Significant Penalties.  As a reminder, it is imperative that employers meet this compliance deadline because the penalties for non-compliance are severe. 

• Failure to comply with Section 409A subjects the employee to accelerated taxation of the non-compliant NQDC (including all of the other NQDC that is treated as payable under the same type of plan).
• The employee would also be subject a 20% penalty tax (i.e., in addition to ordinary income tax) on any non-compliant NQDC that must be included in the employee's income, plus interest for the underpayment of taxes (even in circumstances where payments of the NQDC are not actually made to the employee).
• Employees may also be subject to additional adverse tax consequences, including additional penalties, if they are taxpayers in certain states (such as California) with respect to vested deferred compensation.
• The employer may also be subject to penalties if it fails to withhold taxes and/or report the includible income as a result of the non-compliant deferred compensation.

Broad Applicability.

• Section 409A applies to all employers, including public companies, and private companies, whether large or small, non-profit organizations and quasi-governmental employers.  Employees, as well as non-employees, such as independent contractors, consultants, and directors are subject to Section 409A.
• Section 409A is not limited to traditional deferred compensation arrangements - it is broad in its application and can potentially apply to equity awards, employment agreements, severance arrangements, change of control agreements, cash bonus and performance incentive plans, and many other types of arrangements that have not been viewed as deferred compensation.  Any arrangement that gives the employee a legally binding right to compensation in one year that will or might get paid in a later year may potentially be subject to Section 409A.

Transition Relief Ending.  Under transition relief that ends on December 31, 2008, employers may still have an opportunity to make certain changes to arrangements providing for NQDC.

• NQDC arrangements may be amended to provide for different payment elections (so long as such changes do not cause an amount otherwise payable in 2008 to be paid in a later year or cause an amount payable in a later year to be paid in 2008).  After 2008, any changes must comply with the onerous requirements on subsequent deferrals and anti-acceleration rules.
• Employers may also amend arrangements that would otherwise be subject to Section 409A to comply with exceptions that may be available to exempt the arrangements from Section 409A (such as the short-term deferral and involuntary separation pay plan exceptions).
• Discounted stock options and stock appreciation rights (SARs), which are subject to Section 409A, may be substituted with non-discounted stock options/SARs (based on the fair market value on the original date of grant) in order to exempt the stock rights from Section 409A (note that this transition relief is generally not available to discounted stock options/SARs held by certain Section 16 officers).  Alternatively, discounted stock options or SARs that are subject to Section 409A may be amended prior to the end of the transition relief period to provide for fixed exercise/payment dates that comply with the time and form of payment requirements under Section 409A.

Special Issues.  The Section 409A regulations are replete with hidden traps and obscure issues that can easily cause an arrangement to be subject to Section 409A or to cause an NQDC arrangement to fail to comply with the complex rules of Section 409A.  Employers are encouraged to seek legal counsel to aid in the review of their compensation arrangements to help them identify all potential Section 409A issues.  The following are some examples of these less than apparent Section 409A issues:

• RSUs with Retirement Acceleration (or similar) Provisions.  Restricted Stock Units, or RSUs, may be exempt from Section 409A if the underlying shares are delivered shortly after vesting.  However, if the RSU award accelerates vesting upon becoming retirement eligible or disabled, Section 409A applies.  Therefore, the shares must be delivered on the regular vesting date specified in the award in order to satisfy Section 409A.
  
  
  
• Option Plan Providing for Deferral of Option Gain.  Stock options/SARs are generally exempt if they are granted with an exercise price equal to fair market value on the date of grant and the stock rights do not provide for any deferral feature.  However, to the extent the plan pursuant to which a stock option/SAR was granted provides for deferral of option gain, and the agreement incorporates the terms of the plan, Section 409A may apply to these stock rights.

• Payments upon Execution of Release.  Severance or other similar payments that are NQDC subject to Section 409A made contingent on the execution of a release may not comply with Section 409A if the fixed payment date is tied to the date the release is executed rather than the "separation from service" of the employee (e.g., the agreements should state that the payment will be made within a specified period following separation from service rather than following execution of a release). 

