The recent release of the long-awaited final regs on nonqualified deferred compensation under Code Sec. 409A did not bring a much-hoped-for extension of the effective date for full implementation of the rules. The final regs - all 209 pages of them, and the 186 pages it took to explain the changes made or not made to the proposed regs - do not extend the transition relief for compliance beyond Dec. 31, 2007.That does not leave much time for compliance, let alone formulating tax strategies that take maximum advantage of the small leeway that the final regs provide to employers. Compensation plans drafted under the proposed regulations must be compared against the final regs. Decisions on whether a plan should be terminated must be made. Final plan designs must be drafted and adopted. And then an explanation of the terms of the compliant plan must be explained (and sold) to the key executives who the plan has been adopted to keep happy in the first place.


Plans must comply with the regs and be amended by Jan. 1, 2008. The government declined to extend transition relief for compliance beyond December 31.

While the plan documents must explicitly comply with Code Sec. 409A, a plan does not have to be entirely in one document. An election form can provide some of the critical terms. In addition, there does not have to be a lot of detail in the compliance document(s). Nevertheless, a plan cannot use a savings clause to provide for the nullification of plan provisions that violate Code Sec. 409A.

As a general rule, the plan must specify the amount payable (or the terms of a formula determining this amount), and the payment schedule or triggering events that result in payment. If the company is publicly held, the plan must provide for the six-month-delay requirement for the top 50 officers with incomes of $130,000, plus certain owner-employees.


Code Sec. 409A generally applies to amounts deferred after Dec. 31, 2004. The final regs clarify that grandfathered amounts include an account balance, such as a bonus, that is earned and vested before this date, even if the bonus amount is not calculated and credited until 2005 or later. For a non-account-balance plan, any actuarial assumptions and methods that were reasonable to use as of Dec. 31, 2004, to determine the grandfathered amount may continue to be used in subsequent years.

On the other side of the coin, amounts deferred before Jan. 1, 2005, are subject to Code Sec. 409A if the plan providing the benefits is "materially modified" after Oct. 3, 2004. The final regs clarify and give comfort to some taxpayers: Payment under a domestic relations order is not a material modification. A change to stock rights will not be treated as a material modification if the change would not be treated as a new grant of a stock right or as an extension of the stock right resulting in a deferral feature from the date of grant.

Once a plan is materially modified, however, there is no turning back: Compliance with Sec. 409A is based on the terms of the plan, and any actions taken under it after the date of the material modification.


Stock rights are the staple of many executive compensation plans. In this area, the government has shown flexibility in allowing a variety of interpretations within the "intent of Code Sec. 409A" until hard and fast rules are enforced starting in 2008.

Notice 2006-4 provides that until the effective date of final regs, stock rights granted on or after Jan. 1, 2005, need only meet a good-faith or reasonable-valuation standard for determining whether they are granted at fair market value. Taxpayers may also rely on the proposed or final regs to determine the fair market value of the underlying stock.

Unfortunately, however, the Treasury's largesse only goes so far: Stock issued on or after April 17, 2007, must comply with the final regs to be treated as "service recipient stock" that is exempt from Code Sec. 409A.

Before Jan. 1, 2008, plans must operate in good-faith compliance with Sec. 409A. Notice 2006-79 indicates that compliance with the proposed or final regs is not required, but will be treated as reasonable good-faith compliance. Nevertheless, for an employer to intentionally cross that line and defend another interpretation of Sec. 409A would not make much sense.

A plan may provide, or be amended to provide, for new payment elections, regarding time and form of payment of deferred amounts, on or before Dec. 31, 2007. These elections can only apply to amounts that would not otherwise be payable in 2007, and may not cause an amount to be paid in 2007. A deferral election also can be made for a short-term deferral if the election is made before Jan. 1, 2008, and before the amount would have been paid.


A payment election under a nonqualified deferred-compensation plan may be linked to an election under a qualified plan through Dec. 31, 2007, provided that the time and the form of payment comply with the terms of a deferred-compensation plan in effect on Oct. 3, 2004. A non-discounted stock option or stock appreciation right may be substituted for discounted options and rights through Dec. 31, 2007, provided that the cancellation of the discounted rights is not in exchange for cash or vested property.

A plan maintained under one or more collective bargaining agreements does not have to comply with Code Sec. 409A until the earlier of Dec. 31, 2009, or the expiration date of the last agreement.

Some plans will need shareholder approval and may have to be amended conditionally, pending approval in 2008. Plans requiring approval by a board can comply by Jan. 1, 2008.


Elections made before Jan. 1, 2008, that comply with the proposed regs or the transition guidance will be deemed to comply with Code Sec. 409A, even if amounts are deferred beyond 2007.

For a program established before April 17, 2007 (the date on which the final regs were published), in cases in which an initial deferral election has not been made by Jan. 1, 2008, because of a good-faith interpretation of the rules, an election may be made by Dec. 31, 2008, whether the plan would have required an election before or after Dec. 31, 2008.


Individuals and employers may elect to change the time and form of payment of amounts previously deferred at any time through Dec. 31, 2007. A payment scheme that violates the final regs must be brought into compliance with the final regs as of Jan. 1, 2008.


If a service provider has begun to receive benefits before Jan. 1, 2008, based on a reasonable payment trigger, but the event would not trigger payment under the final regs, payments may continue, or may be halted by Dec. 31, 2007, and the payment terms may be amended to comply with the final regs. If payments have not commenced by Jan. 1, 2008, but the payment trigger has occurred, payments may begin, or the time and form of payments may be amended to comply with Code Sec. 409A.

If the service provider is treated as having separated from service under the final regs by Dec. 31, 2007, the plan must treat the service provider as having separated from service on or after April 17, 2007.


The penalty for not complying with the new rules under Code Sec. 409A is "eye-catching" at 20 percent, especially considering the complexity of the provisions. After all, the government took more than a year and over 300 pages to issue the final regulations - and still didn't have time to address certain issues or offer sample documents. It chose not to issue model language for plans to comply with the regs, citing the "complex and varied universe of deferred-compensation plans."

For a deadline of Dec. 31, 2007, to be met for all practical purposes, amendments must be decided upon by the fall of 2007, given the time needed to obtain plan approval in many instances, and to educate and sell the new compensation packages to the elite workforce.

Admittedly, further strategies will be developed to maximize benefits under the regs. However, compliance to avoid the imposition of a 20 percent penalty and the acceleration of tax is the first order of business.

Some die-hards still hope that yet another extension of the deadline will be given once the real complexity of full compliance is realized, especially by those employers without the cadre of benefits lawyers available to only the largest companies. But for now, the government is remaining firm on the date, and as a result, practitioners must begin the arduous task of reviewing - and rewriting - current compensation packages against those hundreds of pages of final regs just issued.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.

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