IRS Releases Proposed 409A and 457 Deferred Compensation Guidance

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The IRS recently released proposed Section 409A and Section 457 guidance.

Since the original 409A regulations were issued in 2007, the practicing community has anxiously awaited additional guidance; hoping it will make the requirements under 409A and 457 easier for employers and practitioners to administer. In general, 409A outlines the rules and regulations for all employers maintaining non-qualified deferred compensation plans, while 457 specifically relates to plans maintained by tax-exempt organizations and state and local governments. The new proposed regulations provide some clarifications but do not alleviate many of the difficulties associated with administering deferred compensation arrangements.

Some of the highlights of the proposed guidance are detailed below:

  • Currently, a separation of service may or may not occur when an employee terminates employment but continues to be employed in a consulting capacity. The determination is made based on the reasonable expectation of the number of hours to be worked as detailed in the employment agreement. The new rules seem to indicate that a separation of service does not occur until a separation of service has occurred under the rules (service levels would decrease to less than 20% of the levels prior to the employment change).
  • Clarification that stock rights designed to avoid 409A inclusion are not deemed to be deferred compensation solely because the amount payable due to a service provider’s termination for cause or that was within their control, is based on a valuation method that is less than fair market value.
  • The proposed regulations allow a stock option to be granted by an entity prior to the date the employee is actually hired, as long as it is reasonably anticipated they will be hired by the entity within the next twelve months. Previously, the employee actually had to be employed by the entity prior to granting the option.
  • As a result of the death of an employee, an inadvertent 409A violation will not occur if payment is made to the beneficiary by 12/31 of the year following the year of death.
  • Clarification that the 409A regulations apply separately and in addition to the rules under IRC 457A.
  • Enhanced definition of what constitutes a “substantial risk of forfeiture” under 457(f).
  • Exclusion of certain types of bona fide severance and vacation pay plans from 457.

The non-qualified deferred compensation plan rules are quite complex. In particular, the interplay between 409A and 457 is very challenging. The proposed regulations do help with some of the complexity but in the end, those of us affected by these complex rules were hoping for so much more.

Employers should work with their advisors to understand the impact of the proposed changes now and moving forward. To further discuss the impact of the proposed regulations, please contact Aronson’s Compensation and Benefits Practice Director Mark Flanagan at 301.231.6257.

About Mark Flanagan

Mark Flanagan has written 14 post in this blog.

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