Client Alert: 409A Compliance Deadline
The deadline for full compliance with Section 409A of the Internal Revenue Code relating to the deferral of compensation for employees and other service providers is December 31, 2008. We do not believe that the IRS will extend this compliance deadline. Therefore, it is crucial for those companies who have delayed reviewing their compensation-related arrangements to do so promptly in order to meet the deadline.
Why is the deadline important?
- Employee satisfaction. Employees are subject to a 20% excise tax for failure to comply with Section 409A. Since Section 409A, among other things, governs issues regarding severance and bonuses, key executives and salespersons are especially likely to be affected.
- The Company also loses. A company that fails to comply with Section 409A will have to correct or supplement its withholdings, which may involve the payment of penalties and interest. The company may also be unable to make certain representations regarding Section 409A compliance in its financing or acquisition documents, thereby potentially losing or otherwise adversely affecting a deal. Such representations are now routinely required in these types of transactions.
What does my company need to do now?
Inventory and review current documents for compliance with Section 409A, including:
- Employment agreements and offer letters
- Severance agreements
- Post-employment fringe benefits
- Change of control agreements
- Advisory Board arrangements
- Consulting agreements
- Bonus and other cash incentive arrangements
- Commission plans and arrangements
- Equity plans, stock options and stock appreciation rights
- Phantom stock agreements
- Restricted stock unit plans
- Salary deferral arrangements
- Deferred compensation plans
- Supplemental retirement plans (“SERPs”)
- Tax gross-up and indemnification arrangements
Certain types of plans are generally exempt from Section 409A, including:
- Qualified retirement plans, such as 401(k) plans and pension plans
- Most group health plans
- Bona fide sick leave and vacation plans
- Disability plans
- Death benefit plans, such as group life insurance plans
- Certain medical expense reimbursement plans
- Incentive stock options meeting the requirements of Code Section 422
- Most direct grants of restricted stock
Consider unwritten arrangements
Review all unwritten arrangements regarding compensation to ensure compliance with Section 409A. (This means, for example, founder arrangements, back of the envelope arrangements and unwritten sales commission plans.) Employers must reduce all unwritten arrangements that are subject to Section 409A to writing by December 31, 2008.
Devise a plan to bring non-compliant compensation-related arrangements into compliance by December 31, 2008.
In many instances, this will involve drafting or amending agreements which may require Board approval. Employee consent may also be required. It is important to start this process now so that all available amendments or revisions can be made in a timely manner.
Devise a plan for internal controls and compliance.
After all current arrangements are brought into compliance with Section 409A, it will be important to make sure that all future arrangements are compliant from the start. Therefore, processes and procedures will need to be adopted to ensure that compensation-related arrangements are reviewed for compliance prior to being used or adopted, and that any modifications or amendments to these types of arrangements are reviewed in advance for potential Section 409A consequences.
Contact any of the attorneys listed below to help with your document review or ongoing compliance procedures and needs.
Please be advised that the review process cannot generally be accomplished on a moment’s notice. Therefore, it is extremely important to plan ahead and begin this process as soon as possible.