December 5, 2007
On December 3 the Internal Revenue Service issued Notice 2007-100, which provides a limited voluntary correction program for certain operational violations of Section 409A of the Internal Revenue Code. Under the program, many operational violations can be corrected in the year in which the violation occurs. In addition, relief applies in limited circumstances for operational violations that are corrected in years after they occur. Taxpayers who take advantage of the program receive specified relief from the harsh consequences of a Section 409A violation, which generally include immediate tax of all amounts deferred under the plan (as well as all plans of the same "type" that are aggregated with that plan), a 20% additional tax, and an interest charge.
General Eligibility Requirements. In order for the program to be available with respect to a particular violation, the following requirements generally apply:
Correction of Violation in the Same Taxable Year in Which the Violation Occurred. Notice 2007-100 provides generous relief for correcting operational violations in the same year they occur. In particular:
Correction of Violations Involving Limited Amounts Occurring During Taxable Years Before 2010. Notice 2007-100 provides much more limited relief for correcting operational violations in years after they occur. In general, principles similar to those discussed above apply. However, the correction program is available only if the improper payments do not exceed the Code section 402(g) pre-tax elective deferral limit applicable for the year in which the operational failure occurs (this limit is $15,500 for 2008). In addition, the amount that is "corrected" by repayment to the employer is still subject to income tax and the Section 409A additional tax in the year of distribution, but is not again taxed when it is properly distributed (although any earnings thereon are subject to ordinary income tax). Finally, this portion of the correction program is limited to errors that occur in taxable years beginning before January 1, 2010.
On its face, it may appear that this portion of the correction program is not particularly helpful to employees, since income tax and the 20% additional tax apply to the repaid amount. However, that appearance is deceiving. In general, if there is a Section 409A operational failure with respect to an employee, the employee is immediately subject to income tax and the Section 409A penalties on all amounts deferred under the plan with respect to which the error occurred and all other plans of the same type. For example, if an "early" distribution of $10,000 is made to an employee with a $2 million balance in the plan, the entire $2 million balance generally would be subject to income tax and the Section 409A penalties. The benefit of the correction program is that only the amount subject to the administrative failure is subject to the adverse Section 409A treatment. Thus, in the preceding example, the $1,990,000 remaining balance would not be impacted.
In addition to the fairly limited scope of the program with respect to corrections in years after the operational failure occurred, the program imposes more stringent reporting requirements than for "same year" corrections. Both the employer and the employee are required to file statements with the IRS along with their tax returns for the taxable year in which the operational failure was discovered.
Conclusion. The IRS should be commended for establishing the program. It will allow taxpayers to correct many operational errors and avoid (or at least limit) the draconian Section 409A penalties that can be imposed on innocent employees.
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
Stephen W. Fackler (650-849-5385, [email protected]),
Charles F. Feldman (212-351-3908, [email protected]),
David West (213-229-7654, [email protected]),
David I. Schiller (214-698-3205, [email protected]),
Michael J. Collins (202-887-3551, [email protected]),
Sean Feller (213-229-7579, [email protected]),
Amber Busuttil Mullen (213-229-7023, [email protected]),
Jennifer Patel (202-887-3564, [email protected]),
Chad Mead (214-698-3134, [email protected]),
Kimberly Woolley (415-393-8225, [email protected]),
Jonathan Rosenblatt (650-849-5317, [email protected]), or
John C. Cook (202-887-3665, [email protected]).
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