Cause for Concern
Although the Notice provides guidance, its examples also give employers cause for concern. For example:
- Termination of employment. The phrase “termination of employment” may violate section 409A if it leads to payments in situations not permitted under section 409A (for example, where an employee reduces their hours or is re-hired as an independent contractor providing significant services after termination of employment). Previously, the IRS had informally indicated that the term was acceptable. See Notice 2010-6, Section IV.B.
- Severance payment timing. Severance payments contingent on a release of claims or the end of a rescission period may violate section 409A (if the compensation to be paid is subject to section 409A). See Notice 2010-6, Section VI.B.
The Notice provides guidance on how to address these types of plan documents failures.
The Notice notes that if a plan has ambiguous terms (such as payment to be made “as soon as possible”), the plan will not necessarily be deemed to have violated section 409A if the employer does not have a pattern or practice of interpreting the term in a manner that violates section 409A. These terms, however, may be corrected by adding a savings clause (that the language will be interpreted in a manner that complies under section 409A) or by revising the language to comply with section 409A. See Notice 2010-6, Section IV.
Eligibility Requirements
The Notice lists a number of criteria for a plan to be eligible for document correction including the following:
- Only inadvertent or unintentional failures may be corrected.
- All similar failures must be corrected.
- The employee’s tax return must not be under examination and the employer’s tax return must not be under examination with respect to nonqualified deferred compensation.
- The employee must pay all taxes related to the section 409A correction.
- The employer must satisfy information and reporting requirements.
The Notice provides guidance on correcting the following failures:
- Impermissible definition of permissible payment event.
- Impermissible payment period.
- Impermissible payment event and payment schedules.
- Impermissible initial deferral election.
- Failure to include six-month delay.
- An ability to correct certain errors in the year in which the employer adopts a plan.
The Notice also clarifies the following aspects of Notice 2008-113 (See Notice 2010-6, Section XIII):
- Clarification of the subsequent year correction method for late payment.
- Clarification of how to calculate the amount that must be repaid when an early payment has been made in the form of property (such as stock).
- Clarification of calculation of the amounts.
Transition Relief
The Notice provides special transition relief for the corrections allowed under the Notice stating that if the correction is done on or before December 31, 2010, the plan is treated as having been corrected on January 1, 2009. The Notice also provides relief for certain corrections made before December 31, 2011.
Why It Is Important To Act Now
The Notice provides helpful guidance, but also gives employers an urgent reason to review their plans and arrangements (including and perhaps especially employment agreements and severance agreements). If there is a plan document failure, the Notice may allow this to be corrected but then also require correction of operational failures that occurred prior to the correction. If you have questions about the Notice or your plans or arrangements, please contact the attorney in the Benefits and Compensation practice group with whom you work.