United States: IRS Extends 409A Compliance Deadline Again

IRS Notice 2007-86, released October 22, 2007, responds to employer pleas by extending Code Section 409A transition relief for an additional year, to December 31, 2008. The key provisions of the Notice include:

• Employers have until December 31, 2008 to amend plan documents to conform to the provisions of Section 409A and the final 409A regulations;

• Plans are not required to designate 409A-compliant times and forms of payment before the end of 2007;

• Employers have until January 1, 2009 to comply with the final 409A regulations;

• Plan operations through December 31, 2008 must comply with a reasonable, good faith interpretation of Section 409A, but after December 31, 2007, they cannot rely on the proposed 409A regulations;

• Deferred compensation payment elections currently linked to qualified plan payment elections are allowed to remain in effect until the end of 2008; and

• Certain transition election opportunities have been extended to December 31, 2008.

Employers Have Until December 31, 2008 to Amend Plan Documents to Comply with Section 409A

The final 409A regulations published in April would have required employers to amend plans by the end of 2007. Notice 2007-78, published last month, granted partial relief from that deadline, giving employers until December 31, 2008 to complete plan amendments. Notice 2007-78 also required employers to designate in writing, by the end of 2007, distribution provisions that comply with Section 409A. Notice 2007-86 revokes these requirements, eliminating the requirement that employers designate distribution provisions by the end of 2007.

Plan Operations through December 31, 2008 Must Comply with a Reasonable, Good Faith Interpretation of Section 409A

The final regulations, published in April, would have required full operational compliance beginning January 1, 2008. The partial relief granted in September did not change that date. Notice 2007-86 provides broad operational relief for an additional year. Between now and January 1, 2009, employers are required to operate their plans in accordance with Section 409A, Notice 2005-1, and other generally applicable 409A guidance and, to the extent possible, the plan terms. After December 31, 2007, except as specifically provided in Notice 2007-86, employers can not rely on the proposed regulations. Reliance on the final 409A regulations will constitute reasonable, good faith compliance with Section 409A.

Other Transition Opportunities Extended Until December 31, 2008

Both the final 409A regulations and the partial relief published in September would have terminated transition elections and other transitional relief effective at the end of 2007. Notice 2007-86 extends many of these additional transition provisions for an additional year. Specifically, Notice 2007-86 provides that between now and January 1, 2009, subject to the same limitations previously applicable to such transition elections, employers may amend plans to:

• Permit new elections regarding time and form of payment for all deferrals since January 1, 2005;

• Modify an arrangement to fit within the exception for short-term deferrals or one of the exceptions applicable to distributions payable solely upon involuntary termination; or

• Add 409A-compliant payment terms for certain stock rights subject to Section 409A.

Notice 2007-86 also addresses:

• 409A Corrections Program. According to Notice 2007-86, the IRS anticipates issuing "as soon as possible" guidance regarding a 409A corrections program for unintentional operational failures.

• Use of Offshore Trusts or Restrictions on Assets in Connection with a Change in the Employer’s Financial Health. Notice 2007-86 provides no relief from prior guidance relating to assets held in offshore trusts or trusts with certain funding triggers. To avoid taxation under Section 409A, plans must comply with Section 409A(b) and any other applicable guidance before the end of 2007.

• Operational Violations. Notice 2007-86 extended the transition relief limiting taxation to the year in which an operational failure occurs and other means that limit taxation during the transition period.

• Miscellaneous. The guidance provided in Notice 2007-78 relating to the application of the substitution rule to extensions of employment agreements and the application at the beginning of the installment period of predetermined cash-out provisions did not change.

Now that the IRS has provided this additional relief in response to employer complaints that compliance before 2008 created undue hardship, there could be a natural tendency to relax and perhaps delay 409A compliance efforts until the second half of 2008. We think that would be a mistake. The IRS is unlikely to provide any additional extensions. Full operational compliance requires careful analysis and, inevitably, will require addressing numerous unforeseen issues. Employers that have already begun this analysis should complete it. Employers that have not yet begun should start now.

Although we recommend continuing current efforts to comply operationally, we also think that most employers should wait until late 2008 to adopt the required plan amendments, unless there are compelling business reasons to adopt them sooner. Waiting to adopt the documents, however, does not mean that employers should wait to start drafting the documents. We think that most employers will benefit from preparing draft documents sooner rather than later. Getting the documents ready, but not adopting them until later in the year, will facilitate the required analysis, but will also preserve flexibility during the remainder of the reasonable good-faith transition period.

Finally, we encourage employers to review the transition elections and other opportunities that will remain in effect until the end of 2008. Participants might be given another opportunity to change the time and form of distributions for all amounts subject to Section 409A. Employers and participants both should consider changing arrangements to fall within the short-term deferral exception or one of the exceptions for amounts payable solely upon involuntary termination, where applicable. Stock rights subject to Section 409A should be carefully reviewed; some employers might decide it is more advantageous to revise their stock rights to comply with Section 409A than try to avoid Section 409A.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.