Companies Should Consider Installing New Deferral Plans Before
July 1 to Maximize 2009 Compensation Deferral Opportunities
Companies with 401(k) Discrimination Testing Problems Should Also
Consider New Plans ASAP
By Louis R. Richey, J.D.,
SRVP
McCamish Systems Retirement Group - 409A Plan Services, McCamish Systems, LLC, Atlanta, GA
Introduction
Although §409A 1
imposes strict rules on the timing of employee deferral elections,
there may still be opportunities for companies to establish
nonqualified deferred compensation arrangements for certain 2009
compensation amounts. This may particularly be the case with respect
to certain performance bonuses for calendar year 2009. In addition,
there may be opportunities to establish new plans that would allow
employees to defer some or all of their compensation for services to
be performed after the plans are put in place.
Under the general deferral election timing rules of §409A, an
employee's deferral election is required to be made on or before the
beginning of the calendar year in which the related services are
performed.2 For example, if an
employee wants to defer a portion of his or her 2010 base
compensation, the employee would have to make an irrevocable deferral
election no later than December 31, 2009. There are, however, two
special deferral election timing rules under §409A that may allow
for mid-year deferral elections, or elections after the beginning of
the calendar year in which the related services are performed.
First, there is a special deferral timing rule for
performance-based compensation, which provides that the deferral
election with respect to such compensation can be made no less than
six months before the end of the performance period, provided such
performance period is at least 12 months and the deferral election is
made before the amount is calculable and substantially certain to be
paid.3 For example, if an annual
bonus for calendar year 2009 is payable in March 2010 and otherwise
qualifies as performance-based compensation, an employee could elect
to defer up to 100% of the bonus as late as June 30, 2009. However, if
that election is made one day later, on July 1, 2009, under the new
plan/new employee special election timing rule discussed below, the
maximum deferral opportunity drops to 50% of the bonus (i.e.,
only a pro-rata deferral would be permitted if the conditions for the
new plan/new employee rule can be met).
Second, there is a special deferral election timing rule for new
plans and newly eligible employees, which provides that the initial
deferral election generally must be made within 30 days of initial
eligibility and can only apply to compensation for services performed
after the election.4 For example,
if on June 1, 2009 an employer establishes a new plan effective July
1, 2009, an employee could elect on or before June 30, 2009 to defer
some or all of his or her compensation for services performed on or
after July 1, 2009. It should be emphasized, however, that the plan
aggregation rules apply for purposes of this exception, and therefore,
if an employee was previously eligible to participate in another plan
of the same type (e.g., another elective account plan), the
employee generally will not be eligible for this special rule with
respect to the new plan.5
These mid-year deferral election opportunities are discussed in
greater detail below.
Special Deferral Timing Rule for “Performance-Based
Compensation”
The §409A definition of “performance-based
compensation” is not the same definition used under
§162(m).6 Under §409A,
performance-based compensation generally is defined as an award that
is:
(1)
variable and contingent on the satisfaction of pre-established
organizational or individual performance criteria (quantitative as
well as qualitative factors), and
(2)
not obviously attainable and ascertainable at the inception of the
bonus performance period or when the election to defer is
made.
In addition, operationally the bonus must have been communicated in
writing to the participants within the first 90 days of the start of
the performance year (e.g., by April 1 in the case of a
calendar year performance plan). The bonus also must cover a 12 month
period of performance and the participant must have worked the entire
performance period.7 (See the
attached Exhibit A for a more detailed Performance-Based Compensation
Quick Qualification Checklist.)
Moreover, under the special timing rule for a new elective deferral
plan, § 409A essentially provides for a 30-day deferral election
period for newly eligible
employees.8 Accordingly, the
sooner an initial deferral election can be made the better. In fact,
new plans that start the plan enrollment process after June 1,
2009, will need to remind the employees who are eligible that they
still only have until June 30, 2009, to submit their elections
if they want to defer their performance-based compensation for 2009,
even though the initial 30-day deferral election period might run past
June 30, 2009 (e.g., a 30-day enrollment window from June 15,
2009, through July 15, 2009). For this reason, most employers will
want to enroll the employees in a new calendar year plan by June 30,
2009, at the latest, to take advantage of the special deferral timing
rule for performance-based compensation.
Special Deferral Timing Rule for New Plans or Newly-Eligible
Employees
A new elective deferral plan generally should start as early in the
year as possible to maximize the employees' deferral opportunities on
all compensation attributable to services performed after the plan is
established and the deferral election is made. The plan design should
also permit deferral of salary, commissions and most other types of
compensation, as well as bonus compensation, to provide participants
the most attractive and flexible deferral opportunity. The maximum
salary deferral allowed in the first plan year is the remaining salary
due to be paid, subject to any other limitations on amount set by the
sponsor. Here again, the sooner the plan gets started the larger the
amount of compensation that is eligible for deferral in the first plan
year.
