<nobr>Dec 4, 2007</nobr>

Treasury, IRS Release Guidance on 409A Correction Program

The Treasury Department and Internal Revenue Service (IRS) December 3 released Notice 2007-100, providing transition relief and guidance on a program to correct unintentional operational failures under section 409A. The program will not allow relief for plan terms and provisions that unintentionally do not meet the section 409A requirements or other section 409A failures.

The notice provides guidance for correcting certain unintentional operational failures of nonqualified deferred compensation plan provisions subject to section 409A that are corrected in the same taxable year. It also provides transition relief through 2010 for operational failures involving amounts up to the limit on elective deferrals under tax code section 402(g) that are not corrected in the same taxable year by limiting the amount of income inclusion and additional taxes.

To qualify for relief, the employer must take "commercially reasonable" steps to ensure that the operational failure does not occur again and meet other conditions, such as reporting requirements. The notice provides examples of how the program would apply in specific situations, including inadvertent payment to a specified employee before the end of the six-month period following the specified employee's separation from service. Part II of the notice addresses the failure to defer an amount or an inadvertent payment of an incorrect amount. It also provides methods to correct excess deferrals corrected in the same taxable year.

Part III provides guidance relating to failures to defer amounts not in excess of the limit on elective deferrals under 402(g)(1)(B) for qualified plans that are not corrected in the same taxable year. Under the relief provided in Part III, the amount includible in income under section 409A(a) as a result of such failure is limited to the excess amount paid to the employee, and does not include any other deferred compensation under the plan, and the amount is includible in income only when paid to the employee in accordance with this section. In addition, with respect to this amount includible in income under section 409A(a), the employee is required to pay the additional 20 percent tax, but is not required to pay the premium interest tax.

Part III also provides relief for the deferral of excess amounts when the amount that should have been paid to the employee does not exceed the limit on elective deferrals under 402(g)(1)(B) for qualified plans that are not corrected in the same taxable year. The notice allows the employer to pay the employee the amount that should have been paid or made available to the employee by the later of the end of the employee's taxable year in which the failure is discovered or the fifteenth day of the third month following the date upon which the failure is discovered. The amount of the excess deferral is includible in income under section 409A(a) when paid, the employee is required to pay the additional 20 percent tax, but is not required to pay the premium interest tax.

Examples illustrate how the correction program would apply to each type of inadvertent operational failure. Part IV of the notice contains information and reporting requirements.

Part V of the notice lays out a potential corrections program. The program under consideration would cover failures that are not covered under the relief in Part III of the notice because the amount involved is too large and may also provide the relief in Part III for small amounts permanently. In addition, it is expected that the program under consideration would, in general, permit an employee with respect to whom an operational failure occurred that is addressed by the program but not eligible for the relief provided in Part III of the notice, to include an amount in income, and pay the additional taxes under section 409A with respect to, only the amount involved in the operational failure, and not other amounts deferred under the plan.

The corrections program under consideration would have the following aspects:

• Relief would only be available with respect to an operational failure that has occurred notwithstanding the employer's reasonable efforts to comply with the terms of the plan.


• Relief would only be available with respect to an operational failure if the employer also took commercially reasonable steps to avoid a recurrence of the same type of operational failure.


• Relief would also not be available to correct an operational failure that is egregious, intentional, or where the failure is directly or indirectly related to participation in an abusive tax avoidance transaction.


• If the operational failure involved an accelerated payment that did not otherwise satisfy the plan's terms and the requirements of section 409A(a), the correction of the failure would require that the employee return the amount improperly paid. The employee would not be entitled to any loss or deduction for either the year of the repayment or the year to which the correction applied. However, if the plan does not otherwise violate the provisions of Section 409A and the applicable guidance, the employee would be required thereafter to include in gross income only additional amounts subsequently paid from such plan (as if the amount taken into gross income in the year of the failure resulted in investment in the contract with respect to the amount that was actually included in gross income for the year of the erroneous payment).


• Relief would not be available for an accelerated payment that did not otherwise satisfy the terms of the plan and the requirements of section 409A(a) if the employer made the payment proximate to a financial downturn or a significant risk that it would not be able to pay the amount deferred when the payment became due under the plan.


• If the operational failure involved an amount that was improperly deferred (for example, an excess deferral), or an amount of deferred compensation that was not paid to the employee on the payment date, the correction of the operational failure would require the employer pay the amount to the employee. The employee would be required to include the amount in gross income in the taxable year in which the failure occurred and not at the time the employer made the corrective payment, with the employee being required to report the amount on an original or amended return for such year and pay the appropriate tax thereon.


• Earnings (potentially including losses) for the period of time after the operational failure through the date of correction would be required to be taken into account.


• In addition to the requirement of income inclusion described above, the employee would be required to pay income taxes, including the additional section 409A taxes (and any applicable interest on the underpayment), as applicable. The employer would be required to file applicable reporting forms with the IRS. If both employer and employee met the requirements for the correction program, the employer would not be liable for any failure to withhold income taxes on the amount required to be included in income under section 409A as a result of the operational failure, to the extent the amounts required to be included in income had not been paid or made available to the employee.


• Some or all of the relief may not apply to executives considered to be insiders.

Notice 2007-100

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