The IRS recently announced a Section 409A compliance initiative project. The IRS audit project will focus on approximately 50 employers, all of whom were previously identified for employment tax audits. The IRS indicated that it will focus its examination on: (i) initial deferral elections; (ii) subsequent deferral elections; (iii) distributions; and (iv) application of the six-month delay rule for specified employees of publicly traded companies. Representatives from the IRS said that the examination will be limited to the top 10 most highly compensated employees of each employer.
If you are not participating in the compliance initiative project, now might be a good time to review your “nonqualified deferred compensation” arrangements for compliance with Section 409A. As a reminder, the following types of arrangements often fall within the scope of Section 409A:
- Deferred compensation plans (such as salary and bonus deferral programs)
- Supplemental retirement plans.
- Severance plans.
- Annual or multi-year incentive bonus arrangements.
- Employment agreements that provide for severance, change in control or other future contingent payments.
- Discounted stock options and certain stock appreciation rights.
- Change in control agreements.
- Phantom stock plans.
- Restricted stock unit agreements.
If an arrangement violates Section 409A, the employee is required to include in income all vested amounts deferred or subject to the arrangement (regardless of whether the employee is entitled to receive a payment in that year). In addition, the employee must pay an additional 20% tax (over and above the regular federal income tax already owed) and interest penalties. These penalties apply not only to the arrangement that violates Section 409A, but also to any other similar arrangement between the employer and the same employee.