In a widely anticipated move, the IRS and the Department of the Treasury have extended the transition period for complying with Code § 409A to January 1, 2008 from the current January 1, 2007 deadline. The extension was announced in Notice 2006-79, which also:
- Extends the Code § 409A transition period provided in the preamble to the proposed regulations (except with respect to certain discounted stock rights, discussed below);
- Provides additional transition relief for certain payment elections in "linked plans" and certain collective bargaining arrangements; and
- Extends the deadline for amending arrangements covered by Code § 409A until December 31, 2007, generally.
Enacted as part of the American Jobs Creation Act of 2004, Code § 409A imposed strict new requirements on a broad range of non-qualified deferred compensation plans. IRS Notice 2005-1, which was issued shortly after the adoption of the new law, set forth initial guidance with respect to the application of Code § 409A and it also established a transition rule period through 2005. Late in 2005, the IRS and Treasury extended the transition rule period through December 31, 2006. It was anticipated at the time the transition period was established that final regulations would be issued in time for a projected final regulation effective date of January 1, 2007. While IRS and Treasury still anticipate issuing final regulations before the end of 2006, they have extended the Code § 409A transition period for another year in an effort "to allow sufficient time for taxpayers and their representatives to analyze the final regulations and come into compliance."
The specific relief provided Notice 2006-79 is as follows:
(1) Transition Relief
Plans adopted on or before December 31, 2007 will not be treated as violating the basic Code § 409A provisions respecting elections and the time and manner of payment before December 31, 2007 if (i) the plan is operated through December 31, 2007 in reasonable, good faith compliance with the Code § 409A’s requirements, and (ii) the plan is amended on or before December 31, 2007 to conform to the provisions of the new law. With respect to any issues not addressed in prior guidance, a plan must be operated consistent with a "good faith, reasonable interpretation" of Code § 409A.
(2) Changes in Payment Elections
During the Code § 409A transition period, and despite express rules to the contrary, a plan may provide, or be amended to provide, for new payment elections on or before December 31, 2007, with respect to both the time and form of payment of such amounts, so long as the plan is so amended and elections are made on or before December 31, 2007. But after January 1, 2006 (and on before December 31, 2006), the election or amendment may apply only to amounts that would not otherwise be payable in 2006 and may not cause an amount to be paid in 2006 that would not otherwise be payable in 2006. Also, elections to change the time and form of payment of a benefit made on or after January 1, 2007 and on or before December 31, 2007 may apply only to amounts that would not otherwise be payable in 2007 and may not cause an amount to be paid in 2007 that would not otherwise be payable in 2007.
Discounted stock options, which are treated as providing for a deferral of compensation subject to Code § 409A, may be amended to provide for fixed payment terms or to permit holders to elect fixed payment terms, provided that the option is amended and any elections are made on or before December 31, 2007.
(3) Payments Linked to Qualified Plans
The ability to link a payment election under a nonqualified deferred compensation plan to an election under a qualified plan (including 403(b) and 457(b) plans) has been extended through 2007. Under this rule, for periods ending on or before December 31, 2007, an election as to the time and form of a payment under a nonqualified deferred compensation plan that is controlled by a payment election made by an employee or beneficiary under a qualified employer plan will not violate the requirements of Code § 409A.
(4) Special Rule Relating to Substitutions of Non-Discounted Stock Options and SARs.
Notice 2005-1 allowed plan sponsors to replace a non-compliant (i.e., discounted) stock option or stock appreciation right with a stock option or stock appreciation right that would not have constituted a deferral of compensation under Code § 409A, provided that the cancellation and re-issuance occurred on or before December 31, 2005. The proposed regulations extended this rule until December 31, 2006, but only to the extent a cancellation and re-issuance in 2006 does not result in the cancellation of a deferral in exchange for cash or vested property in 2006. Notice 2006-79 further extended this period too, with an important exception: cancellation and re-issuance in 2007 cannot result in the cancellation of a deferral in exchange for cash or vested property in 2007.
(5) Collectively Bargained Arrangements
A nonqualified deferred compensation arrangement maintained under a collective bargaining agreement in effect on October 3, 2004 is not required to comply with the provisions of Code § 409A until earlier of the date on which it terminates or December 31, 2009.
(6) Other Transition Issues
Under one of the provisions of Notice 2005-1, certain requirements would not be applicable to elections made on or before March 15, 2005 so long as the plan was timely amended to comply with Code § 409A (i.e., December 31, 2005). The March 15, 2005 deadline for initial deferral elections was not extended by the proposed regulations, but the plan amendment deadline was extended to December 31, 2006. Because of taxpayer confusion over the interaction of these two provisions, the regulators extended the time for plan amendments for both purposes.
(7) Exception for Certain Discounted Stock Rights with Respect to Publicly Traded Corporations
The transition relief accorded by Notice 2006-79 does not extend to stock options or stock appreciation rights in the stock of a publicly traded company issued to a Section 16 reporting person (i.e., officer, director or beneficial owner)1 for which the applicable company did not timely report the compensation expense associated with the discount stock right. Accordingly, the exercise price of a discount option in the stock of a publicly traded company granted to an officer or director, which was not timely reported on the financial statements of the company (i.e., a backdated stock option), must be adjusted to fair market value on the original date of grant by December 31, 2006, or be subject to Code § 409A and its requirements.
Conclusion
The relief provided by Notice 2006-79 is welcome. Complying with Code § 409A has proved to be a daunting endeavor. Even if final regulations are issued in 2006, if past experience is any guide, it will take at least a full year to digest the new rules and apply them to all of the various plans, programs, agreements and other arrangements that are subject to, or are potentially subject to this new law. By extending the transition period at this time and in this manner, the regulators have taken much of the pressure off of regulated plan sponsors and their advisors-but only for now.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
