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As I noted last Friday, on January 5, 2010, the IRS issued Notice 2010-6, Relief and Guidance on Corrections of Certain Failures of a Nonqualified Deferred Compensation Plan to Comply with §409A(a) (the "Notice"). Importantly, the Notice does much more than just offer correction methods. It contains numerous examples of situations that the 409A final regulations do not clearly address – and provides for significant penalties for many plan provisions that a normal person might view as a foot fault.
If you were naïve enough (like many of us) to believe that the IRS would cut employers a little slack with respect to word-for-word compliance with terms defined in the 409A regulations, such as Change in Control and Disability, you are in for big surprise. Check out this amazing example from the Notice:
Employee participates in a plan that provides for a payment of $100x to her upon the earliest of her attaining age 65, death, or a "change in control" of Employer. The definition of "change in control" under the plan does not satisfy the definition of a change in control event under 409A solely because the definition includes an initial public offering of more than 30% of the stock of Employer. On February 15, 2011, at which time Employee G is age 50, Employer amends the definition of change in control under the plan to delete the occurrence of an initial public offering of Employer stock as a "change in control" of Employer and does not add any other change in control events that would cause a payment under the plan. Employer has an initial public offering of 33% of Employer stock on July 1, 2011.
The Employer corrected the provision before the initial public offering, but the initial public offering occurred within one year following the date of correction. Thus, even if Employer does not pay Employee any amount under the plan due to the event, Employee must include 25% of the "amount deferred under the plan" to which the pre-correction plan provision applied in income under 409A, and pay all applicable Federal taxes, including the additional 20% tax on such amount (but not the additional premium interest tax), and Employer must report 25% of the amount deferred as income under 409A for 2011 on the Form W-2, Box 1 and Box 12 using Code Z, for Employee. However, Employee will not be required to include in income under 409A any further amount solely as a result of the pre-correction plan provision.
The Notice not only does not allow even a slight variance from the definition arbitrarily imposed by the regulations, but also imposes a penalty even after the employer revised the definition to comply!
In my next Blog, it gets worse. [Remember, they are from the government and they are here to help.]
Michael S. Melbinger
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