A final issue that frequently arises under arrangements that are subject to Section 409A is the subsequent deferral of nonqualified deferred compensation. The subsequent deferral rules apply to nonqualified deferred compensation in the event there are subsequent changes to the time and form of a payment of nonqualified deferred compensation. Although a subsequent deferral of nonqualified deferred compensation is not prohibited under Section 409A, the subsequent deferral rules provide that a subsequent change or delay in a payment or a change in the form of a payment is permissible, but only if certain conditions are satisfied.5 In order for a subsequent deferral of nonqualified deferred compensation to be valid, the following conditions must be satisfied: (i) the subsequent deferral election may not take effect until at least 12 months after the date on which the election is made; (ii) generally, the payment with respect to which such election is made must be deferred for a period of at least five years from the date such payment would otherwise have been paid; and (iii) generally, the subsequent deferral election must be made at least 12 months before the date the payment is scheduled to be paid.6 For example, assume an employer and an employee have a deferred compensation agreement in place to pay the employee a certain amount of deferred compensation each year over a period of 10 years upon such employee’s retirement. The employee’s targeted retirement date is Dec. 31, 2024. The annual installment payments will be made on each annual anniversary of the employee’s retirement with the first installment scheduled to be paid on Dec. 31, 2025. The employee desires to subsequently defer the payments so they commence at a later date. In order for the employee to validly make a subsequent deferral election, the election must be made on or before Dec. 31, 2024, and the deferred compensation payments cannot commence earlier than Dec. 31, 2030. As a practical matter, it is beneficial to discuss the subsequent deferral rules with clients at the outset of establishing a deferred compensation arrangement because the rigidity of the rules render subsequent deferrals impractical at times. Similar to the prior issues discussed, a violation of the subsequent deferral rules will result in a violation of Section 409A. In light of the foregoing, it should be noted that the penalties under Section 409A are substantial. To the extent a violation of Section 409A occurs, the amount of deferred compensation that is originally deferred is deemed to be included in the service provider’s (e.g., the employee’s) gross income. Additionally, such amount included in a service provider’s gross income is subject to a 20% excise tax (in addition to a specified interest rate penalty). So, the service provider (or the employee or contractor) is subject to liability in the event of a violation of Section 409A. Finally, additional reporting requirements are imposed in the event of violations. Although penalties are harsh under Section 409A, correction procedures are available under which taxpayers can avail themselves in the event documentation or operational errors do arise under Section 409A. Deferred compensation can be used as a great tool to attract, retain, and reward employees and contractors. Professional service providers should be aware of the benefits of deferred compensation as well as the red flags to appropriately advise clients. The rules and regulations contained within Section 409A that govern nonqualified deferred compensation are complex, but non-qualified deferred compensation is becoming an increasingly popular benefit to provide to a company’s workforce. The professionals at Koley Jessen are equipped to advise on the structure, implementation, and operation of deferred compensation arrangements to achieve the client’s goals. Peter Langdon is an attorney in Koley Jessen’s Employment and Benefits Department. With extensive experience advising clients on employee benefits, executive compensation, nonqualified deferred compensation, and general employment law matters, he is well equipped to navigate the complex landscape of employee benefits. For further inquiries, contact Langdon at peter.langdon@koleyjessen.com. ENDNOTES 1 I.R.C. § 409A(d)(1). 2 Treas. Reg. § 1.409A-1(b)(1). 3 Treas. Reg. § 1.409A-3(j)(1). 4 Treas. Reg. § 1.409A-3(f). 5 Treas. Reg. § 1.409A-2(b)(1). 6 Treas. Reg. § 1.409A-2(b)(1)(i)-(iii). Tax and accounting manager wanted immediately for Omaha CPA firm. Knowledge of tax, accounting, and auditing concepts required. Send resume to Berger, Elliott & Pritchard, CPAs, L.L.C., 1301 S. 75th Street, Suite 200 or email to info@bepcpa.com. BETTER TAX SEASON BETTER FIRM BETTER PLACE TO WORK TAX AND ACCOUNTING MANAGER 13 nescpa.org
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