409A Update: Action Required By December 31, 2007 Despite Limited Extension For Written Compliance With Code Section 409A

On September 10, 2007, the IRS issued Notice 2007-78 (the "Notice") and granted limited relief for bringing nonqualified deferred compensation plans into written compliance with Section 409A of the Internal Revenue Code ("Section 409A"). However, the Notice still requires most major decisions be made and documented before December 31, 2007.

The relief granted by the Notice is very limited in scope and does not relieve employers of the requirement to specify in writing Section 409A-compliant times and forms of payment of deferred compensation by December 31, 2007. Employers are still required generally to take action to bring documents into material compliance with Section 409A by December 31, 2007.

Employers now have until December 31, 2008 to bring nonqualified deferred compensation plans or arrangements into full written compliance with the final Section 409A regulations. However, according to the Notice:

• Plans or arrangements must be operated in compliance with the final regulations on and after January 1, 2008, except as otherwise provided in the Notice;
• Section 409A-compliant times and forms of distributions must be specified in writing by the end of 2007; and
• Changes to "good reason" definitions to bring them within the Section 409A safe harbor definition must be in writing by the end of 2007.

This Alert summarizes the key provisions of the Notice and suggests how employers should proceed during the remainder of 2007.

The Notice provides that, in general, a nonqualified deferred compensation arrangement will not violate Section 409A simply because the plan or arrangement contains provisions that violate Section 409A or fails to contain provisions required by Section 409A, so long as the plan or arrangement is operated in compliance with Section 409A on and after January 1, 2008. Final amendments or plan documents must be adopted by December 31, 2008, effective retroactively to January 1, 2008, and must accurately reflect the plan’s or arrangement’s operation during 2008.

The Notice does not delay the effective date of the Section 409A final regulations. Employers must still operate nonqualified deferred compensation arrangements in compliance with the Section 409A final regulations on and after January 1, 2008.

Nonqualified deferred compensation plans or arrangements must contain provisions in writing that comply with the time and form of distribution requirements under Section 409A by the end of 2007. Section 409A-compliant times and forms of distribution may be specified in a separate written document and then incorporated into the plan document by amendment after January 1, 2008.

A plan or arrangement that specifies permissible payment events allowed under Section 409A by the end of 2007 is considered to be in compliance with the time and form of distribution requirements even if the plan or document does not include Section 409A-compliant definitions of those permissible payment events. For example, a plan that specifies in writing that payments will be made upon a participant’s disability but does not include a Section 409A-compliant definition of "disability" is considered to meet the Section 409A time and form requirements under the Notice. However, the plan must be amended to include a Section 409Acompliant definition of "disability" prior to December 31, 2008.

The Notice clarifies circumstances in which the definition of "good reason" in an existing employment agreement may be modified to bring it within the safe harbor definition in the Section 409A final regulations before December 31, 2007. Such revisions must be in writing by the end of 2007 for severance paid upon a "separation from service" for "good reason" to be eligible for the exemption from Section 409A for separation pay upon an involuntary "separation from service."

According to the Notice, the IRS and Treasury Department anticipate issuing future guidance that creates a limited voluntary compliance program for certain unintentional operational failures to comply with Section

409A. Corrections allowed under such a program may include allowing the failure to be corrected within the same taxable year, and limiting the amounts of deferred compensation that are included as income and subject to the 20% additional tax as a result of a failure.

• Have legal counsel review each arrangement that may provide for a deferral of compensation. This is a high priority item if it has not already been done since the deadline of December 31, 2007 is quickly approaching. For a list of arrangements that may be subject to Section 409A see our earlier PoGo Alert, which can be found at http://www.pogolaw.com/articles/2311.pdf.
• Discuss with legal counsel what changes need to be made in the operation of the arrangements. Determine and finalize any needed changes to the arrangements’ design by December 31, 2007.
• Permissible payment events must be designated in writing by December 31, 2007, though definitions and other plan provisions can be amended in 2008 to comply with Section 409A.
• Elections as to time and form of payment must be designated in writing by December 31, 2007.
• Changes to conform "good reason" definitions to the involuntary separation requirements under Section 409A must be in writing on or before December 31, 2007.

• Beginning on January 1, 2008, arrangements must be operated in compliance with Section 409A and finalized design choices.
• Plan documentation must comply with the written documentation requirements under Section 409A on or before December 31, 2008. Amendments must be effective retroactive to January 1, 2008.

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.