03/01/2010 10:28:00 AM EST
A More Permanent Section 409A Correction Program
IRC Section 409A imposes severe consequences on the recipient of nonqualified deferred compensation for any violation of the Section's plan documentary or operational requirements. Documentary compliance was required for all existing arrangements by December 31, 2008, and it applies to all new arrangements from the inception of the arrangement. While initially transition rules provided some flexibility, and the first correction program provided some relief, this first permanent correction program (Notice 2008-113) provides more and welcome relief for inadvertent errors.
A violation triggers the 20% penalty tax and interest penalty tax for not only the amount of the violation and the arrangement involved, but for all arrangements or plans in the same category of “plan” under Treasury Regulations Section 1.409A-1(c) and all deferrals under those combined plans. A minor slip can have dire and disproportionate federal income tax consequences for the recipient of nonqualified deferred compensation. Thus, some of the drivers that were behind creating the employee plan compliance resolution system (EPCRS) for qualified plans are now in place for nonqualified deferred compensation, but only some. Congressional endorsement of nonqualified deferred compensation and potentially broad-based negative consequences of noncompliance are missing as underpinnings for this program, and that gap has contributed to a different tone and more restrictions even under this new, expanded effort.
While initially transition rules provided some flexibility, and the first correction program provided some relief, this first permanent correction program (Notice 2008-113) provides more and welcome relief for inadvertent operational errors. Correction is unquestionably preferable to being subject to the severe potential Section 409A penalties.
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The first signs of flexibility about strict compliance with the requirements of IRC Section 409A , as amended (the “Code”) in practice were found in the transition rules in Notice 2005-1 and the subsequent extensions of the transition relief in Notice 2006-79, Notice 2007-86, and the preambles to the final regulations and to the proposed regulations. As the transition relief and the first transitional correction program expired the IRS issued the first permanent correction program. The first permanent program is found in Notice 2008-113.
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Notice 2008-113 does not provide any relief for failures that result when the document providing the nonqualified deferred compensation has not been amended to comply with section 409A of the Code. Notice 2008-113 also provides no relief for violations of the funded plan rules under section 409A(b) of the Code (plans funded upon a financial trigger of the service recipient, plans funded offshore and plans funded while the service recipient's qualified defined benefit plan is insufficiently funded)...
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The relief provided by Notice 2008-113 is available only if all of the requirements for the applicable correction method are satisfied. In addition to any unique requirements for each specified type of correction, the following general requirements must also be satisfied in every case.
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Commercially Reasonable Steps to Prevent Recurrence...
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Federal Tax Return Is Not Under Exam...
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Plan Terms Compliant With Section 409A...
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Failure Does Not Relate to Exercise of a Stock Right...
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Inadvertent and Unintentional Operational Failure...
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No Listed Transaction. The operational failure must not be directly or indirectly related to participation in any listed transaction under Treasury Regulations section 1.6011-4(b)(2) (e.g., it must not be related to an abusive tax avoidance transaction or an “ATAT”).
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If Repayment is Required, Full Payment is Made...
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Not for Erroneous Payments in Year of Substantial Financial Downturn. Relief will not be provided for an erroneous payment paid during any taxable year of the service provider in which the service recipient either (i) experienced a substantial financial downturn that indicated a significant risk that the service recipient would not be able to pay the deferred compensation when due, or (ii) otherwise experienced financial or other issues that indicated a significant risk that the service recipient would not be able to pay the amount deferred when due...
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Other Considerations. Use this Notice carefully, in strict compliance with its terms at least initially, because any use of this Notice is subject to examination by a suspicious Service, and because the taxpayer has the burden to prove eligibility to use the program and compliance with its terms.
Copyright © T. David Cowart and Greta E. Cowart
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