Over the next six months, prepare to get bombarded with e-mail alerts and posts and such about Section 409A of the Internal Revenue Code (couldn’t everyone have come up with a better name?). Trust me, the hype is going to be comparable with one of those old monster movies.

Why? Because December 31, 2008 is now the deadline for companies to get their non-qualified deferred compensation plans and arrangements — which includes employment in separation agreements — into full compliance with Section 409A of the code.

Despite the importance of this provision, and its application to both private and public companies, it’s not going to affect everyone.  It’s really going to have the most impact on companies that routinely make deferred compensation decisions.

What is deferred compensation? According to one definition:

         An arrangement in which a portion of an employee’s income is paid out at a date after which that income is actually earned. Examples of deferred compensation include pensions, retirement plans, and stock options. The primary benefit of most deferred compensation is the deferral of tax.

What are the key concepts of 409A? Since there is a lot to it, here are just a few bullet points; we’ll cover more in upcoming posts.

  • Elections to defer compensation must be made in a timely manner;
  • Compliance with 409A rules is critical for distributions of deferred compensation;
  • Severe (20%) penalty for non-compliance with rules.

For separation agreements, there are additional requirements to comply with, but many may be exempted under a broad exception. For executives, however, 409A is going to have a serious bark. 

What should employers be thinking about now?

  • Figure out what arrangements you have now to determine if Section 409A even applies;
  • If you have an arrangements or agreement in which 409A may apply, determine whether changes need to be made to confirm with Section 409A;
  • Review all practices relating to payments on separation from service.

There are lots of other details here and for employers that have any doubt about whether Section 409A applies, they should learn more about it.  But rather than panic, all employers should use the next 6 months to seek appropriate legal advice, get more information, and ensure that all their arrangements comply with these new rules.  There’s plenty of time left to comply.