Proposed Section 409A Regulations. Marina's article, "Correcting Document Failures of Plans With Nonvested Deferred Compensation Under Proposed Section 409A Regulations" was published in the February 2017 issue of the BNA Tax Management Compensation Planning Journal (45 BNA Tax Mgmt. Comp. Plan. J. 69 (2017)). The article discusses how employers sponsoring certain executive compensation plans for their executives may amend such plans to comply with recently issued, proposed rules under section 409A ("Section 409A") of the Internal Revenue Code of 1986, as amended, 81 Fed. Reg. 40,569 (June 22, 2016), corrected by 81 Fed. Reg. 51,413 (Aug. 4, 2016) (the "Proposed Regulations"). Compliance is necessary to avoid immediate inclusion in income of the deferred compensation and additional taxes a plan participant may have to pay in the event the plan document fails to meet Section 409A criteria for timing or form of the distributions or initial or subsequent deferral elections.
Section 409A Restrictions and the Proposed Anti-Abuse Rule. The article focuses on means of correcting the plan language with respect to cash deferrals that remain subject to vesting conditions as of the date the plan sponsor detected the error. Prior to the Proposed Regulations, many employers assumed they could make virtually any changes to the plan document to revise the time or form of payment of the accruals so long as the forfeiture condition had not yet occurred. Some of these plan amendments may have circumvented the Section 409A restrictions. In response, the IRS included in the Proposed Regulations a three-prong "anti-abuse rule" to ensure that employers do not amend plans in violation of Section 409A requirements. In the event of noncompliance, the deferred amounts that are subject to forfeiture instead would be treated as vested, includible in income of the plan participant and subject to additional taxes in the tax year of the violation.
Certain Requirements Under the Proposed Anti-Abuse Rule for Plan Amendments. As a general matter, under the proposed anti-abuse rule, employers must be careful to make the correcting amendments with respect to nonvested deferrals prior to the beginning of the tax year in which the vesting condition for the deferred compensation would be satisfied. In addition, the IRS would look at the relevant facts and circumstances to determine whether an employer properly amended the plan for amounts subject to forfeiture. Therefore, the proposed anti-abuse rule offers only a framework for analyzing how properly to correct a plan document failure. Accordingly, plan sponsors and participants who wish to amend the plan or discover Section 409A errors in the plan document should consult with a tax advisor to determine the specific application of the proposed anti-abuse rule to a plan for compiance with Section 409A and if possible, to avoid an immediate tax event and penalties for the plan participant.
Proposed Anti-Abuse Rule Compliance for Tax-Exempt Employers. Employers, which are exempt from Federal income tax under Section 501(c)(3) and sponsoring nonqualified plans with deferrals in excess of the Section 457(b) limits must be aware of the requirements under the proposed anti-abuse rule, as may be modified or supplemented by the concurrently issued, proposed regulations under Section 457(f), 81 Fed. Reg. 40,548 (June 22, 2016). Applicability of the proposed anti-abuse rule may vary among plans of for-profit and tax-exempt employers, respectively. For example, a tax-exempt sponsor of a Section 457(f) "ineligible" plan may be able to make a correcting amendment for amounts subject to forfeiture before the date the risk of forfeiture lapsed, rather than prior to the beginning of the tax year in which the vesting condition occurred. Thus, exempt organizations sponsoring nonqualified plans for their employees likewise should seek tax counsel in amending an ineligible plan or correcting a plan document failure to ensure Section 409A compliance and avoid or minimize any adverse tax consequences for the nonprofit executive.