IRS unveils Code Sec. 409A deferred compensation voluntary corrections program

Taxpayers will be pleased to find that the IRS has, as promised, unveiled a voluntary corrections program under Code Sec. 409A for unintentional operational failures of nonqualified deferred compensation plans. The definition of nonqualified deferred compensation casts a wide net and includes such common payments as stock options, delayed bonuses, severance plans, and tiered pay plans. The new IRS program comes in three parts. There is no relief for intentional violations of Code Sec. 409A, or for plan terms that fail to comply with Code Sec. 409A. The new program only covers unintentional operational noncompliance with the new rules.

The initial program will address routine violations. The three parts of the voluntary corrections program include:

• Correction of operational failures in the same year to avoid income tax inclusion;
• Transitional relief limiting the amount includible in income for operational failures occurring before 2010; and
• A proposed permanent corrections program for larger amounts.

Same-year corrections

Under the program, if an unintentional operational failure is corrected in the same year that it occurred, the employee (or independent contractor) does not have to include any amount in income. An employer must correct the violation and take commercially reasonable steps to prevent recurring failure. An employer claiming relief for a same-year correction must attach to a timely filed tax return for the year of the failure a statement entitled “Sec. 409A Relief under Notice 2007-100.”

Improper deferral

If a deferred amount is paid in the year it should have been deferred, or before a selected payout event, the amount will be treated as timely deferred if the employee repays the amount by the end of his or her tax year in which the payment was made.

A second type of operational error that can be corrected in the same year is an improper deferral of an amount that should have been paid currently. The excess amount is not treated as deferred compensation if it is paid to the employee by the last day of the employee’s year in which the amount was withheld.

Transition relief

An amount owed may be limited under the second program for an employee’s taxable year beginning before 2010. Moreover, there is no relief if the plan’s service provider is being audited for the year in which the failure occurred.

If your business makes any other payment to employees other than straight immediate wage payments, you need to be concerned about Code Section 409A rules.  Please do not hesitate to call this office for further details.

(Notice 2007-100; TDNR HP-707)