409a Corrections

In 2003, the House Ways and Means committee proposed a bill that basically “eliminated” the possibility of Deferred Compensation, all because executives at Enron had “swapped” out future compensation for a life insurance benefit that was outside the creditors of both the individual and company creditors. With the approval of the board, who did not know that the company was failing, they accelerated their payments before it came to light.

Fast forward to today, and the implementation of IRC 409A, there are specific rules and guidelines defined to prevent what occurred in 2003. The ultimate version of the law, states that a company has to define numerous items as part of the deferred compensation plan at the time the plan is established. The plan document outlines the responsibility of the employer and the employee, inclusive of when and how the compensation is earned and paid (which are two very different things for tax purposes depending on the tax structure of the company that you work for), and defines all of the terms of the plan.

A list of items defined in the plan document or it’s addendum should include, and are not limited to the following:

  • Plan Date
  • Effective Date
  • Payment Dates
  • Who can defer
    • Employer
      • Is it discretionary?
      • Is it a match?
    • Employee
      • How much can be deferred
        • Base Salary
        • Bonus
        • Performance Based Comp?
    • When can you defer
  • When you can take a payment
  • How you can take a payment
    • Lump Sum?
    • Equal Payments (3-5-10 years)?
  • When can it be re-deferred

Penalties

Companies tend to make a number of errors when it comes to Section 409A compliance, including:

  • Incorrect calculation of plan deferrals and distributions
  • Failure to make deferral or distribution elections in a timely manner
  • Failure to comply with Section 409A definitions for specified terms
  • Early payment of an amount payable in a later year
  • Late payment of an amount payable in an earlier year

Unfortunately, with errors come significant penalties, including:

  • Immediate income recognition of the participant’s entire plan balance (the “taxable amount”) with respect to the year of error
  • Potential late payment penalties and interest on the taxable amount
  • Additional 20 percent excise tax and “premium interest tax” on the taxable amount
  • Potential late penalties and interest on failure to withhold
  • Restating and refiling previous years’ tax forms (e.g., Forms W-2 and 1099 for companies and Form 1040 for plan participants)

409A Correction Program

The good news is, if the plan sponsor catches an error within two years of the error occurring, the IRS has a voluntary correction program that can help you avoid sizeable taxes and penalties, which are subject to the size of the company, the plan size, and whether the failure was willful or not in the the failure (if found by the IRS).

More info on the IRC 409A Correction program can be fore here https://www.irs.gov/pub/irs-drop/n-10-06.pdf

** This information is provided with the intent of educating the public. It is not intended to be all encompassing and may or may not apply to your specific plan. Please contact your accountant or attorney to see if this is applicable to you and your company.