Treasury Issues Limited Section 409A Transition Relief and Guidance
September 12, 2007
On September 10, 2007, the Treasury Department issued Notice 2007-78 (the “Notice”) promising “2008 Transition Relief and Additional Guidance on the Application of § 409A to Nonqualified Deferred Compensation Plans.” While the Notice does provide limited relief, it is by no means a general delay in the effectiveness of the final rules under Section 409A (January 1, 2008) and does not relieve companies from the need to review their plans for compliance prior to December 31, 2007. Rather, it provides additional time for companies to make certain plan amendments required by Section 409A. The Notice also provides some relatively helpful guidance. The following is a brief, high-level summary of the Notice.
Written Plan Compliance Transition Relief
Companies need to ensure that each of their deferred compensation plans timely designate in writing the time and form of payment of compensation deferred under each plan by December 31, 2007 (unless a later date is permitted under the final regulations themselves). The Notice provides that certain other required amendments to such plans may be made at any time prior to December 31, 2008 (retroactively to January 1, 2008), however, without disqualifying the plans. These include:
- Deleting certain written plan provisions that do not comply with Section 409A and adding certain written plan provisions necessary for compliance, so long as the plan, disregarding the presence or absence of such provisions, otherwise provides for a compliant time and form of payment.
- Conforming plan definitions of such terms as “change in control”, “disability”, “unforeseeable emergency” and “separation from service” to the definitions set forth in Section 409A.
- Specifying that tax-gross up payments must be made by the end of the employee’s taxable year next following the taxable year in which the employee paid the related taxes.
- Amending plans to change a specified payment date or fixed schedule of payments so long as it does not affect the taxable year in which the payment is made.
- Adding the six-month delay provision for specified employees.
However, it is important to note that at all times the plan must be operated in compliance with Section 409A and its provisions applied as if the foregoing amendments had already been made. It is also important to note that ensuring that plan provisions regarding the designation of a time and form of payment comply with Section 409A requires companies to review all deferred compensation plans in time to make any necessary amendments to such provisions.
Good Reason Guidance
While the Notice provides relief to amend a plan’s definition of “good reason” prior to December 31, 2007, in order to meet the involuntary separation safe harbor provisions of Section 409A, such relief appears to be limited to changing provisions that companies feel already meet the standard required under Section 409A (notwithstanding that they do not fall within the safe harbor) and to removing provisions that companies feel do not already meet the standard required under Section 409A. Moreover, any such amendments may not affect amounts that otherwise would be payable in 2007.
Employment Agreement Guidance
Substitution of benefits under one agreement for those under another presents Section 409A issues because it could be characterized as paying the same benefits at one time rather than another (that is, an acceleration or deferral of the time of payment). The Notice clarifies that the following does not constitute a substitution of benefits under a new employment agreement for benefits under an old employment agreement:
- Entering into a new agreement upon expiration of an old agreement or extending an old agreement that, in either case, did not provide for payment of compensation upon expiration of the term of the old agreement.
The Notice clarifies that the following may constitute a substitution of benefits under a new agreement for benefits under an old agreement:
- Renewing or extending an agreement that provides for the payment of compensation upon a nonrenewal of the agreement.
Companies that have employment agreements that provide for compensation upon nonrenewal need to revisit these agreements before they are next renewed as renewal could cause adverse Section 409A consequences.
Voluntary Compliance Program
The Notice states that the Treasury Department and the Internal Revenue Service anticipate establishing a limited voluntary compliance program with respect to certain unintentional operational failures in Section 409A compliance.
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A copy of Notice 2007-78 is attached. Please feel free to call any of your regular contacts at the firm or any of our partners and counsel listed under Employee Benefits in the Our Practice section of this website if you have any questions.
CLEARY GOTTLIEB STEEN & HAMILTON LLP