Employers that act before the end of 2012 may be able to correct potentially costly violations of Section 409A of the Internal Revenue Code (Section 409A) in employment agreements, separation agreements, and other arrangements with employees that condition benefits on signing a release.
After most employers revised these types of arrangements in 2008 to comply with Section 409A, the IRS issued surprising guidance in 2010 specifying that arrangements may violate Section 409A if the timing of payments is based on the employee taking some action, such signing a release of claims, noncompete agreement, and/or nondisclosure agreement.
Because this guidance was a surprise, many arrangements that were revised in 2008 to comply with Section 409A may include inadvertent violations. As a result, the IRS is allowing employers to correct arrangements before the end of 2012 without penalty.
In order to take advantage of this transitional relief, employers should review all current employment agreements, separation agreements, and other deferred compensation arrangements and identify any arrangements under which the employee may delay payment of benefits by delaying the signing of a release or some other action.
Unless these arrangements are exempt from Section 409A, they generally should be amended before the end of the year to remove the employee’s ability to delay payment (e.g., by requiring payments to commence on the 60th day after separation from service) and the employer should disclose the correction in an attachment to its tax return for 2012.
Additional corrective action, as explained more fully in IRS Notice 2010-80, may be required for arrangements that were initially adopted in 2011 or later, or if benefit payments have already commenced.
For more information about this transition relief, or about any executive compensation issue, please contact a member of our Employment Group or call 208.344.6000.