On October 22, 2007, the Internal Revenue Service issued Notice 2007-86, which provides relief through 2008 for amending nonqualified deferred compensation plans to comply with the final regulations issued under Section 409A of the Internal Revenue Code, and a much-needed extension of certain transition relief through 2008. This new guidance supersedes the previous, limited transition relief issued in September.

Comment: Although the Section 409A compliance deadline has been extended to December 31, 2008, it is important to continue the process of reviewing and updating your nonqualified deferred compensation arrangements now so that all appropriate documentation and operations will be in compliance by the December 31, 2008 deadline. The Employee Benefits and Executive Compensation Group stands ready to assist you in analyzing and documenting your Section 409A compliance efforts.

Payment Elections

Under the extended transition relief, executives, directors and other service providers subject to Section 409A may elect, through December 31, 2008, to change the time and form of payment of their nonqualified deferred compensation benefits without regard to the Section 409A restrictions. Any such transition election made in 2008 cannot affect amounts otherwise payable in 2008 and cannot accelerate payment into 2008. Effective January 1, 2009, Section 409A generally will prohibit changes in the time and form of payment of such benefits, unless a change is elected 12 months in advance of payment, and payment is delayed at least five years.

Comment: Those who wish to accelerate payment of their nonqualified deferred compensation benefits into 2008 must still elect to do so by December 31, 2007. Executives and directors who made previous transition elections regarding the time and form of payment of their nonqualified deferred compensation benefits may change such elections by December 31, 2008, without regard to the Section 409A restrictions, so long as the change does not affect any amounts that would otherwise be payable in 2008.

Linked Plans

Under Section 409A, the time and form of payment of a nonqualified deferred compensation benefit generally must be set at the time of deferral, and cannot be linked to the time and form of payment of a qualified plan benefit (which may be changed subsequent to deferral). Thus, for example, the time and form of payment of a nonqualified 401(k) excess plan benefit must be de-linked from the corresponding qualified 401(k) plan. However, the extended transition relief permits the continued linking of nonqualified and qualified plans until December 31, 2008.

Plan Documentation

Taxpayers are required to comply with a good faith interpretation of the Section 409A statute and prior guidance issued on nonqualified deferred compensation arrangements. For 2008, taxpayers are not required to comply with the final Section 409A regulations. However complying with the final Section 409A regulations will be considered a good faith interpretation of Section 409A. All nonqualified deferred compensation arrangements must be amended to comply with Section 409A and the final regulations by December 31, 2008.

Comment: Employers who are in the final stages of amending their nonqualified deferred compensation plans to comply with Section 409A should continue to do so. Good faith operational compliance with Section 409A is required during the transition period, and it is advisable to have plan documents that reflect plan operations. To the extent that there are any clarifications to the Section 409A guidance issued during the transition period, plans can always be amended to reflect such clarifications (if applicable).

Discounted Stock Options

Discounted stock options or stock appreciation rights (SARs) are subject to Section 409A. Stock options and SARs granted with an exercise price equal to at least 100% of the fair market value of the underlying stock on the date of grant are not subject to Section 409A. The IRS previously provided transition relief permitting the replacement of a discounted stock option or SAR with a non-discounted stock option or SAR until December 31, 2006. The new guidance extends this transition relief until December 31, 2008.

Employment Agreements

IRS guidance issued in September 2007 regarding the application of Section 409A to certain employment agreement provisions (including severance provisions) has not changed, even though the documentation requirements have been extended through December 31, 2008. Thus, for example, to the extent a "good reason" voluntary termination provision in an employment agreement does not provide a substantial risk of forfeiture, the employment agreement may not be amended to conform the good reason provision to a Section 409A-compliant good reason provision in order to exempt a severance payment from Section 409A.


Copyright © 2007 by Ballard Spahr Andrews & Ingersoll, LLP. This newsletter is a periodic publication of Ballard Spahr Andrews & Ingersoll, LLP and is intended to alert the recipients to new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and specific legal questions you have.