Deferred Compensation Arrangements Must be Updated by December 31, 2008
August 8, 2008

December 31, 2008 is the final deadline for making sure that all of your non-qualified deferred compensation arrangements (NDCAs) comply with Section 409A of the Internal Revenue Code. The deadline likely will not be extended. Companies and their executives have less than six months to take the following actions:

• Identify and inventory all NDCAs,
• Identify and consider available exemptions from Section 409A,
• Develop strategies to bring non-exempt NDCAs into compliance with Section 409A, and
• Draft (and/or revise) all necessary documents, including employee communication materials.

Your business likely has one or more NDCAs, perhaps even more than you think. Section 409A's broad reach allows it to hide in unexpected places. Section 409A applies all types of arrangements, written or verbal, between a business and anyone involved with the business for the payment of future compensation based on services provided now or in the past.
Here are just a few examples of the types of arrangements that may be subject to Section 409A:

• bonuses,
• severance payments,
• phantom stock awards,
• restricted stock awards,
• consultation fees,
• director fees,
• “cashed-out” sick or vacation time.

The rules do not eliminate any of the existing rules that govern the payment of executive compensation. Rather, they are additional rules that apply to executive compensation and all forms of deferred compensation, as defined by Section 409A. There is no way to feel confident about your business's compliance with Section 409A until all of your NDCAs have been identified, inventoried and analyzed.

Failure to comply with Section 409A after December 31, 2008, is extremely costly. If the IRS finds that a NDCA is not in compliance, your employees covered under the NDCA can be hit with the following penalties:

• immediate taxation of all the vested deferred compensation, plus

• a 20% penalty tax, plus

• interest at 1% above the IRS late payment rate from the date the deferrals first “vested.”

Section 409A applies to all types of businesses, including corporations, partnerships, sole proprietors and not-for-profits. The people who are affected include employees, directors, partners, and independent contractors. Even arrangements that cover only one person may be subject to Section 409A.

Section 409A provides detailed rules for such terms as: (1) the timing and form of compensation deferral elections, (2) efforts to change deferral elections, (3) the timing and form of distributions, (4) efforts to accelerate or further defer distributions, and (5) plan terminations.

Fortunately, the news is not all bad. Section 409A does not govern the amount of deferred compensation or even when it vests.

Once all of your business's NDCAs have been identified, the next step is to see if any of them fall within the various exclusions from Section 409A. For example, profit sharing and 401(k) plans, ESOPs, incentive stock options and certain involuntary severance payments are generally excluded from Section 409A. In addition, plans that are not excluded, such as bonus arrangements, can be structured to fall outside of Section 409A, such as by using its “short-term” deferral rule.

NDCAs that are not excluded must be set forth in writing. (In fact, we would recommend documenting all deferred compensation arrangements, even ones that are not subject to Section 409A.) The written document(s) must include such terms as: (1) the individuals or group to be covered, (2) the amount of compensation to be deferred, (3) the time of payment, (4) the form of payment, and (5) any change in prior deferral elections.

We strongly urge our clients to give immediate careful attention to the tasks identified above. Remember: 12/31/08 is the deadline -- one that will be missed unless work is begun well in advance. The T&L Employee Benefits and Executive Compensation Group has a great deal of experience helping our clients resolve the many issues caused by Section 409A. Of course we are available to help you too.

If you have any questions, please contact:

Barry D. Berman, Esquire
bberman@tandllaw.com
(443) 927-2115

or

John R. Paliga, Esquire
jpaliga@tandllaw.com
(443) 927-2114