IRS Begins Section 409A Compliance Initiative

The Internal Revenue Service (IRS) is getting ready to ramp up enforcement of Section 409A of the Internal Revenue Code. The federal agency recently announced the launch of a new project to assess the level of taxpayer compliance with Section 409A—the provision that regulates nonqualified deferred compensation plans. At the American Bar Association’s Section of Taxation meeting last month, an IRS attorney spoke unofficially about the compliance initiative summarizing its key points as follows:

  • Fewer than 50 taxpayers will participate in the audit, most of whom are large employers with business assets greater than $10 million, i.e., Large Business and International (LB&I) taxpayers.

  • The companies were selected from a group of employment tax cases that had previously been identified for employment tax audits, based on the probability that the taxpayer would have nonqualified deferred compensation plans.

  • The project will focus on:

  1. initial deferral elections;

  2. subsequent deferral elections; and

  3. payouts under Section 409A, including the six-month delay for specified employees.

  • The audit will be conducted using standard information document requests.

  • The inquiry will be limited to the 10 highest-paid employees in each company.

  • The project is expected to be completed within 12 months.

  • The project is a tool for the IRS to test compliance and evaluate and refine its audit techniques.

  • The Small Business/Self-Employed (SB/SE) division of the IRS will conduct the project.

Key Takeaways

The limited scope of this project means that the vast majority of employers will not be audited yet, but it well could be the first step toward the development of a broader compliance project. Many 409A issues can be corrected under the IRS’s 409A corrections programs.

We recommend that employers review or audit their nonqualified deferred compensation plans and arrangements for compliance with Section 409A on an annual basis because employers have the greatest opportunities to reduce, and in some cases eliminate, the risk of Section 409A taxes and penalties if noncompliance is corrected in the same year as the error (or as soon as possible thereafter).  However, once an employer or executive is being audited by the IRS audit for such issues, the 409A corrections programs are generally unavailable.

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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