TAX NEWS - January 2010

IRS announces voluntary correction program for section 409A document failures

The Internal Revenue Service on January 5 issued Notice 2010-6, which provides methods for taxpayers to voluntarily correct certain types of failures to comply with the document requirements of section 409A. This correction program is intended to encourage taxpayers to review nonqualified deferred compensation plans for section 409A document failures.

Notice 2010-6 modifies Notice 2008-113 (providing relief for certain operational failures to comply with section 409A) and

Notice 2008-115 (providing guidance regarding section 409A reporting and withholding requirements for 2008 and subsequent years).

Taxpayers may rely on Notice 2010-6 for taxable years beginning on or after January 1, 2009. The modifications to Notice 2008-113 are effective for service provider taxable years beginning on or after January 1, 2010, but may be relied upon for service provider taxable years beginning before that date. The modifications to Notice 2008-115 are generally effective for service provider taxable years beginning on or after January 1, 2009, provided that the modifications to Notice 2008-115 that are due to changes to Notice 2008-113 are effective for service provider taxable years beginning on or after January 1, 2010, but may be relied upon for service provider taxable years beginning before that date.

The notice provides retroactive relief as well. If a plan document failure is corrected on or before December 31, 2010, the plan may be treated as corrected as of January 1, 2009, for purposes of applying relief in the notice.


General requirements

To be eligible for relief under Notice 2010-6, the taxpayer must satisfy general eligibility requirements (other than with respect to certain ambiguous terms, as discussed below), requirements for a particular correction method, and information and reporting requirements. The taxpayer has the burden of demonstrating eligibility for relief. A taxpayer's eligibility for relief is subject to examination by the IRS.

Relief is not available for intentional failures or failures that are directly or indirectly related to participation in any listed transaction under reg. section 1.6011-4(b)(2). Notice 2010-6 does not provide relief for stock rights or to certain plans where the time and form of payment is linked to one or more other nonqualified deferred compensation plans or one or more qualified plans. Certain relief for discounted stock rights is set forth in Notice 2008-113. Generally, relief is not available to service providers and service recipients that are under examination before correction under the notice is completed.

Notice 2010-6 requires service recipients to (1) attach a statement to their tax return explaining their reliance on the notice and (2) to provide information to service providers. In some instances, a service provider may be required to attach a statement to its tax return. If a service provider is required to include amounts in income during a taxable year that follows the year of the correction, the service provider and service recipient must attach statements to their federal tax returns for the subsequent year.


Eligible document failures

If the taxpayer meets all of the eligibility requirements and information reporting requirements, relief may be available for specified document failures. The correction methods generally require the plan to be amended and, in some instances, require a portion of amounts deferred under the plan to be included in income under section 409A, subject to the additional 20 percent income tax, but not the premium interest tax. In some circumstances, amendment must be accompanied by correction of related operational failures, under Notice 2008-113. Notice 2010-6 provides details regarding the specific requirements for correction of each failure.

The following is a list of the document failures addressed in the notice.


Ambiguous plan terms – An ambiguous plan term includes a provision for payment to be made "as soon as reasonably practicable" upon a section 409A permissible payment event, or provides similar timing language. An ambiguous plan term also includes a term that is undefined or has an ambiguous definition, such as "termination of employment" or "acquisition." This correction can be available without regard to the general eligibility requirements and does not require amendment, if the plan is operated in compliance with section 409A. Certain failures can be treated as correctible operational failures, subject to a timely amendment and satisfaction of other applicable conditions.


Impermissible definition of otherwise permissible payment event – This relief addresses plan provisions that provide for payment upon separation from service, change in control, or disability based on definitions that do not comply with section 409A. These errors may be corrected through amendments that conform to the terms of the notice. In the case of separation from service or change in control, however, if an event that would have been a distribution event under the noncompliance terms of the plan occurs within the one-year period following the amendment, a percentage of the amount deferred must be included in income under section 409A and is subject to the 20 percent additional income tax.


Impermissible payment period following a permissible payment event – This relief generally addresses plans that provide for a section 409A-compliant payment event but provide for payment more than 90 days following the event or allow the service provider to choose the taxable year of payment. In some situations, a plan that has operated in compliance with section 409A may be amended retroactively, provided that 50 percent of the amount deferred is included in income and subject to the 20 percent additional tax.


Impermissible payment events and payment schedules – The notice provides relief for plans that provide for payment upon permissible and impermissible payment events, plans that have only impermissible payment events, certain impermissible alternative schedules, and impermissible reimbursement or in-kind benefit provisions. In some situations, the notice also requires that 50 percent of the amount deferred must be included in income and subject to the 20 percent additional tax.


Failure to include the six-month delay – If a plan fails to include a provision that provides for the six-month delay for payments upon separation from service to specified employees, relief is available if the plan is amended before the event occurs. If a specified employee in fact separates from service within one year after the amendment and the amendment operates to avoid a payment that would have been due under the pre-amendment plan terms, 50 percent of the deferred amount under the plan must be included in income and subject to the 20 percent additional tax.


Impermissible deferral elections – Relief is available for initial deferral elections that do not comply with section 409A(a). This relief does not apply to elections as to time and form of payment since relief for certain of these failures is available in other sections of Notice 2010-6.


Amendment period following a service recipient's initial adoption of a plan – Notice 2010-6 provides relief for certain new plans that have a document failure within the first year the legally binding right to deferred compensation was established.