Section 409A of the Internal Revenue Code (Section 409A) imposes strict rules governing the timing of deferred compensation payments, such as when and under what circumstances such payments can be made. It comes with significant penalties, imposing a 20% tax (and other adverse tax consequences) on non-compliant deferred compensation.
Is severance considered deferred compensation covered by Section 409A? The answer may be surprising.
In general, deferred compensation for Section 409A purposes is defined as a legally binding right arising in one calendar year to receive compensation that may be paid in a future calendar year.
Under that broad definition, an entitlement to severance under an employment agreement, severance plan or other contractual arrangement may qualify as deferred compensation, meaning that the severance would need to be structured to comply with Section 409A’s strict timing rules. However, there are also many exceptions to Section 409A.
