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IRS Provides New Section 409A Document Correction Program

Employee Benefits Law Update J. Paul Jacobson, Robert D. Rothacker, David P. Olson, Amy A. Ciepluch, Sarah M. Linsley, Marla B. Anderson

Earlier this week, the IRS issued Notice 2010-6. The Notice provides methods for taxpayers to correct certain provisions of their deferred compensation arrangements that would otherwise fail to satisfy the document requirements applicable under Section 409A of the Internal Revenue Code. Taxpayers that take advantage of the document correction program can avoid or reduce the current income inclusion and additional tax penalties under Section 409A.

Background

Section 409A provides a complex set of requirements for various non-qualified deferred compensation arrangements and imposes significant tax penalties on participants for noncompliance. An arrangement that does not satisfy the Section 409A requirements will cause participants - generally directors and executives - to recognize taxable income currently and subject them to an additional 20 percent income tax.

A non-qualified deferred compensation arrangement must comply with the Section 409A requirements in both form and in operation. The IRS has previously issued guidance that permits employers to correct Section 409A operational errors. The guidance in Notice 2010-6 permits the self-correction of certain plan document failures.

Relief Provided by the Correction Program

The correction program is intended to encourage taxpayers to review non-qualified deferred compensation plans to identify provisions that fail to comply with the Section 409A documentation requirements, and to promptly correct those plan provisions. Accordingly, the Notice provides:

  • Clarification that certain language commonly included in plan documents will not cause a document failure.
  • Relief permitting correction of certain document failures without current income inclusion or additional taxes under Section 409A, provided, in certain circumstances, that the corrected plan provision does not affect the operation of the plan within one year following the date of correction.
  • Relief limiting the amount currently includible in income, and the additional taxes under Section 409A for certain document failures if correction of the failure affects the operation of the plan within one year following the date of correction.
  • Transition relief permitting corrections of certain document failures without current income inclusion or additional taxes under Section 409A, if the document failure is corrected by December 31, 2010, and any operational failures resulting from the document failure are also corrected.

The full text of the Notice can be found here.

Recommendations

Now is the time to review your deferred compensation arrangements for compliance with Section 409A. Identification of errors and careful consideration of correction alternatives is the best way to reduce or avoid the significant Section 409A penalties.

If you have questions about the Section 409A Correction Program, please contact Paul Jacobson at (414) 277-5631 / paul.jacobson@quarles.com, Robert Rothacker at (414) 277-5643 / robert.rothacker@quarles.com, David Olson at (414) 277-5671 / david.olson@quarles.com, Amy Ciepluch at (414) 277-5585 / amy.ciepluch@quarles.com, Sarah Linsley at (312) 715-5075 / sarah.linsley@quarles.com, Marla Anderson at (414) 277-5453 / marla.anderson@quarles.com or your Quarles & Brady attorney.