On the same day it released proposed regulations under Section 457 — as reported in our "New 457 Regulations for Nonqualified Deferred Compensation Plans of Tax-Exempt and Government Employers" update —the IRS released proposed regulations under Section 409A modifying or clarifying specific provisions.
For the most part, the clarifying changes confirm practitioners' understanding of how the provisions should work (for example, separation from service when transitioning from employee to independent contractor). Where the IRS proposed clear changes to the regulations, the modifications provide relief targeted to very specific or uncommon situations (for example, permitting acceleration of payment to comply with foreign conflict of interest laws). Thus, many of the proposed clarifying changes either will not require plan amendments to take advantage of the changes or will not impact a large number of plans.
However, at least two of the proposed changes address common occurrences affecting nearly every deferred compensation plan, and plan amendments may be required or advisable in order to take advantage of the considerable administrative relief provided. These changes, discussed below, involve timing of payments to be made upon death of a service provider or a beneficiary.
The death of a service provider is an event that can trigger a payment under a deferred compensation plan. Many employers have found it challenging to make death benefit payments within the time frame required under the existing regulations, given the timing of the probate process or the time required to track down beneficiaries. Taking into account this potentially extended process, some plans actually provide for payment to be made in the calendar year following the year of death, for no other reason than to ensure that payment can be timely made under the current rules.
The proposed regulations provide that a payment made on account of a service provider's death will be considered timely if it is made at any time during the period beginning on the date of death and ending on December 31st of the year following the year of death. The plan need not specify when during this period the payment will be made. The proposed regulations allow an amendment providing for this flexibility to be made at any time, and the amendment will not be considered to be either a prohibited subsequent deferral election or acceleration. So, for example, a plan that currently provides for payment to be made within 90 days following the service provider's death can be amended to permit payment to occur at any time from the service provider's death until the end of the following calendar year.
Current 409A regulations provide that payments may be accelerated due to a service provider's death, but they do not address whether payments can also be accelerated on the death of a beneficiary who has commenced payments. Similarly, current regulations allow for a plan to be amended at any time to accelerate payment on a service provider's death, but no similar provision expressly permits an amendment for accelerated payment on a beneficiary's death. The proposed regulations clarify that acceleration is permitted on the death of a beneficiary and that this provision may be added to a plan at any time, without constituting a prohibited acceleration. Plan sponsors should review plan documents and overall plan objectives to determine whether an amendment is appropriate.
While the proposed changes described above are not effective until the regulations are finalized, the proposed regulations may be relied upon until final regulations are published. It is important to note that several other clarifications included in the proposed regulations (not described above) are effective immediately and relate to positions that the IRS has concluded are not proper under existing regulations. These clarifications relate to:
- Whether a transfer of restricted stock or a stock option constitutes a payment;
- Whether a taxable contribution to a 402(b) trust (nonqualified, funded plan) constitutes a payment;
- Whether the flexibility to determine if a separation from service occurs in connection with an asset sale applies to a stock sale treated as a deemed asset sale; and
- Which plans must be terminated in order to apply the exception to the anti-acceleration rules that requires the service recipient to terminate all plans in the same category.
In addition to the numerous changes that impact plan design and operation, sponsors who have need to correct noncompliant deferred compensation amounts should be aware that the proposed regulations would impose further restrictions on the ability to correct "unvested" amounts.
In light of these newly proposed regulations, plan sponsors should review plan terms and administrative practices to determine whether they conform to these IRS interpretations and to identify opportunities to simplify plan administration and compliance.