California Doubling Of 20% Federal Tax Increase Under IRC Section 409A


Originally published in State Bar of California Taxation Section 2013 Sacramento Delegation in February 0f 2013.

Executive Summary -

Under Internal Revenue Code Section 409A (“Section 409A”), all amounts deferred under a nonqualified deferred compensation (“NQDC”) plan are currently includible in income to the extent not subject to a substantial risk of forfeiture (i.e., vested) unless taxpayers comply with the extensive and complicated requirements of Section 409A. In addition to immediate taxation of vested NQDC plus interest, Section 409A increases the federal income tax rate by an additional 20%. Section 409A broadly applies to all classes of service providers, including low-level employees, directors and many independent contractors. The increased tax applies to the worker, not the employer. Section 409A penalizes often unsophisticated service providers who have little influence over the timing of payments and little ability to navigate complex tax rules. Low-level employees and small transactions are not exempt from Section 409A.

Since Section 409A’s enactment in 2004, Treasury and the Internal Revenue Service (“IRS”) have issued thousands of pages of guidance in an attempt to interpret and apply this broad legislation to a myriad of industries and compensation structures. Despite the volume of regulatory guidance that has been issued under Section 409A, the application of this complicated legislation to many industries, including very important California industries, remains unclear despite eight years of extensive introspection by the most highly qualified tax advisors, as well as Treasury and IRS officials.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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