Correcting 409A Documentary Failures under

IRS Notice 2010-6: The Price you Pay for Delay

Brenda Berg and Jane Francis
May 19, 2010
409A Recap: How did we get
here?
• Internal Revenue Code Section 409A imposes strict rules on
nonqualified deferred compensation plans and other deferred
compensation arrangements. A NQDC plan is required to comply
with 409A in both form (document) and operation.

• Various guidance was issued between 2005 and 2007, culminating

with final regulations in April 2007. “Reasonable good faith”
standard.

• Deferred compensation plans were required to be in documentary

compliance with Section 409A by December 31, 2008.

• The IRS provided an opportunity to correct certain limited 409A

operational failures under Notice 2007-100 and later expanded in
Notice 2008-113; however, until the issuance of Notice 2010-6,
there was no method for correcting document failures.

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409A Recap: Why do we care?

• Failure to comply with Section 409A results in a

tax imposed on each affected participant based
on the entire value of his or her nonqualified
deferred compensation plus a 20% penalty and
interest.
• Correcting under Notice 2010-6 can avoid or
reduce these drastic consequences.
• The relief coincides with an audit initiative
launched by the IRS regarding 409A
compliance.

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Overview of Notice 2010-6

• New correction program is intended to

encourage taxpayers to review their nonqualified
deferred compensation plans to identify
provisions that fail to comply with the
requirements of Section 409A, and to correct
those plan provisions promptly.
• Early correction is important not only because
the relief is generally not available once the
taxpayer is under audit, but also because some
of the relief under the Notice is time sensitive.
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Why Notice 2010-6 is helpful

• If NQDC arrangement is subject to 409A, then a

written document is required. Notice 2010-6 can
be used as a checklist for designing a compliant
document.
• If taxpayer reasonably believed plan was a
“grandfathered” plan exempt from 409A and now
determines that it does not meet grandfathered
status, can correct now.
• If correction made does not affect operation of
the NQDC arrangement, no inclusion of income
required.
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Special Transition Rule

• Taxpayers can avoid 409A income inclusion

otherwise required for the correction relief, such
as the type described above due to the
impermissible event occurring within one year
after the correction, if the document failure is
corrected by December 31, 2010.
• BUT if an improper payment was made (or
should have been made, if the amended
definition applied) by December 31, 2010, there
is also an operational failure that must be
corrected under Notice 2008-113.
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Eligibility for Correction Under
Notice 2010-6

• Relief is only available for failures that are

inadvertent and unintentional.
• Neither the service provider nor the
service recipient can be under
examination for a year in which the failure
existed.
• Must take commercially reasonable steps
to correct all plans with substantially
similar document failures.
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Eligibility for Correction Under
Notice 2010-6
• Can’t be a plan “linked” to a tax-qualified plan
such as a pension plan, or a plan granting “stock
rights.”
• Failure can’t be related to a listed transaction
under Section 1.6011-4(b)(2) (abusive
transactions identified by the IRS from time to
time).
• Must be one of the failures specifically identified
in the Notice and you have to do all of the things
required for correction under the Notice.

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Essential 409A Compliance
Elements

• Written plan.
• Timely deferral elections.
• Must elect time and form of distribution
when legally binding right to compensation
is obtained.
• No acceleration of distribution.
• Required delay for “specified employees.”
• Extremely limited ability to further defer
payment.
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Failures Eligible for Relief

• An otherwise permissible payment event such as “termination of

employment,” “disability,” “separation from service,” “change in
control,” or “acquisition” that is not defined in the document, or is
improperly defined.

• A payment period that is more than 90 days following a permissible

payment event, or a payment period that is dependent upon the
participant executing a non-compete or non-solicitation agreement
or a release of claims.

• An impermissible payment event, such as an initial public offering

(that does not otherwise constitute a change in control as defined in
the 409A regulations) or enrollment of a child in college.

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Failures Eligible for Relief

• Impermissible alternative payment schedules that apply depending

on which payment trigger occurs, for example, a lump sum if the
participant has an involuntary separation from service versus ten
annual installments if the participant has a voluntary separation from
service.

• Employer or participant discretion to change the time or form of a

payment that is due, such as the discretion to pay in a lump sum or
annual installments, discretion to delay payments if certain cash flow
targets are not met, or discretion to make subsequent deferral
elections.

• Employer discretion to accelerate payments events, such as

discretion to pay before the participant separates from service even
though the plan provides for payment upon separation from service.

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Failures Eligible for Relief

• Impermissible reimbursements, like country club dues,

after separation from service.

• Failing to include the six-month delay for payments to

“specified employees.”

• Provisions that don’t comply with 409A’s initial deferral

election timing rules, such as applying the election
deadline for performance-based compensation to a
bonus that does not qualify as performance-based
compensation.
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Creation of New Failures under
Notice
• Notice expands potential violations.
– Timing of written document requirement
• Regulations provide no document failure can occur until the
written plan deadline has expired. Notice indicates
documentary failure at time NQDC arrangement reduced to
writing—could be much earlier.
– Releases?
• Notice allows correction where payment is contingent upon
execution of a non-compete agreement, a non-solicitation
agreement, or a release following a permitted 409A payment
event such as separation from service.
• It is permissible to forfeit a payment if a release is not signed
within the required period, but there is a 90-day limit.

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Possible Actions Required for
Correction

• Amendment of NQDC arrangement AND

all other arrangements.
• Current or future inclusion of amounts in
income and payment of tax.
• Information and reporting requirements,
even without inclusion in income.

