In October the law with respect to nonqualified deferred compensation plans was significantly revised as a part of the American Jobs Creation Act of 2004 which created new Section 409A of the Internal Revenue Code. A summary of the statutory provisions was distributed as a special newsletter on October 12, 2004 (located at www.foley.com/employeebenefits.) On December 20, in Notice 2005-1, the Internal Revenue Service released its initial set of guidance and transition rules regarding the new law.
The new Section 409A rules generally apply to "amounts deferred" on and after January 1, 2005, and given the short time between enactment and the January 1, 2005 effective date, the question most often asked by plan sponsors is what needs to be done by December 31, 2004. On this point, the Notice provides welcome transition relief that is consistent with informal comments previously made by Treasury Department officials that compliance with Section 409A will not be a year-end "fire drill."
Although the Notice sets forth a host of definitions and interpretations, the following transitional rules provide the essential framework that will enable plan sponsors and participants to make an orderly transition to the new rules during 2005.
- Plan Amendments. Good faith operational compliance is required from January 1, 2005 onward, but formal plan amendments to comply with the new rules may be adopted as late as December 31, 2005.
- Timing of Deferral Elections. For a plan that is in existence on December 31, 2004, the plan may permit deferral elections to be made as late as March 15, 2005 for 2005 compensation, as long as such amounts have not been paid or become payable on or before the date on which the election is made.
- Revocation of Prior Deferral Elections. A plan adopted before December 31, 2005 may be amended to permit a participant or the employer, during calendar year 2005, to revoke (or otherwise reduce) a deferral election with respect to amounts that would otherwise be subject to the new rules.
- Payment Elections . With respect to amounts subject to the new 409A rules, a plan may be amended to permit new payment elections with respect to amounts deferred prior to the election. Because Section 409A generally prohibits acceleration of distributions, one area of concern had been that a participant’s distribution election with respect to post-2004 deferrals should be in place by December 31, 2004. For example, if a plan provides for distribution in 10 annual installments unless the participant has elected a lump sum payment, the concern was that a participant’s election of the lump sum payment, if desired, needed to be in place by December 31, 2004 because any election of the lump sum payment option during 2005 would be an acceleration of distribution with respect to benefits accrued from January 1, 2005 through the date on which the election is made. The new rules permit a plan to be amended to permit the initial distribution election with respect to amounts subject to the new rules to be made as late as December 31, 2005.
- Termination Flexibility . Through 2005, plans may be terminated and/or individual participants may be given lump sum distributions without being subject to the 20% penalty tax .
- Stock Appreciation Rights . No action is required prior to December 31, 2004 with respect to SARs. Most SARs will need to be revised during 2005.
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.
