Background - Section 409A of the Internal Revenue Code (Section 409A) regulates the payment of non-qualified deferred compensation. If a plan or agreement is not otherwise exempt from Section 409A and does not comply with its provisions, the amounts payable under such plan or agreement are immediately includable in income and subject to an additional 20% penalty tax. Deferred compensation may also be subject to interest penalties if early taxation occurs and the required income tax is not paid on time. There may be adverse tax consequences under state law as well. For example, California also imposes a 20% penalty tax on non-compliant deferred compensation arrangements.
The Timing of Payments Conditioned Upon Execution of a Release May Not Comply with Section 409A -
Many deferred compensation arrangements, such as change of control plans and employment agreements providing for severance, require that the employee first execute a release of claims or return company property before receiving any of the payments under the agreement or plan. 1 The Section 409A regulations do not allow individuals receiving deferred compensation payments to choose the year in which the payments begin. Based on this provision in the regulations, the IRS has taken the position that without restrictions around the timing of the execution of the release, the employee may execute or delay execution of the release in order to select the calendar year in which the payments will be made and, therefore, the arrangement may not comply with Section 409A.
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