Why Put Off Until Tomorrow: The Latest on Deferred Compensation

Deferred compensation works well as a means to reward key employees. It also can have certain benefits for business owners of various stripes. However, Section 409A of the Internal Revenue Code, enacted as part of the American Jobs Creation Act of 2004, has muddied the waters a bit over the past couple of years. It imposes a variety of requirements on many different types of arrangements, including some that are not immediately recognizable as deferred compensation schemes. On April 10, 2007, the IRS issued the final regulations for Section 409A. This Bulletin covers the highlights.


In this case, we’ll start at the end and work backwards. In clarifying the regulations the IRS set a deadline for amending plans and agreements to comply with Section 409A: December 31, 2007. If you have any type of non-qualified deferred compensation plan, you will need to review all of them for compliance.

These plans include:

  • Elective deferred compensation plans/agreements.
  • Non-elective deferred compensation plans/agreements.
  • Severance agreements.
  • Deferred bonus arrangements.
  • Equity compensation arrangements.
  • Employment agreements that provide for payment on termination.

As you can see, the range of plans and arrangements covered by Section 409A is fairly broad. Also note that you may have some deferral elections in place under older plans; these will need to be reviewed, too. The IRS has warned that failure to comply with these rules could result in significant and detrimental tax results.


The new regulations tend to follow the proposed regulations.

In particular they:

  • Clarify the definition of a deferred compensation payment.
  • Add guidance for the short-term deferral exception.
  • Provide exceptions from Section 409A for certain severance payments, such as termination for cause.
  • Allow limitation of payments based on defined formulas or fixed restrictions (such as annual firm income), so long as these definitions and restrictions are established before the date payment has to be made.
  • Permit the delay of deferred compensation if payment threatens the employer’s ability to continue as a going concern.
  • Offer more flexible ways for valuing stocks in start-ups and privately-held companies.
  • Permit greater flexibility in exercising stock option and stock appreciation rights without triggering Section 409A.
  • Treat similar deferred compensation arrangements as one plan when calculating Section 409A penalties.

Although the final regulations are effective January 1, 2008, there is some indication that they may be applied retroactively to the date Section 409A was originally passed. It is expected that the IRS will not expect that plans be retroactively amended, but will expect that businesses be able to show evidence that they have made a good faith effort to comply.


This is one of those circumstances when you are not going to want to proceed without professional advice. The risks are too great and the rules too complicated for you to go it alone. Depending on thenumber and variety of arrangements you have that fall under Section 409A, you will want to get a CPA firm, an actuarial consultant or both to review them for compliance and develop any required plan amendments for you.


The new regulations do not fully address how Section 409A applies to some classes of business, including:

  • Partners and partnerships
  • Offshore funding
  • Springing trusts

They also do not cover all the essentials on income calculation and inclusions. Further guidance is expected from the IRS on these issues.


Most firms – from sole proprietorships and other “pass-through entities” to giant C corps – use some sort of non-qualified deferred compensation arrangement. While the new Section 409A regulations make these arrangements somewhat more onerous to administer, there may still be some benefit to implementing and using them.

If you would like to find out more about the range of plans you can implement and how they might help you, please feel free to contact me at wbergstein@akmcpa.com.

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