July 18, 2012
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Employment Contracts and Nonqualified Deferred Compensation Plans May Require Amendment By Year-End
In order to maintain compliance with Section 409A of the Internal Revenue Code, employers should review and correct, as needed, by December 31, 2012, any nonqualified deferred compensation plans and employment contracts in existence since on or before Dec. 31, 2010, to avoid possible income tax and penalties.
Section 409A of the Internal Revenue Code applies to employment, severance, nonqualified deferred compensation, and other arrangements that provide for post-termination severance or other compensation unless the agreement qualifies under an exception, such as a payment within 2 1/2 months after the year in which entitlement to payment occurs. Nonqualified deferred compensation and employment agreements may not qualify for an exception and therefore must comply with Section 409A.
Under federal employment laws, employees are often provided a minimum period, often up to 45 days, following termination of employment to consider a release before signing it, and a minimum period (generally seven days) following execution of a release to revoke it.
Certain nonqualified deferred compensation plans and employment agreements have provisions that condition payment upon an individual’s signing a release of claims against the employer. Release provisions with waiting periods that in effect allow a person to pick a payment in the current or following year do not comply with Section 409A. Agreements with this problem, if any benefit is vested, that have been in existence since on or before Dec. 31, 2010, must be amended before the end of 2012 to avoid section 409A tax problems for employees and employers. Plans and agreements entered into after Dec. 31, 2010, if any benefit is vested, are not eligible for this transition relief and can be corrected only through the IRS’s Section 409A document correction program, if eligible.
For covered agreements existing on or before Dec. 31, 2010, with noncompliant release provisions, employers have been able to rely on a transition period under which no document or operational failure will be deemed to occur if either:
Correction Agreement Or Plan After Dec. 31, 2012
What Employers Should Do Now
If you have questions about compliance with Section 409A, please contact your Lathrop Gage attorney or a member of the Employee Benefits department listed on this alert.
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