On October 4, 2006, the Internal Revenue Service issued Notice 2006-79, providing additional transition relief for sponsors of nonqualified deferred compensation plans with respect to the certain operational and documentation requirements of section 409A of the Internal Revenue Code. Section 409A imposes significant restrictions on executive and deferred compensation arrangements. The Notice extends the deadline for certain aspects of compliance with 409A from January 1, 2007 to January 1, 2008. This extension reflects the delay in publishing final 409A regulations (which were issued in October 2005 in proposed form). Final regulations are still expected before the end of 2006.

The Notice generally extends through 2007 the following transition relief provisions.

  • Plan Amendments. Although nonqualified plans must be operated on and after January 1, 2005 in reasonable, good faith compliance with 409A and published IRS guidance, formal amendment of plan documents to reflect 409A may be postponed until December 31, 2007.

  • Transition Payment Elections. Nonqualified plans may permit participants to make new elections on or before December 31, 2007 with respect to both the time and form of payment of amounts subject to 409A. Such elections will not be treated as violating 409A's restrictions on subsequent payment elections or acceleration of payments. However, any transition payment election made in 2006 cannot apply to amounts that would otherwise be payable in 2006, and cannot accelerate payment into 2006. Likewise, any transition payment election made in 2007 cannot apply to amounts that would otherwise be payable in 2007, and cannot cause an amount to be paid in 2007.

  • Linked Plans. Some nonqualified deferred compensation plans link the timing or form of payment to the election made by the participant under a related qualified plan. While such "linked" elections generally will violate 409A, the Notice extends through 2007 relief that permits nonqualified plan payments based on linked elections.

  • Short-Term Deferrals. A deferral election may be made with respect to an amount that is a "short-term deferral" under 409A, so long as the election is made before 2008 and before the year in which the amount would otherwise be paid. A "short-term deferral" is compensation earned and vested in one tax year that is payable no later than 2½ months into the following tax year. Under this rule, for example, an employee could elect prior to the end of 2006 to defer the payment of an employer bonus for 2006 services that would be otherwise payable in February 2007.

  • Stock Rights. A deferral election under the transition rule generally may apply to outstanding stock rights (other than discounted stock rights). For example, an outstanding stock right that provides for a deferral of compensation (and hence is subject to 409A) may be amended to provide for fixed payment terms consistent with 409A, or to permit holders to elect fixed payment terms consistent with 409A.

Executive and deferred compensation issues continue to receive a lot of attention from the IRS and other government agencies. Noncompliance can lead to substantial tax penalties for executives and other adverse consequences. Employers should proceed with extreme caution in designing, amending and operating nonqualified deferred compensation arrangements.

Copyright © 2006 by Ballard Spahr Andrews & Ingersoll, LLP. (No claim to original U.S. government material.) This publication is intended to alert recipients to new developments in the law. It does not constitute legal advice or a legal opinion on any specific facts or circumstances. The contents are intended as general information only. You are urged to consult your own lawyer concerning your situation and specific legal questions you may have.