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Information and Reporting
Requirements
• Service Recipient- attaches to its federal income
tax return for taxable year in which it corrects the
failure AND in taxable year subsequent to the
year in which correction occurred IF service
provider required to include amount in income.
• Service Provider-receives statement that
provider entitled to relief under Notice for
reporting of income (if applicable); W-2 or 1099
coded with 409A failure noted if required to
include in income. Possible repayment
obligations.
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What is NOT a Failure
According to the Notice?

• Term providing payment “as soon as reasonably

practicable” following the permissible payment
event, or under conditions substantially similar.
– Unless there is a pattern or practice of making late
payments, counting permissible payment event as the
trigger for required payment date.
– Could still have an operational violation if don’t pay in
accordance with the document terms.

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Do You Have to Use the Notice
to Correct?

• Non-vested Amounts: Proposed

regulations for 409A income inclusion
only tax vested amounts – so there is no
failure until then.
• Is it a reasonable interpretation that you do
not have a violation?
• Are you within written document deadline?
• Other tax and contract correction doctrines
(rescission, “scrivener’s error”)?
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General Correction Principles

• Must amend before problem arises and make

amendment effective immediately.
• Must correct with most restrictive interpretation to service
provider.
• “Date of correction” is latest of date on which
amendment adopted, is effective, or is set forth in
writing. NOTE: under transition rule, date of correction is
retroactive to January 1, 2009.
• Look-forward period: Generally, if impermissible event
occurs within one year of the date of correction, service
provider must include into income 50% (or 25%) of
amount deferred (subject to 20% penalty, but no
interest).

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Examples: Undefined Payment
Term
• Plan provides for payment upon “termination of
employment,” which is not defined.
– Does plan have a 409A “savings clause?” Then
interpret this to comply if possible (if hasn’t been
interpreted otherwise before). Then no correction
required (not a 409A violation).
– If no savings clause but wasn’t interpreted wrongly
before, then can amend the plan to comply (either
with savings clause or correct definition).
– If was interpreted wrongly before, can treat as an
operational correction, fix under Notice 2008-113, and
amend the plan.
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Examples: Bad Definition of a
Payment Term
• Plan provides for payment upon “termination of
employment,” which is defined to mean the date
that the employer no longer considers the
individual to be an employee of the employer
– If the incorrect payment event already occurred
(either under bad definition, or under a correct 409A
definition), it’s too late!
– Amend the plan to make definition comply, effective
immediately.
– One-year look-forward period (if past 2010): 50% of
the deferred amount must be included in income and
is subject to 20% 409A penalty.
– IRS reporting required.
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Examples: Impermissible
Payment Period
• Plan provides for payment after 409A
“Separation from Service,” to be paid within 6
months after separation occurs, in employer’s
discretion
– Amend the plan to remove the payment period or limit
the period to 90 days (and no service provider
discretion).
– If the separation has already occurred, can still
amend if it’s done within a reasonable time after
separation, IF paid within 90 days of separation, AND
50% of deferral is included in income & penalty.
– IRS reporting is required.
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Examples: Discretion Regarding
Payment Schedule
• Plan provides for service provider (employee)
discretion to elect a lump sum or 10 annual
installments upon distribution event, with lump
sum as a default.
– Must remove discretionary language.
– If default time or form in NQDC arrangement, must
use default, so in this case, lump sum is payable.
– If no default, must use time/form that would result in
latest final payment date.
– One-year look-forward period (if past 2010): If an
event that was corrected occurs, 50% income
inclusion rule applies.
– IRS reporting is required.
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Examples: Impermissible
Payment Event
• Plan provides for payment upon a child’s
entrance to college.
– Must amend to remove event before event selected
by service provider.
– One-year look-forward period (if past 2010): If any of
the impermissible payment events would have
required payment, 50% income inclusion rule applies.
– If ONLY impermissible payment events before
amendment, also must replace with provision
providing payment on later of separation from service
and 6th anniversary of date of correction.
– IRS reporting is required.
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Examples: Initial Deferral
Election
• Plan allows deferral of 2012 annual bonus (to be
otherwise paid March 15, 2013) up to June 30, 2012, but
annual bonus doesn’t qualify as performance-based
compensation.
– If election was made by December 31, 2011 (correct election
deadline), then no amounts are included in income.
– If election was revoked by December 31, 2011, then no 409A
violation (and no deferral either).
• Correction (amendment) must be made by end of
second taxable year following taxable year in which
applicable initial deferral election was required (2013).
• IRS reporting is required.

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Examples: Failure to Include
Six-Month Delay Rule
• Plan does not contain restriction for specified
employees that requires a six-month delay of a
distribution in the event of separation from
service or change in control.
– Correct before event occurs by amending NQDC
arrangement to add restriction.
– Further, the amount may not be paid before later of
18 months following date of correction or 6 months
following date of payment event.
– One-year look-forward period (if past 2010): If
payment event occurs, 50% income inclusion rule
applies.
– IRS reporting is required.
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Where Do We Go From Here ?

• ABA Comments issued April 30, 2010.

– Requests include: tighter definition of “under audit;”
broader ability to use Notice based on “reasonable,
good faith” effort to comply; expansion to stock rights
issues and short-term deferral failures; elimination of
linked plan carve-out; deletion of reporting
requirement where no income inclusion; clarification
of release requirements and forgiveness failures prior
to the date of the release
• IRS signaled intent to combine Notices 2008-
113 and 2010-6 into single Revenue Procedure.
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Now is the Time

• If you get nothing else out of this

presentation, remember this: the window
for possible tax-free correction closes on
December 31, 2010.

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Q&A

Brenda R. Berg (303) 295-8029

brberg@hollandhart.com
Jane O. Francis (303) 295-8599
jfrancis@hollandhart.com

Holland & Hart LLP

P.O. Box 8749
Denver, Co 80201-8749

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