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CCH® PENSION AND BENEFITS — 9/14/07

Practitioners wrestle with 409A compliance issues

Employers striving to meet the January 2008 deadline for bringing their nonqualified deferred compensation plans into compliance with Code Sec. 409A will need to resolve several issues highlighted by benefits practitioners at an American Law Institute-American Bar Association (ALI-ABA) video webcast held on August 30, 2007. Among the questions that employers may need to address are: whether the plan has enhanced benefits or otherwise been materially modified, so as to prevent application of the grandfather exception; how to specify goals under performance-based plans; and whether their executive severance plan complies with the authorized exception for separation pay arrangements.

“People are going to have a very tough time” complying with the final regulations by the deadline, program moderator William Sweetnam of Groom Law Group, Chartered, said. The final regulations were released in April 2007. “It’s almost overwhelming ... as we go toward the end of the year,” Program co-chair Elizabeth Drigotas of Deloitte Tax LLP indicated. In addition, said Sweetnam, there is other guidance coming out “to worry about,” on funding and offshore arrangements, for example.

Sweetnam explained that a deferred compensation plan can be grandfathered out of Code Sec. 409A , but this option is lost if a material modification is made to the plan. Enhancing a benefit is a material modification, but reducing a benefit is not. An increased interest rate for imputed earnings may be a material modification, Drigotas commented, but Dan Hogans of Morgan, Lewis & Bockius suggested that a reduction or a change from one “reasonable” rate to another may be acceptable. Hogans recently left Treasury after working on the Code Sec. 409A regulations.

Sweetnam indicated that an account balance plan could be bifurcated, with one plan grandfathered and the other covered by Code Sec. 409A . However, this requires more administrative effort by the employer and extra communications with participants.

Performance-based plans

The requirements for performance-based plans, such as bonus plans, provide an exception to the election requirements by permitting a deferral election after the period of service has begun, Drigotas said. The plan must specify the goals for paying the compensation. The goals can have some subjectivity but cannot be purely discretionary. For example, the employer can identify a pool of compensation and then evaluate employees individually. If the goals are changed, this exception is lost.

Designing a deferral scheme may be difficult. Hogans suggested giving participants an early default election, or making deferral nonelective, and then allowing a subsequent election.

Separation pay

The exclusion from Code Sec. 409A for separation or severance pay has a number of requirements. John McGuiness of the Groom Law Group said that a benefits scheme could be determined after the plan took effect. Even though the statute has few requirements, Hogans said it made administrative sense to map out the benefits and describe them in the plan document. Drigotas noted the difficulty of drafting a “perfect” document. “There are too many unknowns” and future circumstances may change, she said.

The severance pay exception requires that the employee be involuntarily terminated or else terminate employment for good reason. McGuiness pointed out that executive severance plans may not meet this exception. But many companies do not want to renegotiate employment contracts. Moreover, it may be difficult to have directors approve changes by the end of 2007. In addition, the IRS has suggested that revising the “good reason” clause may violate restrictions on adding a substantial risk of forfeiture or extending the payout period.

For more information on this and related topics, consult the CCH Pension Plan Guide.

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