Section 409A of the Internal Revenue Code has applied to informal church retirement arrangements since 2005. On April 10, 2007, the IRS issued Final Regulations, effective in 2008, to provide clarity to the requirements. The deadline for document compliance was to be December 31, 2007. Then, on September 10, 2007 (IR-2007-157), the IRS extended the document compliance deadline to December 31, 2008 but it did not extend the January 1, 2008, effective date of the final regulations.
On October 22, 2007, the IRS released Notice 2007-86 (the “Notice”), extending the deadline for compliance with the final regulations of Code Section 409A to January 1, 2009. The extension in this Notice supersedes the more limited extension that was announced in September 2007. Although “good faith” operational compliance continues to be required, employers now have until December 31, 2008, to amend their plans to reflect compliance with the final regulations under 409A. However, employers desiring to amend the distribution provisions of their plans in a manner that would impact amounts that would otherwise be payable in 2008 must do so by the end of this year. In addition, if employers intend to offer employees the opportunity to make new distribution elections, employees desiring to make a new distribution election to govern payments that would otherwise be payable in 2008 must still make that election on or before December 31, 2007.
Failure to comply with new 409A regulations may leave employees holding the bag. The penalties for non-compliance include taxation of vested benefits, a 20% penalty, and interest charges on the total balance. All of this plus a major headache is leaving employees skeptical of entering such plans.
Overview of Section 409A
The American Jobs Creation Act of 2004 created Internal Revenue Code Section 409A. This section restricts deferral elections, distribution elections, and distribution events under non-qualified deferred compensation plans. However, since this act became effective in 2005 the Internal Revenue Service (IRS) has only required that employers operate the plans that fall under this act in good faith until final regulations detailing compliance requirements are published. On April 17, 2007 the IRS published these final regulations.
Impact of Section 409A Non-Compliance on Exempt Organizations and Employees
An organization’s failure to comply with these new regulations by the December 31, 2007 due date will lead to severe financial consequences for participants, including:
- Being taxed on their vested benefits,
- Incurring an additional 20% tax penalty, and
- Being subject to interest charges
What plans are included in Section 409A?
The act has broadened the definition of what is considered as a non-qualified deferred compensation plan. The following is a partial list of examples that are included under this definition:
- Plans providing for elective deferrals of salary, bonus or other compensation
- Supplemental executive retirement plans
- “Excess” plans intended to make up for the statutory limits on benefits under qualified retirement programs
- Some severance pay programs or change in control agreements
- Some bonus and long-term incentive plans
- Employment agreements that provide for deferred bonuses, retirement income, some severance or change in control benefits
- Some arrangement with non-employees, such as directors, contractors and consultants
- Some split-dollar life insurance arrangements
- Section 457(f) plans (ineligible deferred compensation plans)
Plans Exempt from Section 409A
The following are exempted by statute or regulation from these new compliance regulations:
- Qualified pension and profit sharing subject to Sections 401(a) or 401(k) and other tax-favored vehicles such as Section 403(a) or (b) annuity arrangements, SEPs, or Section 457(b) programs.
- Welfare-type plans such as bona fide vacation leave, sick leave, disability pay or death benefit plans
Section 409ACompliance Requirements
The following is a partial listing of the requirements to be in compliance with section 409A:
- A distribution may only be made at:
- Separation from service,
- Disability or death,
- Time specified in the arrangement, or
- Unforeseeable emergency or change in control
- Generally, the election by the participant to defer compensation must be made before the beginning of the year that such compensation is deferred. However, there is exception for the first year and performance compensation. Such election must also specify the time and form of payment
- Once an amount has been deferred, there are significant restriction the ability to change the timing and form of payment)
Section 409A Reporting Requirements
Section 409 requires plan sponsors report on Form W-2 (for employees) or Form 1099 (for non-employees) all amounts deferred under a nonqualified deferred compensation plan during the year.
Any amounts includible in gross income due to the failure to comply with Section 409A requirements. Additionally, any amount includible in gross income of an of an employee due to a Section 409A violation are considered wages for withholding purpose and also must be reported as such on the sponsor’s IRS Form 941.