• Same Payment upon Disability as upon Involuntary Separation.  Some employment or severance agreements may provide for the same payment upon an involuntary termination as provided in connection with an employee's termination of employment resulting from a disability.  Although Section 409A provides for an exception for payments that would otherwise be subject to Section 409A if they are payable solely upon an involuntary termination under the separation pay plan exception (subject to limitations on amounts and payment period).  However, this separation pay exception is not available if the employee is also entitled to the same payment if he or she terminates employment as a result of a disability.

• Unwritten Annual Bonus Plans.  Annual bonus plans or other short-term incentive compensation plans are generally exempt if the bonuses are paid within the short-term deferral exception period - within 2 ½ months following the year that the bonuses are earned.  Many employers maintain annual or short-term incentive plans that are not in writing.  The lack of a written document evidencing the terms, including the time that bonus payments will be made under the plan, creates the potential for such plans to be operated in a way that will cause the payment to be paid outside of the short-term deferral period, resulting in a Section 409A violation.  In addition, a written bonus plan providing for payment between January 1st and March 15th of the year following the year bonuses are earned where payment is delayed beyond this specified period may nonetheless avoid violating Section 409A so long as payment is made before the end of the calendar year.

• LTIP Prorated Payments.  Some Long-Term Incentive Plans, or LTIPs (the performance period under which may span several years), provide for, either under the terms of the LTIPs themselves or under the terms of the employment or severance agreements to which LTIP participants are party, a pro-rated payment of the LTIP bonus to the extent the LTIP participant severs employment prior to the end of the performance period.  The pro rated payment is made at the same time as payments are made to other LTIP participants who remain in service (generally, within a relatively short period following the end of the performance period).  Even though the amount of the pro-rated payment may not be determinable until the performance period has been completed, the LTIP participant who severs employment is considered to be vested in that payment at the time employment terminates.  Section 409A is likely to apply to the pro rated payment unless the payment is made within the short-term deferral period or another exception under Section 409A applies. 

• Post-Termination Health Reimbursement Expenses.  Self-funded health reimbursements plans, including arrangements in which the employer directly pays all or a portion of the premiums on behalf of the employee, are generally exempt from 409A during the period that the employee would be entitled to COBRA continuation coverage.  However, discriminatory self-insured plans providing for taxable benefits would be subject to Section 409A and special provision need to be added to comply with Section 409A.

• Taxable Reimbursements.  Taxable reimbursements and in-kind benefits payable after termination of employment (e.g., certain relocation benefits, country club dues, tax preparation and financial services fees, and certain payments for cooperating with litigation and investigations) may be subject to Section 409A and must incorporate special provisions in order not to violate Section 409A's rules on timing of payments.

• Acceleration of Payment/Vesting.  While it is permissible under Section 409A for an employer to exercise discretion to accelerate vesting of an RSU or LTIP award subject to Section 409A or other NQDC arrangement, an employer may not use its discretion to accelerate the payment of an award that has become vested to a date earlier than the payment date provided in the plan. 

• Performance-Based/Forfeitable Compensation.  Provisions in an employment or severance agreement or other NQDC arrangement that permit payment of compensation even if performance conditions are not met or, in the case of forfeitable compensation, even if minimum service requirements are not met (e.g., a payment is made upon termination of employment other than for cause even if performance or minimum service requirements are not met) will prevent an employee from making a deferral election after the commencement of the service period to which such compensation relates (i.e., generally, deferral elections must be made prior to the beginning of the year in which services will be provided).

• Separation from Service.  "Separation from service" (a permitted payment trigger under Section 409A) does not have the same meaning as termination of employment.  An employee who has reduced the number of hours worked may be treated as having a separation from service although the employee remains a part-time employee and an employee who continues to perform services as a consultant or another advisory capacity may not be treated as experiencing a separation from service.  To avoid confusion as to when a payment subject to Section 409A is due in connection with separation from service, an employer may wish to incorporate the separation from service guidelines in the Section 409A regulations in lieu of termination of employment provisions.