What about Companies with Fiscal Year Performance-Based
Compensation Plans?
There may still be mid-year deferral opportunities for fiscal year
bonus plans that qualify as performance-based compensation under
§409A (e.g., a performance bonus payable on account of an
employee's performance for the fiscal year beginning April 1, 2009,
and ending March 31, 2010). The process for a fiscal year bonus
plan is to determine the end of the fiscal year bonus performance
period, and subtract six months and one day to determine the
§409A deadline for performance-based compensation. This may or
may not help in 2009. Remember that the fiscal year bonus still
must meet the §409A definition of “performance-based
compensation” to obtain the special 100% maximum deferral
election opportunity.
What About Companies Failing Qualified Plan Nondiscrimination
Testing?
Many qualified 401(k) plans failed their nondiscrimination testing
last year and more are expected to fail this year because of the
impact of economic conditions on lower paid participants. For some
companies this was a new experience. However, such qualified plan
testing failures seem likely to repeat and expand in 2009, in light of
continuing negative economic trends and companies dropping their 2009
401(k) employer incentive matching contributions. Elimination of
employer matches will likely further discourage participation by lower
paid employees and thereby increase qualified plan nondiscrimination
testing failures. Therefore, a company that failed its 2008 qualified
plan testing and is facing a similar problem in 2009 should consider
installation of a nonqualified deferral plan as soon as possible to
help solve the current deferral limitations for its highly compensated
employees. The nonqualified deferral plan can also address 401(k) caps
and “includible compensation” limitations and any
“lost” company contributions because of the 401(k)
nondiscrimination testing failures in order to provide parity to its
affected employees.
A nonqualified “401(k) wrap plan” feature might be in
order. Section 409A seems to continue to permit this nonqualified plan
design so long as the prior IRS private letter ruling guidance is
followed.9 However, companies must
now separately consider the risk of the application of the DOL
position on the timeliness of qualified plan deposits under this
design.10 Even if a “401(k)
wrap plan” design is not used, a simple nonqualified deferral
plan design would allow highly compensated employees to defer larger
amounts this year into the nonqualified plan in anticipation of
returning 401(k) contributions for 2009, and an early start to a plan
makes this goal easier to accomplish. Of course, implementation of a
nonqualified deferral plan assumes the company has prospective
continuity, future economic viability and healthy cash flow, and is
not facing bankruptcy or reorganization.
Summary
Companies that are anticipating paying performance bonuses and/or
who may fail their 2009 qualified 401(k) nondiscrimination tests
should consider establishing a new nonqualified deferred compensation
plan mid-year in 2009. To qualify for the special deferral timing rule
for performance-based compensation, the plan would have to be
established and an irrevocable election to defer up to 100% of the
bonus would have to be in place by June 30, 2009. Otherwise, an
employee would be limited to a maximum deferral opportunity based only
on bonus compensation attributable to services for the remainder of
the year (i.e., only a pro-rata deferral would be permitted if
the conditions for the new plan/new employee rule can be met).
In addition, even if a company does not anticipate paying
performance-based compensation for 2009, companies may want to
consider establishing a new plan to provide their employees with an
opportunity to defer some or all of their compensation attributable to
services after the plan is established and irrevocable deferral
elections are made, particularly if a company anticipates that it will
not satisfy the nondiscrimination tests for its 401(k) plan in
2009.
However, there are a number of conditions that must be satisfied
before these special deferral timing rules can be utilized.
Accordingly, before any of these special rules are relied upon, a
company should consult with its tax and employee benefit advisors to
make sure that all of the conditions for using the special rules can
be satisfied.
EXHIBIT A
409A “Performance-Based Compensation” Quick
Qualification Checklist
The following questions must all receive a “YES”
answer (except for question #6) for compensation to qualify as
“performance-based compensation” and claim the special
participant election treatment under the §409A that permits the
final irrevocable deferral election to be made 6 months prior to the
end of the bonus performance period. Question #6 sorts out the portion
of compensation (if any) that does not qualify for the special
election opportunity because of the §409A requirement that the
bonus amounts be nonascertainable at the time of the deferral
election. Sorting the nonascertainable from the ascertainable amounts
may require some review.
