of § 409A.
• Step 5: Prepare new, or amend existing, plan documents and contracts by December 31, 2008 to make them fully consistent with the § 409A requirements identified in Step 3 and the application of any grandfathering identified in Step 4.
• Step 6: Conduct sufficient in-house training of human resources and tax compliance staff to ensure that all nonqualified deferred compensation plans and arrangements are administered in accordance with the applicable requirements of § 409A.
• Step 7: To the extent this has not already been done, determine the requirements of “good faith” compliance applicable to the plans and arrangements identified in Step 2 for the period from January 1, 2005 through December 31, 2008.

The § 409A final regulations are complex, and we have only provided a very brief overview of § 409A. We strongly advise you to seek professional assistance with respect to your specific issues. If you have any questions regarding this notice, please contact either: Gregory A. Novotny (415.981.1400; gnovotny@greeneradovsky.com) or Joseph S. Radovsky (415.981.1400; jradovsky@greeneradovsky.com).

PLEASE NOTE: This notice is published by Greene Radovsky Maloney Share & Hennigh LLP for informational purposes on general legal issues. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this information without seeking professional counsel.

CIRCULAR 230 COMPLIANCE: To ensure compliance with revised Treasury Regulations under Circular 230, this is to advise you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding tax-related penalties that may be asserted against the taxpayer. A taxpayer may rely on professional advice to avoid federal tax penalties only if that advice is reflected in a comprehensive tax opinion that conforms to stringent requirements under federal law.