Subsequent deferral elections may bring surprises under Sec. 409A - Grant Thornton - Aug 2008

 



Compensation and
Benefits Bulletin

Focusing on
employee benefits and executive compensation issues

Subsequent deferral elections may bring
surprises under Sec. 409A

By Jeffrey A. Martin, Washington,
D.C.



Subsequent deferral elections could bring unpleasant surprises for employers and
employees after the transition relief for the new deferred compensation rules
under Sec. 409A expires on December 31, 2008.  These elections will have to be
crafted carefully to avoid running afoul of the new rules.



Subsequent deferral elections are changes made to the time and form of payments
under a deferred compensation plan after the time and form of payment have been
initially elected. Employers often want to allow such changes to provide the
flexibility to change payments in the future. The rules under Sec. 409A allow
subsequent deferral elections, but the elections will have to meet the rigid
requirements under Reg. Sec. 1.409A-2(b).



A subsequent deferral election may postpone the payment, but cannot accelerate
it. The general rule under Reg. Sec. 1.409A-2(b)(1) provides that the subsequent
deferral election must be made at least 12 months before the originally
scheduled payment date, and the new payment date must be at least five years
after the originally scheduled payment date. For example, if the original
payment terms provided for a lump-sum payment at the age of 60, the subsequent
deferral election must be made before the employee becomes 59 -- and the payment
date cannot be made earlier than the age 65.



When the employee is initially scheduled to receive a series of installment
payments, the installment payments are generally treated as one payment.
Therefore, the subsequent election must be made at least one year before the
first installment payment date, and all of the installment payments must be
deferred for at least an additional five years. However, a plan may explicitly
state that each installment payment, other than an installment payment under a
life annuity, is treated as a separate payment. In this case, the employee or
employer could then subsequently elect to further defer a portion of the
installment payments, rather than all of them. 



If multiple payment triggers are initially included in a plan, the subsequent
deferral election rules apply separately to each payment trigger. For example, a
deferred compensation plan could provide for a lump-sum payment upon the earlier
of age 60 or the employee’s separation from service. In this case, the employee
or employer could change the age trigger to 65, or a later date, without
changing the payment date with respect to separation from service. In other
words, the subsequent election could provide for payment upon the earlier of age
65 or separation from service. As long as the subsequent deferral election was
made before the employee reached 59, the plan would not violate Sec. 409A. 



Adding or deleting a trigger in a subsequent election, however, will affect
other triggers. If a payment trigger is added, the general restrictions on
subsequent deferral elections will apply to all of the original payment triggers
and the payment must be made after the latest of the payment triggers. For
example, consider a plan that originally would have provided a lump-sum payment
upon separation from service. If the employee subsequently elects to add a
predetermined age as a payment trigger, the plan must also provide that the
separation from service trigger is pushed back five years. So the payment will
be made at the later of five years after a separation from service or the
predetermined age. 



The subsequent deferral election rules under Sec. 409A can result in unexpected
tax consequences if employers and employees are not prepared. Adding a new
payment trigger to a plan after the initial election may result in an
unanticipated delay in payment. To avoid this, employers and employees may
consider including all of the permissible payment triggers (such as death,
disability, separation from service, change in control, specified date, and
unforeseeable emergency) in the initial deferral election. Employers and
employees need to be aware of the rules so they do not encounter any unpleasant
surprises when the Sec. 409A final regulations become effective on Jan. 1, 2009.