NonQualified Deferred Compensation (NQDC)

IRS Section 409A: Additional Transitional Relief

Bowing to requests from law firms and others, the Treasury has announced that the deadline for implementing the new 409A regulations for nonqualified deferred compensation plans has been extended for a year, until December 31, 2008.

Section 409A provides certain requirements applicable to nonqualified deferred compensation plans. If a plan does not meet those requirements, participants in the plan are required to immediately include amounts deferred under the plan in income and pay additional taxes on such income.

On September 10, 2007, the Treasury Department and the IRS issued Notice 2007-78, granting certain transition relief intended to facilitate compliance with the written plan requirements set forth in the final regulations. Commentators stated that although the Notice 2007-78 transition relief was helpful, the transition relief in that notice did not adequately address the need for additional time for service recipients and service providers to analyze all of their plans and make informed and reasoned decisions regarding the changes that would be necessary to bring existing arrangements into compliance with the final regulations.

The new transition relief has been issued as Notice 2007-86.

Why all the talk about NQDC?
NQDC has undergone sweeping tax changes due to Internal Revenue Code Section 409A. The changes affect the design and operation of NQDCs and require employers - and employees - to act wisely to preserve the deferred tax status of executive benefit plans. Plans that aren't compliant will be subject to immediate taxation, 20% penalty, and interest.

What is NQDC?
NQDC is defined as any plan that provides for the deferral of compensation other than qualified and certain welfare benefit plans. Qualified refers to qualifying for favorable tax treatment by the IRS. A company's 401(k) plan or a not-for-profit's 403(b) are common examples of qualified plans. Generally, NQDC includes nonqualified stock options/discount stock, restricted stock units, certain severance plans and change in control arrangements, non-compete and confidentiality agreements,SARs, SERPs, rabbi trusts, and any other plan which has a deferral feature.

What should I do?
First, examine all your plans to determine which have features that subject them to Section 409A. You may have a severance plan, but if it pays out all benefits within the calendar year of the event, it is unlikely to be subject to 409A. If you offer NSOs with an exercise price below fair market value, they are subject to 409A. But if the exercise price is equal to fair market value, then they aren't. As always, with laws, there are interpretations and some exceptions. Examining your plans, and comparing them to the regulations and exceptions is where to start.