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Use of Short-Term Deferral Exception to Avoid Section 409A

To the extent payments under a nonqualified deferred compensation plan satisfy the short-term deferral exception under Internal Revenue Code Section 409A, they are excluded from its purview. To qualify for the exception, the payment must be required to be made, and must actually be made, on or before the 15th day of the third month following the end of the employee’s tax year or the employer’s tax year, whichever is later, in which the right to the payment vests (i.e., is no longer subject to a substantial risk of forfeiture). If no payment date is specified, the payment will qualify for the short-term deferral exception if it is actually paid within the short-term deferral period.

A payment that was designated to be paid within the short-term deferral period, but which is not made until after the end of the short-term deferral period, may continue to qualify for the short-term deferral exception if the taxpayer establishes that it was administratively impracticable to make the payment by the end of the short-term deferral period and that such impracticality was unforeseeable at the time the legally binding right to the compensation arose, or that making such payment by the end of the short-term deferral period would have jeopardized the ability of the employer to continue as a going concern, and the payment is made as soon as administratively practicable or as soon as the payment would no longer have such effect. In addition, a delay may be permitted to avoid the loss of a deduction to the employer under the $1,000,000 cap applicable to compensation paid to certain executive employees of publicly traded companies under Code Section 162(m), where such limitation was not reasonably foreseeable when the legally binding right arose.

Failing to qualify for the short-term deferral exception does not mean the payment is subject to the 20% excise tax, which can still be avoided by meeting the requirements of Section 409A.

This alert is a publication of Loeb & Loeb LLP and is intended to provide information on recent legal developments. This 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 on the content of this alert, please contact Marla Aspinwall at 310.282.2377. 

Circular 230 Disclosure: To ensure compliance with Treasury Department rules governing tax practice, we inform you that any advice contained herein (including any attachments) (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.