“IRS Issues Long-Awaited Proposed Regulations under Section 409A of the Internal Revenue Code”
On September 29, 2005, the Internal Revenue Service (“IRS”) and the Treasury Department issued longawaited additional guidance in the form of proposed regulations (the “Proposed Regulations”), which further interpret Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). Code Section 409A was added to the Code on October 11, 2004 as part of the American Jobs Creation Act of 2004, which introduced significant changes to the tax rules that apply to nonqualified deferred compensation arrangements.
Code Section 409A generally provides for harsh tax consequences if amounts deferred under a nonqualified deferred compensation arrangement do not meet the distribution, acceleration of benefit, and election requirements of Code Section 409A: the amounts deferred under non-complying arrangements not only are taxed immediately, but also are subject to an additional 20% excise tax. In addition, interest is charged on any underpayments of tax resulting from a failure to meet the requirements of Code Section 409A, at the underpayment rate plus one percent (1%).
Code Section 409A generally became effective as of January 1, 2005 with respect to amounts deferred under a nonqualified deferred compensation arrangement on or after such date (as well as amounts previously deferred that were not yet vested as of January 1, 2005). In December 2004, the IRS issued Notice 2005-1, which provided preliminary guidance in the form of Q&As on how to interpret and comply with Code Section 409A. In Notice 2005-1, the IRS provided transitional rules for calendar year 2005 with respect to certain of the Code Section 409A requirements.
Although the Proposed Regulations extend some of the transitional relief provided under Notice 2005-1 until December 31, 2006, several important transitional rules were not extended and may only be taken advantage of until the end of this year. Therefore, it is very important for you to review all of your compensation arrangements as soon as possible to determine if they are subject to Code Section 409A, and if so, whether they comply with Code Section 409A.
This Stroock Special Bulletin focuses on the new guidance relating to compliance with Code Section 409A provided under the Proposed Regulations, as well as on the extension (or non-extension) of the Notice 2005-1 transitional rules.