IRS Issues Guidance on Correction of Certain Failures under Code Section 409A (Notice 2010-6)

The IRS has issued guidance for taxpayers with nonqualified deferred compensation plans on correcting certain failures to comply with the document requirements of IRC Section 409A. Taxpayers may rely on this guidance for tax years beginning on or after January 1, 2009.

Unless specific requirements are met, amounts deferred under a nonqualified deferred compensation plan are includible in gross income under Section 409A to the extent that the deferred amounts are not subject to a substantial risk of forfeiture and were not previously included in income. The amounts includible in income are also subject to two additional taxes.

Nonqualified deferred compensation plans must comply with Section 409A in both form and operation. The newly issued guidance mainly addresses the failure to comply with Section 409A in form (i.e. document compliance).

The IRS guidance, issued in Notice 2010-6, includes the following information:

  1. Clarifies that certain language that is commonly included in plan documents will not cause a document failure.
  2. Provides relief by allowing certain document failures to be corrected without current income inclusion or additional taxes under Section 409A as long as the corrected plan provision does not affect the operation of the plan within one year following the date of correction.
  3. Provides relief by limiting the amount currently includible in income and the additional taxes under Section 409A for certain document failures if correction of the failure affects the operation of the plan within one year following the date of correction.
  4. Provides relief by allowing certain document failures to be corrected without current income inclusion or additional taxes under Section 409A if the plan is the service recipient’s first plan of that type and the failure is corrected within a limited period following adoption of the plan.
  5. Provides transition relief by allowing certain document failures to be corrected without current income inclusion or additional taxes under Section 409A if the document failure is corrected by December 31, 2010, and any operational failures resulting from the document failure are also corrected in accordance with Notice 2008-113 by December 31, 2010. Many examples of common types of failures and the related corrections are also provided.

Modification of Notice 2008-113. The newly issued guidance also modifies Notice 2008-113, which addresses certain operational failures of nonqualified deferred compensation plans. The areas of Notice 2008-113 that have been clarified include: (1) the application of the subsequent year correction method to late payments of amounts deferred; (2) the calculation of the amount that must be paid to the service provider as a correction of a late payment of an amount deferred under a plan if the payment would have been made in property; and (3) the calculation of the amount that must be repaid by the service provider as a correction of an early payment of an amount deferred under a plan if the early payment was made in property.

Modification of Notice 2008-115. Notice 2008-115, I.R.B. 2008-52, 1367, which relates to reporting and wage withholding for 2008 and subsequent years, has also been modified. Specifically, the notice has been modified with respect to: (1) the amount that is required to be included in income by a service provider under Section 409A, and (2) the amount that is required to be reported by the service recipient as an amount includible in income under Section 409A on Form W-2 or Form 1099-Z.

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