The new deferred compensation rules: an increasingly complex solution to a relatively simple problem.

• Author: Rowland, Michele

In October 2005, the Internal Revenue Service issued proposed regulations that provide further guidance regarding the deferred compensation rules in Section 409A of the Internal Revenue Code of 1986. The Proposed Regulations add 238 more pages of guidance on top of the 36 pages of guidance issued by the Treasury Department and the IRS last December ("Notice 2005-1"), and more guidance is coming. This might be a good point to stop and take a look at where we are one year after the enactment of Section 409A.

When did Section 409A become law? Congress enacted Section 409A as part of the American Jobs Creation Act of 2004, which President Bush signed into law on Oct. 22, 2004.

What does Section 409A say? Section 409A provides that amounts deferred under a "qualified deferred compensation plan" are includible in income currently if such amounts were not previously included in income and are not subject to a "substantial risk of forfeiture" ("SRF"), unless the plan meets certain design and administrative requirements. Hence, the "need" for 274 pages (and counting) of guidance to address a relatively small number of perceived abuses with respect to the pre-Section 409A deferred compensation rules.

Why should I care about Section 409A if I don't participate in a deferred compensation plan? You should care for two reasons. First, many compensation arrangements that would not, at first blush, appear to be deferred compensation arrangements are treated as such under Section 409A. Second, if Section 409A applies and the deferred compensation does not comply with Section 409A, then the amount deferred for the year and all preceding years is includible in the recipient's income currently, along with interest (at the IRS underpayment rate plus 1 percent), plus a 20 percent additional tax penalty.

What types of deferred compensation plans are subject to Section 409A? Section 409A potentially covers any plan or individual agreement between a service recipient (such as an employer) and service provider (such as an employee) that provides for the deferral of compensation, including traditional deferred compensation plan, certain stock rights (see below), severance pay, annual or multi-year bonuses, supplemental executive retirement plans (SERPs), and any other compensation arrangement that defers the payment of compensation beyond the taxable year in which the service provider is legally entitled to it. Section 409A applies to employee deferred compensation...