December 31, 2012 Deadline to Correct Certain Section 409A Payment Timing Errors

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December 31, 2012, is the deadline for correcting certain errors in the written provisions of nonqualified deferred compensation arrangements that provide payments that are contingent on the recipient’s execution of a release of claims, or a restrictive covenant agreement or similar document. These errors can occur in any type of deferred compensation arrangement, including severance, nonqualified retirement programs, employment agreements, change-in-control payments, and deferred equity awards. Employers should identify and revise noncompliant agreements by the deadline to avoid potentially significant penalties to the employee or other service provider under section 409A of the Internal Revenue Code of 1986, as amended (“section 409A”), including accelerated inclusion for federal income tax purposes, a 20 percent federal excise tax (and potentially an equivalent state tax), and a federal interest penalty, unless submitted through a correction program that requires notice to the recipient.

Background -

In Notice 2010-6, the Internal Revenue Service (the “IRS”) stated that nonqualified deferred compensation arrangements for which the payment date is contingent on and determined by an employment-related action by the service provider – including execution of a release of claims or noncompetition or nonsolicitation agreement – violate section 409A if it is possible for the recipient to manipulate the tax year of payment by timing the return of a release or other agreement. For example, an agreement subject to section 409A that provides that an employee will receive severance payments commencing within a specified period after returning an executed release of claims violates section 409A because the employee could affect the time when payments would commence during that designated payment period by “timing” his return of the release. If that specified payment period were to straddle two tax years, the employee theoretically could exercise control over the tax year in which the payments would be included in his gross income.

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