December 31, 2012 Deadline for Amending Certain Severance and Other Arrangements for Section 409A Compliance

September 14, 2012

Employers Should Review Plans and Agreements in Which Payment is Conditioned Upon Signing a Release or Agreement to Comply with Restrictive Covenants

Many severance and other arrangements require a terminating employee to execute a release of claims and/or agree to abide by various restrictive covenants (e.g., non-compete, non-solicit, confidentiality, etc.) in order to receive payment.  This may allow the employee to effectively choose the year in which taxation occurs, because the employee controls when the release or restrictive covenant agreement is executed.  If the arrangement is subject to the nonqualified deferred compensation rules of Section 409A of the Internal Revenue Code (the “Code”), this flexibility could result in a violation of Section 409A.

In order to address this issue, in 2010 the IRS issued guidance providing transition relief that allows amendments of arrangements subject to Section 409A of the Code (“Section 409A”) that condition payment upon execution of a release or similar restrictive covenant agreement.  Under that guidance, the deadline by which arrangements implicated by the guidance must be amended is December 31, 2012.


Section 409A imposes significant penalties on deferred compensation amounts paid to employees under a compensation arrangement that does not meet various specified requirements.   In particular, payments under arrangements that do not comply with the requirements may be subject to accelerated inclusion in income, an additional 20% tax, and an interest charge.  Certain states (most notably California) levy additional parallel taxes.  In general, an arrangement is subject to Section 409A unless, under the terms of the arrangement, all amounts must be paid no later than March 15 of the year following the year in which the right to payment “vests.”  Although many severance arrangements are designed to avoid coverage by Section 409A, some arrangements, especially for top executives, are subject to Section 409A (e.g., because they pay out significant severance amounts over time).  A more detailed analysis of the application of Section 409A to severance arrangements is discussed here:  IRS Releases Final Section 409A Regulations on Deferred Compensation.

In Notice 2010-6, the IRS stated that certain compensation arrangements may not comply with Section 409A where the employee’s right to receive payment is conditioned on action by the employee, such as execution of a release of claims, non-competition agreement, or other restrictive covenant.  According to the IRS, such arrangements fail to comply with Section 409A if the employee is able to determine the year in which the payment is made, and thus the year in which such payment will be subject to tax, by controlling the timing of execution of the release (or other restrictive covenant agreement).

Notice 2010-6 provided transition relief permitting employers to amend any such problematic compensation arrangements and avoid the penalties imposed under Section 409A.  Notice 2010-80 updated that notice and extended the relief to permit certain corrections to be made through December 31, 2012 with respect to provisions that were in effect as of December 31, 2010.

Amending for Compliance

Employers should review any plans or arrangements (including employment agreements, severance agreements, etc.) that condition payment upon execution of a release agreement, non-competition agreement, or other restrictive covenant agreement to determine whether they are subject to Section 409A, and if so, if they raise the concerns specified in Notice 2010-6.  Employers should amend these plans or arrangements prior to expiration of the transition relief on December 31, 2012.

If the compensation arrangement currently in place specifies a permissible time period following the payment event (e.g., separation from service) in which payment will be made, amendment pursuant to the transition relief must provide for payment either (1) on the last day of such specified period, or (2) if such period spans two calendar years, in the later year.

If the compensation arrangement currently in place does not specify a permissible time period for payment following the payment event, the amendment must provide for payment either (1) on a specified date either 60 or 90 days following the payment event, or (2) sometime during a specified period not longer than 90 days following the payment event provided that, if such period spans two calendar years, payment is made in the later year.

Employers should note that amending such compensation arrangements often will require the consent of the affected employee and approval of the board of directors or compensation committee.  Employers should therefore review their arrangements soon to allow sufficient time to draft and implement any necessary amendments.


An employer that amends a compensation arrangement in accordance with this IRS guidance must attach an information statement to its federal income tax return for the year in which the amendment is made.  The information statement need not be furnished to the employee, and there is no requirement that the employee attach a similar statement to his or her tax return.  The details for the employer’s information statement are set out in Notice 2010-80, a copy of which we can provide upon request.

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matters addressed herein.

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

Stephen W. Fackler – Palo Alto and New York (650-849-5385 and 212-351-2392, [email protected])
Michael J. Collins – Washington, D.C. (202-887-3551, [email protected])
David I. Schiller – Dallas (214-698-3205, [email protected])
Sean Feller – Los Angeles (213-229-7579, [email protected])
Dina R. Bernstein – Los Angeles (213-229-7206, [email protected])
Justin J.R. Reda – New York (212-351-3987, [email protected])

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