Employee Benefits Law Alert: Year-End Grace Period Deadline Approaches for Correction of Plan Document Failures for Nonqualified Deferred Compensation Under Code Section 409A

Back to Legal Insights
Back to Legal Insights

Earlier this year, the Internal Revenue Service ("IRS") established a correction program for certain problems with nonqualified deferred compensation plan documents under Internal Revenue Code Section 409A. Notice 2010-6 provides ways to correct such plan document failures with reduced or no penalties. In addition, the IRS has just updated and expanded the relief available for plan document failures in Notice 2010-80, issued on November 30, 2010.

If corrections are implemented on or before December 31, 2010, Notice 2010-6 provides relief from all penalties under Section 409A by treating the correction as having been made on January 1, 2009. To take advantage of this transition relief, employers should review their deferred compensation plans and any arrangements providing deferred compensation to determine if any of the corrections outlined in Notice 2010-6 should be made. Notice 2010-80 provides additional time to correct certain provisions in plans that require releases of claims or other agreements by the employee before payments start (described below). (Section 409A and the relief provided in the notices also apply to independent contractors, but for ease of discussion, this alert refers only to employees.)


Section 409A was enacted by Congress in 2004 to regulate nonqualified deferred compensation plans. Detailed final regulations under Section 409A specify the required timing of (1) decisions to defer compensation and (2) payment of deferred amounts. The deadline for compliance with the final regulations was December 31, 2008. Notice 2008-113 provides a correction program for operational errors, and Notices 2010-6 and 2010-80 set out a detailed correction program for plan documents, with special relief for corrections implemented on or before December 31, 2010.

Importance of Compliance

Section 409A operates by imposing harsh tax treatment on employees with deferred compensation that is subject to Section 409A but fails to satisfy the requirements of Section 409A. Adverse tax consequences include:

  • Immediate taxation of deferred compensation in the year the deferred compensation plan fails to comply with Section 409A or the year noncompliant deferred compensation vests.
  • A 20% excise tax on vested deferred compensation.
  • An interest penalty based on the taxes that would have been paid in the year the compensation was deferred.
  • Application to these rules can result in the employee having tax liability, and the employer having income and employment tax withholding liabilities, even though the deferred compensation is not paid.

Relief Provided by Notice 2010-6

Permissible Provisions

Notice 2010-6 does not require correction of certain plan terms that might have been viewed as failing to comply with Section 409A.

  • Payments "As Soon as Practicable" – A plan term that requires payment "as soon as administratively practicable" will not result in a failure to comply with Section 409A so long as the permissible payment event triggering the right to payment is treated as the payment date for purposes of Section 409A.
  • Ambiguous Payment Event Definitions – A plan term that designates a payment event but that either does not define the event or has an ambiguous definition will not result in a failure to comply with Section 409A if the provision can be and is interpreted to comply with Section 409A.
  • Impermissible Definitions of Separation from Service, Change-in-Control Event or Disability – Impermissible definitions of "Separation From Service," "Change in Control Event" or "Disability" can be corrected before a separation from service, change-in- control event or disability occurs.

Permitted Corrections

Notice 2010-6 provides approved correction methods for several types of plan document errors commonly found in nonqualified deferred compensation plans:

  • Impermissible Payment Periods Following a Permissible Payment Event
  • Impermissible Payment Events or Schedules
  • Alternative Payment Schedules for Voluntary and Involuntary Separations and Other Payment Events
  • Impermissible Discretion to Change Time or Form of Payment
  • Impermissible Discretion to Accelerate Payments
  • Impermissible Reimbursement or In-Kind Benefits
  • Failure to Include Six-Month Delay for Payments to "Specified Employees" of Public Companies
  • Impermissible Initial Deferral Election

In addition, Notice 2010-6 provides a special amendment period for correcting document errors following initial adoption of a nonqualified deferred compensation plan or arrangement providing deferred compensation and permits employers until December 31, 2011, to correct payment schedules that are determined by the timing of payments to the employer from a third party.

