Dec. 31 Deadline for Severance Pay Provisions in Employment Agreements to Comply With Section 409A

by Davis Wright Tremaine LLP

[authors: Amy Hwang, Mary E. Drobka, Stuart C. Harris]

Many employment agreements, especially those for high-level executives, provide severance pay upon a change in control or a termination without cause, but only if the employee signs a release of claims. The IRS has noted that these types of agreements may cause problems under Section 409A of the Internal Revenue Code. In addition to highlighting the concern, the IRS also provided a Dec. 31, 2012 deadline for taking corrective steps. Failure to comply with Section 409A could subject employees to substantial tax penalties.

What is the issue with severance, employment releases and Section 409A?
As discussed in prior DWT advisories, Section 409A governs the deferral of compensation, and in particular restricts the discretionary ability of employees and employers to alter the year in which deferred compensation is paid. A violation of Section 409A punishes the employee by accelerating the taxation of the compensation, imposing an additional 20 percent penalty tax, and triggering potential interest charges (additional state taxes may also apply).

When drafting release agreements, employers typically aim to satisfy various employment laws that can indirectly give employees some discretion over the timing of payment. For example, when an employee is over 40 years old, the Age Discrimination in Employment Act requires that the employee be given at least 21 days to consider any release of claim for age discrimination; an employee may choose to sign the release prior to the expiration of the 21-day period, but the employee has the right to wait at least 21 days. As a result, if an employee is asked to sign a release near the end of a year, then the 21-day consideration period effectively enables the employee to choose, in his or her discretion, whether payment will occur in the current year or the following year. The following example illustrates the issue:

Assume an employee has the right to a lump sum severance payment equal to six months of salary if she is terminated without cause and if she signs a release of claims. If the employee is terminated on Dec. 20, without cause, then she could sign the release quickly and receive payment this year or, in the alternative, wait until after Dec. 31, which would delay payment until the next year.

The IRS has identified this scenario (and others like it) as a violation of Section 409A.

Correcting this 409A issue
Fortunately, in Notice 2010-80 the IRS provided that employers and employees could avoid any Section 409A penalties in these types of situations by making appropriate corrections on or before Dec. 31, 2012.

Note: Employers and employees may assume their agreements are problem-free because they were reviewed and revised in 2007 or 2008 to comply with final regulations under Section 409A. That is a faulty assumption. The IRS issued final Section 409A regulations in 2007, and then later developed its opinion about the potential problem with release agreements. In short, a review of agreements in connection with the 2007 final regulations may not have considered the later-identified problem with releases.

If Section 409A applies to a severance pay arrangement1, and the severance payments are not triggered on or before Dec. 31, 2012, the employer and employee can use either of the following two correction methods:

  1. If the agreement or plan does not specify a period during which payment may be made after termination of employment or the employee’s execution of the release, the document may be amended to require that either:
    • Payment will be made on the 60th or 90th day after termination, provided that the release has been signed and become irrevocable prior to the payment date; or
    • Payment will be made within a period of up to 90 days after termination, provided that (i) the release has been signed and become irrevocable prior to the payment date and (ii) if the period spans two calendar years, payment will be made in the second calendar year, regardless of when the release is signed.
  2. If the agreement or plan does specify a period during which payment may be made after termination of employment or the employee’s execution of the release, but the document enables the employee to affect the year in which the payment is made, the document may be amended to require that either:
    • Payment will be made on the last day of the specified period; or
    • If the specified period spans two calendar years, payment will be made in the second calendar year, regardless of when the release is signed.

Correction by means of a written contract or plan amendment that is adopted by Dec. 31, 2012 may be made without any obligation of the employer or employee to report the correction to the IRS. However, if the correction is made after 2012, both the employer and the employee must report the correction to the IRS in order to avoid Section 409A taxes and penalties

What about severance payments triggered before an agreement is corrected?
The IRS Notice also addresses what to do if an employment agreement provided for severance (contingent on signing a release of claims) and the payment of severance is triggered in 2012. If an agreement under that scenario did not otherwise comply with Section 409A, the parties may resolve the Section 409A concern by delaying the severance payment until 2013. Payments that have already been made in 2012 may be eligible for correction under a separate Section 409A correction procedure.

If you have any questions, please contact any of the Davis Wright Tremaine attorneys listed on this advisory or your usual contact.


1 Many severance arrangements are exempt from Section 409A, either as a “short term deferral” that is paid shortly after termination, or under the “involuntary separation pay” exception. Although Section 409A-exempt arrangements do not require correction, it is still best practices to specify a date of payment similar to one of the examples shown in Notice 2010-80. For example, an arrangement that provides for a lump sum payment of severance 60 days after termination, but only if the release is effective by that date, will prevent manipulation of the date of payment and ensure that it always complies with the short term deferral exception.

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.

© Davis Wright Tremaine LLP | Attorney Advertising

Written by:

Davis Wright Tremaine LLP

Davis Wright Tremaine LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.