New Tax Regulations
Seek to Clean House

Have you given your compensation and benefits plans the “white glove” treatment in preparation for the final transition of section 409A of the Internal Revenue Code? Effective January 1, 2009, section 409A is a new set of regulations that seeks to address corporate accounting scandals by targeting many types of deferred compensation programs offered throughout the U.S. The broad brush that the regulations will paint could be a surprise to many companies.

What is a deferred compensation plan? It is a program that promises any sort of compensation in a year later than the one in which the compensation is earned. This means that both traditional executive compensation and nonqualified deferred compensation arrangements will have to be reviewed for either exemption or compliance.

The new rules could also apply to programs such as annual bonus plans, long-term incentives, certain equity arrangements (i.e. as phantom stock), severance plans, employment agreements and lawsuit settlements. Even vacation accruals for the rank and file employees at your company could be considered deferred compensation covered by the new rules if they fall outside of the realm of excluded “bona fide” leave programs.

Penalties for a violation of 409A are stiff and include an immediate participant tax liability for amounts deferred under not only the plan in which the violation occurred, but for all plans offered by the company of the same type or “bucket.” Tax liability for the employees covered by the plan means taxation, plus significant penalties and interest (including a 20 percent excise tax), going back to the years the compensation was “earned.”

Does your company offer any vehicles that are covered by 409A? To determine the answer to that question:

1. Take an inventory of ALL of your company’s deferred compensation programs. Look in all of the obvious places, including the plans mentioned above. Also, make sure that you look for arrangements that might not be as obvious, including verbal agreements or plans that are not well documented.

2. Evaluate your programs for exemption. Certain types of deferred compensation programs are actually exempt from the new regulations. These include:

• “Qualified” plans such as section 401(k) plans, pension plans and tax-deferred annuities;

• Bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plans;

• Nonqualified stock options with an exercise price not less than the fair market value of the underlying stock on the date of grant;

• Incentive stock options that qualify under section 422, as well as employee stock purchase plans designed under section 423 of the Internal Revenue Code; and

• Bonuses or other annually paid amounts distributed within 2½ months after the close of the taxable year in which the applicable services were performed.

3. For plans that do fall under the auspices of 409A, ensure that they are brought into immediate compliance in all required areas, including (but certainly not limited to):

   • Form and timing of distributions;

   • Timing of initial and subsequent deferral elections;

   • Prohibitions against certain accelerations of benefits or payments; and

   • Reporting requirements for plan sponsors and participants

Don’t be afraid to ask for help. These are complex waters to navigate! Many companies will need to engage outside compensation experts, accountants or attorneys to review their arrangements and bring them into compliance before the final December 31, 2008 deadline.

Author: Aimee Lowry, Total Rewards Practice Leader, Helios HR

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