Additional Relief Offered by Notice 2010-80

  • Linked Plans – Notice 2010-6 permits corrections of nonqualified plans in which the amount deferred is determined by the amount deferred under another nonqualified plan. This relief was extended by Notice 2010-80 to arrangements in which the amount deferred under a plan is determined by the amount deferred under a qualified retirement plan. In addition, Notice 2010-6 permits corrections of nonqualified plans in which the time and form of payment under one plan is affected by the payment provisions of another nonqualified plan. There is no similar relief for plans in which the time and form of payment under one plan is affected by the payment provisions of a qualified plan. This relief is available only if the plans are corrected by December 31, 2011.
  • Stock Options and Other Stock Rights – Notice 2010-6 provides no relief for document errors affecting nonqualified stock options or stock appreciation rights. Notice 2010-80 permits correction of stock rights that are intended to comply with Section 409A by specifying when the option or stock right can be exercised.
  • Payment Timing Affected by Employee Action – Employment, change-in-control and severance agreements and plans often condition payment of benefits on execution by the employee of a release of claims, a nonsolicitation agreement or a noncompetition agreement. Payments are delayed until the required document has been signed and, where applicable, any revocation period has lapsed. Notice 2010-6 made clear that such provisions could result in violating Section 409A, because an employee can affect the time and even the year in which payment occurs. Notice 2010-80 expands the options for correcting such provisions and provides two more years (until December 31, 2012) to do so without penalty. For example, an agreement that requires the employee to sign a release of claims before payment of deferred compensation will start and that does not set a time limit for obtaining the release can be amended. The amended provision must provide for payment within 90 days after the employee's separation from service if the employee has signed the release of claims and the period for revoking the release has expired before payment is made within the 90-day period. The agreement would also have to provide that if the 90-day period began in one year and ended in the next, the payment would be made in the second year.

Relief Available for Corrections After December 31, 2010 Corrections of some document errors under Notice 2010-6 after December 31, 2010 will result in penalties under Section 409A, but the amount will be only 50% or 25% of deferred compensation under the plan, depending on the type of failure that is being corrected under the notice.

Conditions That Must Be Satisfied to Take Advantage of Relief Under Notice 2010-6 The relief available under Notice 2010-6 requires the filing information returns and includes other reporting requirements. Notice 2010-80 relieves employers of some of these requirements for corrections made by December 31, 2010.

To qualify for relief, employers must identify all other nonqualified deferred compensation plans with substantially similar document failures and make corrections to all such plans. No relief is available if the tax return of either the employer or employee is under examination by the IRS with respect to nonqualified deferred compensation for any year in which a document failure existed.

What Should Be Done Now

  • Review: Determine whether arrangements that may be subject to Section 409A have ambiguous plan terms or would benefit from the addition of a 409A "savings clause." Legal counsel should review any arrangements that could potentially provide for the payment of compensation in a later year. Remember that all related arrangements must be corrected. For example, to correct one employment or severance agreement, all employment and/or severance arrangements must be corrected.
  • Amend: Any arrangements that would benefit from the relief described in Notice 2010-6 or the addition of a "savings clause" should be amended on or before December 31, 2010 to take full advantage of such relief. This could require negotiations with affected employees and approval by the board of directors and, possibly, shareholders. Where the only issue involves the timing of payments for which the employee must first sign a release of claims or similar agreement, Notice 2010-80 provides an additional two years to address the issue, as long as payments after March 31, 2011 are made in compliance with the Section 409A rules.
Compensation Arrangements That Should Be Reviewed

Employers should review all nonqualified deferred compensation plans as well as agreements that may include deferred compensation, such as severance pay plans, change-in-control agreements and employment agreements. Special attention should be paid to provisions requiring employee action, such as signing a release of claims.


It is important that all arrangements that could potentially provide for the deferral of compensation are in compliance with Section 409A, and the documentary relief available under Notice 2010-6 may be helpful, especially if taken advantage of before the end of the year.

This Client Alert is a brief summary of Notice 2010-6 and Section 409A documentary compliance. In the interest of brevity, many details and issues have been omitted. If you have any questions or would like more information, please contact your Stoel Rives attorney.

Key Contributors

J. Christopher Briggs
See all contributors See less contributors
Saved Pages

Use the arrows to arrange content.  Download pages as a .pdf file or share links via email..

{{ item.Title }} {{ item.AttorneyPosition }}, {{ item.AttorneyLocation }} , C. {{ item.AttorneyCell }} , P. {{ item.AttorneyPhone }} , F. {{ item.AttorneyFax }} {{ item.TypeText }} Remove
You have no pages saved
            {{ state | json }}