Tax Code Section 409A : Some Things You Should Know ABA Section of Labor and Employment Law Employee Benefits Committee Meeting February 19-21, 2009.

Tax Code Section 409A : Some Things You Should Know

ABA Section of Labor and Employment LawEmployee Benefits Committee Meeting

February 19-21, 2009

Consequences of Violating §409A

Daniel N. JanichJanich Law Group

Chicago, IL

Consequences of Violating §409A

What is includible in income? What are the reporting and withholding requirements? Is There an IRS Correction Program?

Proposed §409A Income Inclusion Regulations

• How to determine amounts includible in income under §409A, the 20% penalty & interest

• Issued December 8, 2008; may rely upon pending final regulations

Proposed §409A Income Inclusion Regulations

• Important clarifications—– §409A violations examined year-by-year– Violations of time and form of benefit payments of

unvested amounts may be corrected before vesting occurs

• includes relief for plan document errors where no vesting has occurred under plan

– Deferrals included in income determined as of last day of employee’s taxable year of violation

Proposed §409A Income Inclusion Regulations

– Nonvested amounts and previously included income amounts are subtracted from amount includible in income

– No double taxation – Amounts included in income due to §409A violation are exempt from income tax when actually paid

• Includible income never paid due to employer insolvency entitles employee to deduction, BUT

• No recovery of 20% penalty or interest tax

Proposed §409A Income Inclusion Regulations

20% Penalty & Interest Calculations—• Penalty applied to total amount includible in

income• Interest determined by amount includible in

income for current year, and• Calculated based on hypothetical tax

underpayment at IRS underpayment rate plus 1%

Reporting & Withholding Obligations

• IRS Notice 2008-115• Code “Y” Reporting Requirement—

– Annual reporting of employee deferrals (Form W-2 or 1099-MISC) waived pending future guidance

• Amounts includible in income subject to applicable withholding at supplemental withholding rates

• 20% penalty and interest tax not subject to withholding

Relief for §409A Operational Failures

• IRS Notice 2008-113 issued December 22, 2008

• Provides limited relief for operational failures only

• Application of these rules hinge on—– Timing: When was violation discovered and

corrected?– Amount: What is the deferred amount involved?

Relief for §409A Operational Failures

• Operational Failures Eligible for Correction—– Failure to defer– Early Payments– Excess Deferrals– Below-Market Stock Rights

Relief for §409A Operational Failures

• Failures corrected in same taxable year of failure: No §409A Penalties

• Failures corrected in taxable year immediately subsequent to taxable year of failure: No §409A Penalties, But Interest Payable on Repayment Amounts– “Insiders” Are Ineligible

Relief for §409A Operational Failures

• Failures corrected by end of second taxable year following taxable year of failure: §409A Penalties Apply To Deferred Amounts Involved, Provided Such Amounts Do Not Exceed §402(g) Limit

• Failures corrected in later years: ¶409A Penalties Apply to Deferred Amounts Involved, Requires Repayments to Plan Sponsor

Relief for §409A Operational Failures

• Correction Methods—– Failures to Defer & Early Payments: Service

Provider repays amounts that should have been deferred

– Excess Deferrals: Plan Sponsor must distribute amount of excess deferral

– Below-Market Stock Rights: Plan Sponsor must increase exercise price of stock right to equal FMV of stock on grant date; previously exercised stock rights ineligible for correction

Relief for §409A Operational Failures

• Special Transitional Rule for Non-Insiders—– For operational failures occurring before

December 31, 2007, 2009 is treated as taxable year “immediately subsequent to year of failure”

• Relief requires:– Disclosure of operational failure to affected

participants (Form W-2 or 1099-MISC)– Implementation of steps to ensure that failure

does not reoccur in future– Unavailable if “substantial financial downturn.”