Last Call to Comply with New Deferred Comp Regulations

By Thomas B. Ericksen and Peter O. Watts

The American Jobs Creation Act of 2004, which was signed into law on October 22, 2004, created Internal Revenue Code Section 409A. Section 409A created new rules for the taxation of executive deferred compensation arrangements and the disclosure and reporting requirements. The new rules are a dramatic departure from the prior rules, and the IRS has given companies a limited period of time to amend their plans without violating the new rules.

All deferred compensation arrangements must be amended for compliance with Section 409A by December 31, 2006. Although there is still time to update the plan documents, all arrangements must be operated in good faith compliance with the new law starting January 1, 2005.

Created in response to Enron-type abuses, many believe that the new section is draconian, overreaching, and burdensome, especially to smaller and privately owned companies. There is no question that Section 409A reduces the flexibility, security, and appeal of executive deferred compensation arrangements.

Under Section 409A, all amounts deferred after 2004 under a nonqualified deferred compensation plan are includible in gross income (except to the extent such amounts are subject to a "substantial risk of forfeiture") unless the plan satisfies specified election and distribution requirements. These amounts are also subject to a 20 percent penalty.

New elections as to time and form of payment of deferred compensation may be made until December 31, 2006, without regard to the new Section 409A rules governing the timing of elections and payments. After that date, all payment elections will be subject to the provisions of Section 409A.

The Section 409A rules are complex. Contact your attorney or tax professional for analysis of whether your plan complies with the provisions of Section 409A.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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