Final Deferred Compensation Regulations

On April 10, 2007, the IRS issued its long-anticipated Final Regulations governing deferred compensation plans under Code Section 409A (“409A”). The Final Regulations are effective as of April 17, 2007, with transition rules making January 1, 2008 the key compliance date.

Virtually all deferred compensation arrangements must be amended by December 31, 2007 to comply with the new rules. Failure to comply will cause all deferred compensation under the plan (and, because of aggregation rules, under all plans of the same type) to be taxed to the affected individual when it is earned and vested, at normal income tax rates, plus an additional 20% penalty tax (and interest to the extent the 409A violation causes an amount deferred in a prior year to become taxable).

Highlights 

• For public companies, the Final Regulations significantly enhance the ability to pay severance to specified key employees within the six-month period after termination.
• Public companies will need to identify specified employees in advance in order to comply with document requirements. 
• The Final Regulations significantly expand the ability to extend the exercise period of a stock option following termination of employment. 
• Some common design features will need to be revisited and possibly modified, including offsetting deferred compensation for other debts to the company and cashing out performance-based compensation at involuntary termination. 
• Full documentary compliance is required by December 31, 2007.