NOTICE 2007-78 PROVIDES ADDITIONAL GUIDANCE

(AND LIMITED TRANSITION RELIEF) UNDER CODE SECTION 409A

On September 10, the IRS issued Notice 2007-78, which provides limited transition relief and additional guidance on the application of Code Section 409A to nonqualified deferred compensation arrangements.

Overview of Notice

The Notice includes the following:

Extent of 2008 Transition Relief

Limited Extension of Deadline for Amending Documents

Notice 2007-78 extends the deadline for complying with the written plan document requirement of Section 409A until December 31, 2008, subject to significant conditions discussed below.  To assure that the conditions for the extension are satisfied, employers and other service recipients must carefully review existing documents governing their deferred compensation arrangements, and in many cases, amend those documents, by December 31, 2007.

Notice 2007-78 does not extend other transition relief or otherwise postpone application of the final regulations beyond their January 1, 2008, effective date for most arrangements.  Thus, the transition rules that allow employees and other service providers to make new elections in 2007 regarding the timing and/or form of payments without regard to the general restrictions of Section 409A will still expire on December 31, 2007.

Subject to special conditions governing the time and form of payments discussed below, the Notice provides that an arrangement will not violate the requirements of Section 409A on or before December 31, 2008, merely because its written provisions fail to satisfy Section 409A, provided that the arrangement is operated in accordance with the requirements of Section 409A and is amended, retroactive to January 1, 2008, to comply with Section 409A, on or before December 31, 2008.  This retroactive amendment may not result in the acceleration or additional deferral of payments in violation of the general rules of Section 409A.

Designation of Compliant Time and Form of Payment

The Notice provides that, if there have been deferrals of compensation under an arrangement as of January 1, 2008, but the deferred compensation has not been paid, the arrangement must designate a "compliant time and form of payment" in writing by January 1, 2008.  In addition, an arrangement must designate a "compliant time and form of payment" in writing before any deferrals are made in 2008.  An arrangement designates a "compliant time and form of payment", if its written terms, disregarding any written terms that do not comply with Section 409A guidance, provide a "compliant time and form of payment" (as described below).

Example:  If an arrangement provides for the payment of deferred compensation upon separation from service, but permits the service provider to elect an immediate lump sum payment subject to forfeiture of a specified portion of the deferred amount (a haircut provision), the haircut provision may be disregarded, and the arrangement will be treated as providing for a payment upon separation from service, provided that the haircut provision is not used in operation and is removed by December 31, 2008.

In general, an arrangement provides for a "compliant time and form of payment" only if it provides for an objectively determinable form of payment payable upon:

Example:  An arrangement may provide that a deferred amount will be paid in the form of a life annuity, beginning on the later of the employee's separation from service or reaching age 65.  However, an arrangement may not provide that a deferred amount will be paid during the three years after the employee's separation from service (with the exact timing of the payment during the three-year period determined at the discretion of the employee), because such a term would not provide a compliant time and form of payment.

The Notice provides a number of detailed rules regarding a compliant time and form of payment as well as permissible changes to comply with the final regulations.  To assure compliance with these rules, all arrangements subject to Section 409A must be carefully reviewed before December 31, 2007, and, in many cases, it will be necessary to adopt amendments before that date.

Changes to Good Reason Provisions of Employment Agreements

Under the final regulations, certain payments made on account of an involuntary termination of employment are subject to special treatment.  In the final regulations issued earlier this year, the IRS indicated that an employee's resignation for "good reason" would be treated as an involuntary termination of employment.  The IRS also provided a safe harbor definition of resignation for "good reason."  The Notice describes the circumstances under which an existing employment arrangement may be amended to conform to the final regulations without triggering adverse consequences under Section 409A.

Predetermined Cash Outs

The Notice also provides that, until further guidance is issued, a deferred compensation arrangement may provide that, if the present value of future deferred compensation payments at the original payment date is less than a specified amount, the deferred compensation will be paid as a lump sum and that, otherwise, it will be paid in installments, even if the present value of future payments falls below the specified amount.

Anticipated Limited Voluntary Compliance Program

The Notice provides that the IRS anticipates issuing guidance in the near future establishing a limited voluntary compliance program that will apply to certain unintentional failures to comply with Section 409A.

If you have questions about Notice 2007-78 and how the transition relief may affect your nonqualified deferred compensation arrangements, please contact Marc Sciscoe, Jim Kemper, or Craig Burke.

 

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.