The IRS recently released long-awaited proposed changes to its guidance on the infamously complex and oft demonized IRS 409A rules which govern non-qualified deferred compensation. Major law firms have indicated that the modifications and clarifications included in the proposed regulations are mostly consistent with the current practitioner viewpoints, but that there are several instances where the proposed regulations impact current practices. Among the most significant changes include:
- Corrections of Unvested Amounts Limited. The income exclusion rules of Section 409A provide that a violation in one year which results in adverse tax consequences, if corrected, does not result in adverse tax consequences to unvested and unpaid compensation in following years. However, this ability to correct a plan error under the income exclusion rules were often used to change the time and form of payment of unvested deferred amounts whether or not there was a plan error. The proposed regulations place limits on the ability to change the time and form of payments for unvested awards which do not violate 409A.
- Treatment of Restricted Stock: The 2007 409A regulations stated that the transfer of restricted property (e.g., restricted stock) does not count as a compensation deferral. This led to the view that restricted stock could be used as a form of deferred compensation payment without having to satisfy subsequent deferral election rules. For example, prior to the predefined payment date window, an employee and employer could agree to change the form of payment from cash to restricted stock which would vest for three years after the back-end of the payment window without resulting in an impermissible deferral beyond the specified payment date. The proposed regulations state that a payment of unvested property, which includes restricted shares, will not satisfy an obligation under a deferred compensation plan unless the employee makes an 83(b) election, thus paying tax on the award at the time of the election. Without the 83(b) election, the restricted shares would constitute an impermissible subsequent deferral.
- Payments upon Death and to Beneficiaries: Under the proposed regulations, the categories of permissible payment events has been expanded to include death, disability, or unforeseen emergency of a beneficiary who is entitled to payment due to the service provider's death.