Deadlines for Amending Tax-Qualified Retirement Plans and Executive Bonus Arrangements Rapidly Approaching: Immediate Action Required

May 27, 2009

Two important deadlines for amending tax-qualified retirement plans (such as "401(k)" plans) and executive bonus arrangements are rapidly approaching. All employers need to review their plans and bonus arrangements and ensure that appropriate amendments are adopted in a timely manner.

Tax-Qualified Retirement Plans

Pursuant to IRS procedures that were issued in 2005, employers generally are required to adopt "good faith" amendments to their tax-qualified retirement plans no later than the end of the "remedial amendment period" for the year in which law changes become effective. For calendar year taxpayers, the remedial amendment period generally is September 15 of the next year.

The key changes that became effective for most plans in 2008 were the modifications to the regulations under section 415 of the Internal Revenue Code. Code section 415 sets limits on the amount of contributions and benefits that may be provided under tax-qualified retirement plans. Our April 16, 2007 Client Alert

addressed these regulations in detail. Among other things, the final section 415 regulations: (i) do not permit, with some limited exceptions, amounts paid after termination of employment to be treated as "compensation" under tax-qualified plans, and (ii) eliminate the special correction procedures applicable to contributions credited in excess of the section 415 limitations. Because these changes became effective for calendar year plans on January 1, 2008, calendar year taxpayers generally must amend their tax-qualified plans to reflect these changes no later than September 15, 2009. Failure to adopt timely plan amendments can result in significant IRS sanctions.

Executive Bonus Arrangements

Code section 162(m) provides that compensation payable to a "covered employee" of a public company in excess of $1 million in any year, other than "performance-based" compensation, is nondeductible to the public company. Covered employees generally include the public company’s chief executive officer and the three other most highly compensated executive officers other than the chief financial officer. Compensation must satisfy numerous requirements in order to qualify as performance-based. Among other things, the compensation must be payable "solely" upon achievement of one or more shareholder-approved performance goals. The IRS regulations under section 162(m) provide that compensation will not fail to be performance-based solely because it is also payable in connection with a change in control or the covered employee’s death or disability.

IRS private letter rulings in 1999 and 2006 provided that compensation also will not fail to be performance-based solely because it is also payable if the covered employee is terminated without cause, terminates for good reason or retires. However, the IRS changed its position in PLR 200804004, holding that compensation will not be performance-based for purposes of Code section 162(m) if it is payable without regard to whether the performance goals were achieved in those events even if the employee does not terminate employment and the compensation ultimately is paid upon achievement of the performance goals. In other words, because the amount could have been paid in connection with a without cause/good reason termination or voluntary retirement without regard to achievement of the performance goals, it was not payable "solely" upon achievement of the goals. Please see our February 22, 2008 Client Alert for more details.

The 2008 private letter ruling was very controversial. Following a barrage of complaints, the IRS issued Revenue Ruling 2008-13 on February 21, 2008. This Revenue Ruling affirmed the reasoning of the 2008 private letter ruling, holding that compensation cannot be performance-based if it is payable in the event of the covered employee’s "without cause/good reason" termination or voluntary retirement without regard to whether the performance goal is achieved. However, the Revenue Ruling provides important transition relief. In particular, the IRS will not enforce the new position in the following circumstances:

the period of service to which the performance goals relate begins on or before January 1, 2009; or
the compensation is paid pursuant to the terms of an employment agreement in effect on February 21, 2008 (without respect to future renewals or extensions, including renewals or extensions that occur automatically absent further action by the employee or the company).

Thus, except for the limited exception for preexisting employment agreements, the new rule generally will become effective for performance goals that apply to performance periods beginning on or after January 2, 2009. For calendar year taxpayers, this generally will mean performance periods beginning on January 1, 2010 and thereafter. In order to avoid risking the "performance-based" character of bonuses and other forms of compensation that are intended to be "performance-based" (e.g., performance-vesting restricted stock), executive employment agreements, bonus plans, and other documents should be reviewed, and generally must be amended as necessary no later than the day before the applicable performance period begins.

In order to preserve deductibility for bonuses relating to the 2010 calendar year and later periods, the relevant arrangements, except for "grandfathered" employment agreements as noted above, generally must be amended by December 31, 2009. Amending executive employment arrangements can be a time-consuming process that involves negotiating with the executive and obtaining compensation committee approval of any amendments. Thus, companies subject to Code section 162(m) should review their executive employment agreements, bonus arrangements and related documents as soon as possible to ensure that any required amendments can be adopted by the relevant deadline (December 31, 2009 in most cases).

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following:

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.