On January 5, 2010 the Internal Revenue Service published Notice 2010-6 providing relief and guidance on corrections relating to document failures of non-qualified deferred compensation (“NQDC”) plans to comply with Section 409A of the Internal Revenue Code of 1986, as amended (“Code”). The purpose of Notice 2010-6 is to provide methods for taxpayers to voluntarily correct many types of failures to comply with the document requirements applicable under Code Section 409A to NQDC plans and thereby avoid or reduce the current income inclusion and additional taxes under Code Section 409A. The IRS hopes that this document correction program will encourage taxpayers to review NQDC plans to identify impermissible provisions and correct them promptly.
Background
Code Section 409A generally provides that, unless certain requirements are met, amounts deferred under a NQDC plan for all taxable years are currently includable in gross income to the extent not subject to substantial risk of forfeiture and not previously included in gross income. Code Section 409A further provides that amounts includable in income under Code Section 409A are subject to two additional taxes, (i) a 20% additional tax and (ii) a further tax calculated at a premium interest rate, potentially causing severely adverse tax consequences. A NQDC plan must comply with the requirements of Code Section 409A both in form (i.e., in the provisions of the document) and in operation. The IRS previously announced, in Notice 2008-113, a correction program with respect to certain operational failures, and Notice 2010-6 has been published with respect to the correction of certain document failures.
NOTICE 2010-6
If the requirements of Notice 2010-6 are complied with and document failures subject to correction under the notice are fully corrected in accordance with its provisions, then, except as otherwise provided in the notice, employers will not be required to report, and employees will not be required to include in income under Code Section 409A any amount with respect to such document failure under Code Section 409A for any tax year before the year of correction solely as a result of such document failure being in the written plan during any such earlier year. Notice 2010-6 describes certain circumstances where relief is not available (e.g., where the employer’s or employee’s income tax return is under examination with respect to non-qualified deferred compensation). The notice provides for transition relief with respect to proper corrections made on or before December 31, 2010, allowing the plan to be treated as having been corrected on January 1, 2009 for purposes of applying the relief under the notice and to avoid any income inclusion required by the notice for relief. Some of the document failures addressed by Notice 2010-6 are described below.
Notice 2010-6 provides for the correction of impermissible definitions in a plan document of otherwise permissible payment events (i.e., separation from service, disability or change in control); for example, a definition of “separation from service” that does not comply with Code Section 409A. Prior to Notice 2010-6, such an impermissible definition would have caused a document failure and triggered income inclusion of deferred amounts to the extent not subject to a substantial risk of forfeiture and additional taxes under Code Section 409A. Notice 2010-6 generally permits correction of the definition without income inclusion, if correction occurs prior to an event resulting in application of the impermissible provision and, in the case of separation from service and change in control, unless an event occurs within one year of the date of correction resulting in application of the corrected provision.
Notice 2010-6 also provides for the correction of (i) impermissible payment periods following a permissible payment event, (ii) certain impermissible payment events and payment schedules and (iii) provisions providing for impermissible initial deferral elections. Further, Notice 2010-6 clarifies that plan provisions providing for payment “as soon as reasonably practicable” following a permissible payment event or containing no definition or an ambiguous definition of a payment event may still satisfy the document requirements of Code Section 409A in certain circumstances and not be considered a document failure.
In some cases, as a condition to correction, Notice 2010-6 requires that deferred amounts be included in income under Code Section 409A. In such cases, the relief provided under the notice is conditioned upon the employee’s including the amount in income on the appropriate tax return and paying all applicable federal taxes under Code Section 409A, including the additional 20% tax (but not the premium interest tax), and the employer’s complying with the applicable information reporting requirements.
Most of the corrections of a document failure under Notice 2010-6 must be reported to the IRS by the employer in connection with filing its federal income tax return for the year of correction, as well as for any subsequent year in which an employee is required to include an amount in income as a condition to relief under this notice. For each such year, the employer is also required to provide each employee affected by the document failure a statement containing certain information about the correction for attachment to such employee’s federal income tax return for such years in connection with claiming relief under Notice 2010-6.
This article is intended to provide general information and should not be relied upon as a substitute for legal or tax advice from an experienced tax advisor who has carefully considered your particular facts and circumstances. Information contained herein was neither intended nor written to be used and cannot be used for the purpose of avoiding tax penalties that may be imposed under the Internal Revenue Code or for promoting, marketing or recommending to another party any matters addressed in this article.