The Internal Revenue Service is allowing limited exceptions from coverage of the new deferred compensation rules for certain stock appreciation rights, or SARs, that "do not present potential for abuse or intentional circumvention of the purposes" of Section 409A.

Section 409A, added by the American Jobs Creation Act of 2004, provides new rules for nonqualified deferred compensation plans, generally applicable to amounts deferred on or after Jan. 1, 2005. IRS Notice 2005-1 also contains initial guidance regarding the termination and amendment of nonqualified deferred compensation arrangements, defines a change in ownership or control, identifies the arrangements considered deferred compensation, and outlines the new employer reporting and employment tax obligations.

The definition of nonqualified deferred compensation contains an exception for amounts actually or constructively received by the service provider within a short period following the lapse of a substantial risk of forfeiture, which is intended to address multi-year arrangements.

The notice provides circumstances under which plan payments may be accelerated, such as to meet the requirements of a domestic relations order or for conflict-of-interest divestiture requirements. Although subsequent guidance will, this notice doesn't provide generally applicable methods for calculating the amount of deferrals for a given year. However, a rule is given for calculation of the amount of deferrals before Jan. 1, 2005, for applying the effective date provisions.

The IRS is requesting comments on the guidance in Notice 2005-1 and other aspects of Section 409A. The principles of the notice will be incorporated into more comprehensive guidance in 2005. If additional guidance adopts a position less favorable than in the notice, the expectation is that it will be applied on a prospective basis with adequate transition relief to allow modification of plans.

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