The Internal Revenue Service ("IRS") recently issued Notice 2006-79 announcing that the new regulatory requirements for nonqualified deferred compensation plans under section 409A will not, in general, be effective until January 1, 2008. Under the 2005 proposed regulations, plans and arrangements were required to be in written compliance with the new rules by January 1, 2007. Given the delay in issuing the final regulations (which are expected within the next 60 days or so), the IRS has decided to postpone the regulations' effective date for a year and extend most of the transition rules through 2007. Taxpayers may continue to use the "reasonable, good-faith compliance" standard for operating plans through the end of 2007.
- Changes in Payment Elections or Conditions. A plan may provide (or be amended to provide) for new payment elections anytime on or before December 31, 2007, both with respect to the time and form of payment. An amendment of this type will not be treated as a change in the time or form of payment or an acceleration that would violate section 409A so long as the plan is amended and the elections are made before the end of 2007. A similar rule exists for calendar year 2006. Under the 2006 rule, the election or amendment may only apply to amounts that would not otherwise be payable in 2006 and may not cause an amount to be paid in 2006 that would otherwise be payable in a later year. This same condition applies for the 2007 transition. The Notice further clarifies that this transition rule is available even if it was previously used to change an election.
A new transition rule is provided for short-term deferral plans, i.e., plans that are paid out within 2½ months after the end of the year. A deferral election can now be made with respect to the short-term deferral plan so long as the election is made before 2008 and before the year in which payment is scheduled. This apparently means the bonus scheduled to be paid within the first quarter of 2007 may be still be deferred before the end of 2006 and bonuses scheduled to be paid in the first quarter of 2008 my be deferred up to the end of 2007.
- Wrap Plans. The proposed regulations provided a special rule for nonqualified deferred compensation plans that are linked to qualified plans. That transition rule has been extended through 2007 as well. The Notice expands this relief, however, to extend it to nonqualified plans that are linked to section 403(b) annuities, section 457(b) plans, and certain foreign broad-based plans. Therefore, if a nonqualified deferred compensation plan provides that the time and form of payment to the participant will be the same as the time and form of payment under a related qualified plan, section 409A will not be violated during the transition period through 2007.
- Substitution of Nondiscounted Stock Options and Stock Appreciation Rights. In general, the proposed regulations provide an exception from section 409A for stock options and stock appreciation rights that are granted at fair market value. If the stock option or stock appreciation right was provided at any discount, however, the arrangement is subject to section 409A. Under an existing transition rule, the parties can substitute a nondiscounted stock option or stock appreciation right through the end of 2006, subject to certain conditions. The Notice extends this right of substitution through the end of 2007, but only to the extent that cancellation and reissuance in 2007 does not result in the cancellation of a deferral in exchange for cash or vested property in 2007.
- Initial Deferral Elections. Confusion apparently resulted from the interplay between Notice 2005-1 and the proposed regulations with respect to the requirement that, in order to make initial deferral elections by the March 15, 2005 deadline, the plan had to be amended by the end of 2005. Apparently a number of people were unclear whether that original 2005 deadline was extended by the proposed regulations to the end of 2006. In order to clarify this situation, the Notice states that under this transition rule, the period for amending the plan to bring it into compliance is also extended to the end of 2007.
What is Not Included in the Notice
The Notice is generally intended to alert the general public about the effective date and transition rules for section 409A. It is not intended to cover all of the issues that will be addressed in the final regulations. It should be noted specifically that the Notice does not address the split-dollar guidance, nor does it address the reporting and disclosure requirements under section 409A. We understand that the separate guidance on split-dollar life insurance under section 409A is still on track and is expected to be issued more or less simultaneously with the issuance of the final regulations. Guidance on the reporting and disclosure requirements under section 409A is being separately considered. Another IRS release will be issued later this year specifically addressing the reporting and disclosure requirements. That guidance is expected to state that employers will have to report and withhold on section 409A violations in 2006. (In a previous notice, Notice 2005-94, the IRS suspended reporting and withholding for 2005.) It is further expected that the IRS will delay many of the reporting requirements until 2007 or 2008 because it recognizes that employers need time, after guidance is issued, to develop and program their reporting systems. However, the IRS does not want to postpone withholding requirements any further.
It is also probably worth reiterating that once the regulations are finalized, there are numerous other issues that will be addressed in additional proposed section 409A regulations. These include the taxation rules under section 409A, all of the anti-funding rules in section 409A(b), the reporting and disclosure requirements and the treatment of partnership plans. These rules have not even yet been proposed and consequently will be actively considered in 2007.
This client alert is a publication of Loeb & Loeb and is intended to provide information on recent legal developments. This client alert does not create or continue an attorney client relationship nor should it be construed as legal advice or an opinion on specific situations. For more information, please contact Marla Aspinwall, Chair of Loeb's Executive Compensation Group.
Circular 230 Disclosure: To assure compliance with Treasury Department rules governing tax practice, we inform you that any advice (including in any attachment) (1) was not written and is not intended to be used, and cannot be used, for the purpose of avoiding any federal tax penalty that may be imposed on the taxpayer, and (2) may not be used in connection with promoting, marketing or recommending to another person any transaction or matter addressed herein.