On Friday, the IRS released a new correction program for inadvertent and unintentional Section 409A operational errors in nonqualified deferred compensation plans on and after January 1, 2009.  All such plans must be properly documented by the end of 2008 to comply with Section 409A, as the correction program is not available for documentation errors.  If you have questions regarding the operation of your plan, or if you need assistance in drafting your plan documents, please contact one of our Employee Benefits and Executive Compensation attorneys. A few highlights of the Section 409A correction program are set forth below.

Eligibility.   To be eligible for the correction program, the employer or service recipient must establish practices and procedures to avoid the occurrence of errors; the tax return of the employee or independent contractor cannot be under examination for the year of correction; the error must be fully corrected; and the employer or service recipient cannot be experiencing a financial downturn that would result in an inability to pay the amount when due.

Correction of Stock Rights.  If the exercise price of a stock right is established at a discount, the employer may correct the exercise price for an “insider” (a director, an officer, or a person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security of the employer) no later than the end of the year in which the stock right is granted.  For a non-insider, such correction may be made no later than the end of the taxable year immediately following the taxable year in which the stock right was granted. The correction will exempt the stock right from the application of section 409A retroactive to the date of grant.

Correction in the Same Taxable Year.  An early or delayed payment (including an improper deferral) that is not in accordance with the plan or a properly completed deferral election may be corrected by repaying the amount within the same taxable year to the employer or employee respectively.  This correction avoids early inclusion in income, the 20 percent penalty tax, the premium interest tax, and any additional withholding and reporting requirements.

Correction for Non-Insiders in the Year Following the Year of Failure.  An early or delayed payment (including an improper deferral) that is not in accordance with the plan or a properly completed deferral election may be corrected in the year following the year of the error. If the payment is early (including a failure to defer), the amount must be included in income in the year it is paid and deducted in the year it is corrected. If the payment is late (including an excess deferral), it must be included in income when actually paid. Correction under this method is not subject to the 20 percent penalty tax.

Correction Subject to the 20 Percent Penalty Tax.  Correction of any of the following errors, which cannot be corrected under one of the other correction procedures, is subject to the 20 percent penalty tax, but not the additional premium interest tax.

  • Amounts that do not exceed the Code section 402(g) limit ($16,500 for 2009).
  • Amounts paid early and corrected within two taxable years.
  • Amounts that are not paid within two taxable years after the correct payment date.


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