On December 5, 2008, the U.S. Treasury Department and Internal Revenue Service (IRS) issued two new pieces of guidance under Internal Revenue Code Section 409A.
Expanded Correction Program
The IRS issued Notice 2008-113, which allows taxpayers to correct certain 409A operational failures. The new notice expands and clarifies the prior correction program announced in 2007 in Notice 2007-100 and can be relied upon for taxable years beginning before 2009.
Notable changes made by Notice 2008-113 include the following:
- Expanded ability to correct operational failures in the year following the year of the failure
- Special transitional relief for certain operational failures occurring before January 1, 2008
- Relief limiting the amount of 409A taxes on certain operational failures regardless of the amount involved
- Limited or no ability to make corrections with respect to “insiders” (generally, an officer, director or 10 percent or more shareholder) of both public companies and private entities)
- A requirement to demonstrate that commercially reasonable steps be taken to avoid the recurrence of an operational failure by the end of 2009Unfortunately, the new program still requires an IRS filing by both the service provider and the service recipient. In addition, the new program still does not cover plan document failures (although the IRS requested comments on how such a correction program might work). The fact that the updated IRS correction program does not cover plan document failures highlights the need for employers to ensure that all of their compensatory arrangements are reviewed for 409A compliance and amended as necessary prior to December 31, 2008.
Income Inclusion Guidance
The Treasury Department issued proposed 409A regulations providing detailed guidance on the calculation of amounts includible in income on a violation of section 409A, and the premium interest tax resulting from a Section 409A(a) violation that is not corrected under Notice 2009-113. Specific rules are provided for defined contribution “account balance” plans, reimbursement arrangements, split dollar arrangements and stock rights. The proposed regulations also provide the following:
- An opportunity to correct defects with respect to unvested amounts
- That a failure in one year generally will not affect 409A compliance in a subsequent taxable year if the plan complies during the later year
- Guidance on how a service provider may deduct amounts included in his or her income but never actually received (for instance, because of bankruptcy); the proposed regulations indicate that the Treasury Department intends to allow employers to rely on these proposed regulations for reporting 409A violations in 2008 and to delay annual reporting of compliant 409A deferrals until the regulations are finalized
The proposed regulations do not address how to calculate taxable amounts due to violation of funding rules (relating to offshore assets or transfers in connection with a change in the employer’s financial health) under Section 409A(b).
In addition, the IRS has informally indicated that it will issue guidance either later in December 2008 or in January 2009 under the new Code Section 457A, focusing primarily on the transitional relief for compensation earned on services rendered before 2009.
Further analysis of the new 409A guidance will be provided in an upcoming publication.