September 11, 2007
On September 10, the IRS issued Notice 2007-78, which provides limited relief from the December 31, 2007 deadline to amend arrangements subject to Section 409A of the Internal Revenue Code. Under the Notice, arrangements generally may be amended by December 31, 2008 to incorporate required changes, as long as the amendment is retroactive to January 1, 2008 and the arrangement is operated in accordance with the final regulations under Section 409A during 2008. However, a key condition to this relief is that the time and form of payment still must designated in writing by December 31, 2007. In addition, because plan amendments must be retroactive to January 1, 2008, employers generally will need to make all key plan design decisions by December 31, 2007. Thus, despite the "extension" of the deadline, employers will still need to take action by December 31, 2007 with respect to most arrangements, so the extension offers little real relief to employers. Rather, this extension simply allows employers an additional year in most cases to incorporate these actions into their written plans and agreements (other than the time and form of payment, which generally must be designated in writing by December 31, 2007).
The Notice also declines to extend various transition rules that expire on December 31, 2007. In particular, the ability to change payment elections in 2007 as long as no distributions are moved into or out of 2007 has not been extended. Finally, the Notice provides limited guidance on a few ambiguous items in the Section 409A final regulations issued last April and states that the IRS plans to implement a voluntary program to allow correction of inadvertent operational violations of Section 409A.
Limited Extension of Plan Amendment Deadline
Section 409A imposes a number of requirements that deferred compensation arrangements must satisfy in order to avoid current taxation of participants (and a possible 20% "additional tax" and an interest charge). Under the final regulations, the material terms of plans subject to Section 409A are required to be in writing. The terms that must be in writing include the amount of deferred compensation (or an objectively determinable formula for calculating the amount), the time when deferral elections become irrevocable, the payment events, and, for publicly-traded companies, the six-month delay applicable to distributions made upon separation from service to "specified employees."
Prior to the issuance of Notice 2007-78, plans were required to be amended by December 31, 2007 to incorporate all of the requirements of the final regulations. Failure to timely amend would have resulted in an automatic violation of Section 409A on January 1, 2008, with the resulting adverse tax consequences for participants.
Notice 2007-78 provides some limited relief from this amendment deadline. However, plans must be operated in accordance with the final regulations commencing on January 1, 2008 in all events. The "reasonable good faith" operational compliance standard applicable through December 31, 2007 (which has allowed taxpayers to rely on authority other than the final regulations, such as the proposed 409A regulations and various IRS Notices (such as Notice 2006-79 and Notice 2005-1)) has not been extended.
The plan amendment deadline extension to December 31, 2008 is subject to the following key conditions:
Thus, in order to take advantage of the transition relief, virtually all key plan design decisions need to be made by December 31, 2007. In addition, many key payment terms must be adopted and put in writing by that date. Thus, the main complaint about the December 31, 2007 amendment deadline — that it requires plan design decisions to be made and adopted too quickly while "best practices" are still developing — is not addressed by Notice 2007-78, and employers will still be required to act this year to avoid violations of Section 409A. In sum, this "extension" of the plan amendment deadline offers little real relief to employers.
Other Issues Addressed by the Notice
The Notice also provides guidance on some other issues raised by Section 409A:
Voluntary Compliance Program
The Notice states that the IRS plans in the future to establish a limited voluntary compliance program that will apply to certain unintentional operational failures to comply with Section 409A. The IRS anticipates that the program will provide methods by which certain unintentional operational failures may be corrected in the same taxable year in which the operational failure occurred to avoid application of Section 409A, and other methods by which certain unintentional operational failures may result in only limited amounts becoming includible in income and subject to additional taxes under Section 409A.
The Notice provides helpful guidance on a few issues. In addition, the forthcoming voluntary compliance program may allow employees and other service providers to avoid the draconian tax treatment that results if there is a Section 409A violation. However, the main focus of the Notice — a purported extension of the plan amendment deadline — is subject to so many conditions that it will provide little relief to most employers, who will have to make all important plan design decisions by year-end and implement most payment-related amendments by December 31, 2007. Thus, employers should not be misled by the purported extension of the plan amendment deadline, but rather should be aware that they will still need to take action this year to amend plans to bring them into compliance with the final regulations.
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