Friday, August 31, 2007
EMPLOYEE BENEFITS AND EXECUTIVE COMPENSATIONS NEWSLETTER
INTERNAL REVENUE SERVICE NOTICE 2007-78 OFFERS LIMITED RELIEF FROM CODE SECTION 409A COMPLIANCE; CERTAIN DESIGN DECISIONS AND AMENDMENTS GENERALLY STILL REQUIRED BY YEAR-END
On September 10, 2007, the Internal Revenue Service (“IRS”) issued Notice 2007-78 (the “Notice”), which provides limited relief for compliance with Internal Revenue Code Section 409A and guidance issued thereunder (collectively, “Section 409A”). The Notice does not change the effective date of Section 409A but instead generally provides that full documentary compliance is not required until December 31, 2008, so long as a plan is operationally compliant with Section 409A and plan amendments are retroactively effective to January 1, 2008. Notably, however, the extension allowed for documentary compliance only is somewhat helpful; many important design decisions must be made and certain plan amendments must be entered into by December 31, 2007. Furthermore, “good faith” compliance with Section 409A generally ends on December 31, 2007, and all plans must strictly comply with Section 409A in operation on January 1, 2008. This Memorandum highlights some key provisions of the Notice.
Plan Provisions that Must be Amended by December 31, 2007
- Designation of Time and Form of Payment. Generally, unless a later date has been specified under Section 409A, a plan must designate in writing by December 31, 2007, a Section 409A compliant time and form of payment for deferred compensation (e.g., a lump sum at separation from service, change in control, death or disability). If a payment event is added or deleted after December 31, 2007, the new or removed payment event is subject to the anti-acceleration and subsequent deferral rules under Section 409A.
- Section 409A Exemptions. If a plan currently does not meet but intends to meet the short term deferral rule (also known as the “2½-month rule”) or the severance exemption under Section 409A, the plan document must be amended by December 31, 2007, to include the provisions necessary to meet the applicable exemption.
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- Good Reason Conditions. The Notice clarifies that modification of a good reason condition to conform to the Section 409A good reason safe harbor (which allows a separation to be deemed involuntary for purposes of Section 409A) will not be treated as an impermissible extension of a substantial risk of forfeiture so long as (1) the benefit otherwise is subject to a substantial risk of forfeiture at the time the good reason definition is amended and (2) the definition is amended by December 31, 2007.
- Installments. For purposes of the subsequent deferral rules, a plan can either treat installments as a single payment or a series of payments. If a plan does not state which treatment will be afforded installments, Section 409A contains a default rule to treat the installments as a single payment. Under the Notice, a plan must be amended by December 31, 2007, if installments are to be treated as a series of payments.
Plan Provisions that Must be Amended by December 31, 2008
- Use of Section 409A Compliant Definitions. With some limitations, definitions for separation from service, change in control, unforeseeable emergency, and disability do not have to be revised in the plan document to comply with Section 409A’s descriptions until December 31, 2008. Even though a plan document does not have to reflect the Section 409A definition of certain terms, the plan should operate in compliance with the Section 409A description of such terms.
- Six-Month Wait Requirement. Provided that a plan is operated in compliance with the six-month delay rule for specified employees of a publicly held company, the plan document does not have to include the six-month delay rule until December 31, 2008.
Further, the Notice offers some temporary clarification with regard to the substitution rule and the predetermined cashout rule under Section 409A. First, the Notice provides that if an employment agreement allows for payments upon an involuntary separation but the right to the payments automatically is forfeited at the expiration of the agreement, then a similar provision in a new or renegotiated agreement will not be considered a substitute for the forfeited right under Section 409A. Second, Section 409A is unclear as to whether a plan may contain a provision for a lump sum payment upon the payment date if the total benefit is below a set amount (a cashout). The Notice acknowledges that such a cashout provision may not be permissible under Section 409A but states that, until further direction from the IRS, a cashout is compliant with Section 409A if the cashout is paid in accordance with Section 409A and is nondiscretionary, and the cashout amount is set forth at the time the payment event is designated.
The Notice provides limited relief with regard to documentary compliance with Section 409A. By December 31, 2007, employers not only need to identify and examine all arrangements potentially subject to Section 409A but also must make key design decisions and likely draft, approve and execute certain amendments.
This Memorandum is only a brief summary of the Notice, but if we can be of assistance in answering any questions that you may have regarding the Notice, or ensuring any deferred compensation arrangements are in compliance with Section 409A, please contact one of the attorneys in our Employee Benefits and Executive Compensation Practice Group.
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