(1) Were the requirements to receive the incentive
compensation communicated in writing to the participants not later
than at least 90 days into the performance year? Yes __ No __
(2) Does the performance plan period and each participant's
active participation run for a sequence of 12 full calendar months
(quarterly performance periods, etc. do not qualify)?
Yes __ No __
(3) Is this the only elective account balance plan that the
eligible employee(s) currently participate in? Yes __ No __
(4) Is the plan based upon communicated quantitative and
qualitative factors rather than being wholly discretionary? Yes __ No
___
(5) Will the deferral elections be made not later than 6
full calendar months prior to the end of the performance period (prior
to July 1 for calendar year performance plans)? Yes __ No __
(6)What part of the compensation is NOT readily
ascertainable (calculable & substantially certain to be paid) as
of the election deadline (only the portion of bonus that is not yet
ascertainable as of the date may qualify for the special election if
other factors met)?
__ All of the bonus (up to 100% election)
__% of total
DISCLAIMER
This article and checklist are intended for informational
purposes only and do not constitute a legal opinion or advice to plan
sponsors of existing plans or prospective plan sponsors, and may not
be used as an opinion or advice. Moreover, per IRS Circular 230, this
information may not be used to avoid any income tax penalties imposed
by the IRS and cannot be used as a legal or tax opinion in connection
with the marketing of the plans discussed in the article. If a
corporation desires such an opinion concerning §409A or its
potential impact on and deadlines for an existing plan or potential
plan, it must consult with its own tax and other professional legal or
accounting advisors.
For more information, in the Tax Management Portfolios, see
Brisendine, Veal and Drigotas, 385 T.M., Deferred Compensation
Arrangement, and in Tax Practice Series, see ¶5710,
Nonqualified Deferred Compensation.
1
Added to the Code by §885 of the America Jobs Creation Act of 2004, P.L. 108-357, 118 Stat. 1418.
2
Regs. §1.409A-2(a)(3). See also Preamble to Proposed 409A Regulations, REG-158080-04, 70 Fed. Reg. 57930 (10/4/05), V.A.
3
Regs. §1.409A-2(a)(8). See also Preamble to Final 409A Regulations, T.D. 9321, 72 Fed. Reg. 19234 (4/17/07), VI.C.
4
Regs. §1.409A-2(a)(7). A pro rata percentage is permitted to be deferred based upon the number of days remaining in the performance period divided total days in the performance period (365 if calendar).
5
The final regulations provide that the requirements of §409A generally are applied as if a separate plan is maintained for each employee and all arrangements of the same type in which the employee participates are aggregated and treated as a single plan. For this purpose, the final regulations aggregate the following nine categories of plans separately: (a) elective account balance plans; (b) nonelective account balance plans; (c) nonaccount balance plans; (d) separation pay arrangements (but only to the extent payable solely upon an involuntary separation from service or as a result of participation in a window program); (e) split-dollar life insurance arrangements; (f) reimbursement plans; (g) stock rights; (h) foreign plans; and (i) all other plans. See Regs. §1.409A-1(c).
6
Compare Regs. §1.409A-1(e)(1)-(2) and Regs. §1.162-27(e)(2). For instance, approval of the board compensation committee is not required for §409A “performance-based compensation.” “Equity-based performance-based compensation” is discussed in Regs. §1.409A-1(e)(3). Commissions are discussed in Regs. §1.409A-2(a)(12) and broken into two categories: sales commissions and investment commissions.
7
§409A(a)(4)(B)(iii); Regs. §1.409A-2(a)(8). See also the Preamble to Final 409A Regulations, VI.C.. Unfortunately, there are no specific examples in the regulations covering deferral elections of a performance-based compensation bonus deferral.
8
Regs. §1.409A-2(a)(7).
9
See the Preamble to Proposed 409A Regulations, IX.B., which indicates that the deposit from nonqualified plan to qualified plan is not a prohibited §409A acceleration. See also PLR 9530338 (and subsequent following PLRs) concerning the IRS final approved “401(k) wrap plan” design structure (defer into the nonqualified plan first and then transfer to the qualified plan once allowable amount is known).
10
See generally DOL Reg. §29 CFR 2510.3-102; Proposed Amended Reg. §29 CFR 2510 (2/29/08) concerning safe harbor contributions transfer deadline for small plans under 100. The basic question is whether a “401(k) wrap plan” design meets the requirements of the DOL plan asset regulations governing timeliness of employee contributions? Timeliness of employer deposits to 401(k) plans has been a growing issue at the DOL since 1996. See, e.g., Fyi, Buck Consultants, Vol. 31, Issue 22, Mar. 19, 2008.
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