Daily Tax Update - April 10, 2007

IRS Issues Final Regulations Under Section 409A:  All Employment Agreements, Severance Plans, and Other Deferred Compensation Plans Must Be Reviewed Now So As To Comply By Year-End: Today, the IRS issued the long-awaited final regulations under section 409A of the Internal Revenue Code.  Section 409A requires that deferred compensation arrangements for all service providers meet certain requirements regarding the timing of payments and deferral elections to avoid imposition of immediate taxation and penalties, including a 20% additional tax and interest.

  • Taxpayers were to comply “in good faith” with proposed regulations and other guidance issued in 2005 and 2006.  Now that final regulations have been issued, plan documents covering such arrangements, as well as their operation, must be reviewed to ensure they meet the specific requirements of the new rules.
  • It is vital that all organizations review their employment, severance, supplemental retirement and health, change of control, bonus, incentive, equity, and other arrangements to ensure that they comply, even if these arrangements were reviewed when section 409A was enacted and proposed regulations issued.  Significant new rules have been introduced.
  • Very generally, both documentary and operational compliance with the final regulations is required by the end of 2007.
  • Daily Tax Update readers will receive additional information on these regulations in the next few weeks, and we anticipate hosting a free teleconference on the regulations, so watch this space for your invitation.
  • Major Changes in Brief:  An initial reading of the almost 400 pages of final regulations and preamble indicates that the regulations provide:
(1)  specific rules for documenting how arrangements meet section 409A;
(2)  clarification of the operation of the short-term deferral rules;
(3)  a more liberal definition of severance pay and reimbursements that can be exempt from section 409A;
(4)  special rules for some, but not all, “good reason” terminations;
(5)  liberalization of the rules governing equity compensation under section 409A, but no real relief in the area of discounted stock options other than what has previously been provided;
(6)  special rules permitting “gross ups” for tax purposes;
(7)  expanded relief for arrangements that are “linked” to qualified plans, although limitations still apply;
(8)  additional guidance on the identification of “specified employees” subject to the 6-month delay requirement for payouts upon termination;
(9)  additional rules and relief for benefits under broad-based foreign retirement plans, certain foreign deferred compensation arrangements covering nonresident aliens and others, and tax equalization payments, but the relief provided does not appear to be as broad as many commentators requested;
(10) expanded relief regarding the time and form of payment requirements to address common practices under deferred compensation arrangements; and
(11) new categories of arrangements that will be treated separately (i.e., not aggregated) for purposes of applying the section 409A penalties, thus potentially reducing in some cases the impact of an error on other arrangements providing deferred compensation to a service provider.
  • Notice on Split-Dollar Arrangements: The IRS also released today Notice 2007-34, discussing the effect of section 409A on split-dollar arrangements.  Very briefly, the notice describes what arrangements are subject to section 409A (generally arrangements that provide more than death benefits, and are taxed under the “economic benefit” regime of section 61 of the Code, or, in certain cases, under the loan regime of section 7872 of the Code), and what arrangements are grandfathered.  The Notice also provides transition relief for modifications to split-dollar arrangements needed to comply with section 409A.  All split-dollar arrangements should be reviewed carefully to determine whether they are exempt from, or how they are to be treated under, section 409A.
  • If you have any questions, feel free to contact the Steptoe lawyers familiar with these regulations: Ellen Kohn (ekohn@steptoe.com); Anne Moran (amoran@steptoe.com); Don Wellington (dwellington@steptoe.com); or Catherine Wilkinson (cwilkinson@steptoe.com), or your main Steptoe contact who can direct you to one of our attorneys familiar with these regulations.
  • The new regulations and Notice 2007-34 can be accessed via:

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving. Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them. Read more information on Steptoe's tax practice.