• Replacing NQDC.  Employers need to be careful about replacing a NQDC with a new arrangement that has a different payment date or schedule or with an arrangement that is exempt from Section 409A.  This may arise where a terminating employee renegotiates the provisions of severance or NQDC arrangements or settles a claim to NQDC.  Any new arrangement that acts as a substitute for, or a replacement of, amounts deferred under a NQDC constitutes a payment of NQDC under the prior arrangement and may violate Section 409A's anti-acceleration, timing, or form of payment provisions.

• As Soon as Practicable.  An NQDC arrangement that provides for payment "as soon as practicable" after a Section 409A payment event does not comply with Section 409A.  The arrangement must generally state that the payment will be made within the same calendar year or within 90 days of the payment event.

Other 409A Reminders

• "Specified Employee" Identification.  A publicly traded company is required to determine annually a single list identifying "specified employees," who are subject to a 6-month delay of separation payments, and this list will apply to all of the NQDC arrangements maintained by the employer and each of the members of its controlled group.  In reviewing their NQDC arrangements for any necessary amendments to comply with Section 409A, employers should be mindful to verify that the method and procedures used to determine "specified employees" in each of the NQDC arrangements maintained by the employer and by each of it controlled group members is consistent.  For instance, the potential exists for a determination method adopted for purposes of a SERP or severance policy applicable to a group of employees to differ from a determination method that was negotiated and made part of an executive employment agreement.  Employers may wish to consider taking advantage of this planning opportunity to develop and adopt a single, universal policy setting forth the method and procedures to be used to determine the "specified employees" that would be incorporated into each NQDC arrangement and would obviate the need to include such provision in each NQDC arrangement, as well as to reduce the potential for a conflict or inconsistency in the methods used in all of the NQDC arrangements maintained by the employer and each of its controlled group members.  Separately, failure to adopt and use a single method for the determination of specified employees may force the employer to use the default method for determining who is a specified employee, and the default method may be less advantageous for some employers.

• Reporting and Withholding Guidance.  Employers should watch out for IRS guidance that is expected soon based on informal statements by the IRS earlier in the year that they anticipated providing guidance by mid-summer regarding calculation of amounts to be included in income upon violation of Section 409A and reporting and withholding in connection with these amounts, as well as reporting of amounts deferred and in compliance with Section 409A.  The IRS has also informally stated that they anticipate waiving for another year reporting obligations with respect to deferred amounts that are in compliance with Section 409A.

• "De-Link" NQDC Plan from Qualified Plans.  An NQDC plan that provides for payment of benefits at the same time and form as benefits payable under a tax-qualified retirement plan must be "de-linked" from the tax-qualified plan beginning in 2009.  The NQDC plan will need to provide for new and separate time and form of payment provisions that satisfy the transition relief related to changes to payment elections.

• Good Reason.  "Good reason" termination provisions in employment, severance, change in control and other NQDC arrangements need to be reviewed and possibly revised to comply with guidelines in the Section 409A regulations.  Compliance with the new guidelines may exempt such payments from the application of Section 409A, such as under the short-term deferral exemption.  Failure to qualify for any of the available exemptions may cause such payments to be subject to the six month payment delay applicable to "specified employees" of a publicly traded corporation. 

Beginning on January 1, 2009, all plans providing for NQDC must be in documentary and operational compliance with the final Section 409A regulations.  If employers have not already done so, in light of the many steps and potentially time-involved process in completing any necessary amendments, they must take action now to begin to review their plans for Section 409A compliance to ensure they will meet the deadline.  The attached list of actions items is intended to provide guidance regarding this process.

Recommended Action Items to Meet 409A Compliance Deadline:

Before December 31, 2008, all of the following should be completed:

1. Identify and create an inventory of all arrangements, agreements, plans, and policies that may constitute non-qualified deferred compensation, or NQDC.  Almost any type of compensation arrangement (written or unwritten) can constitute NQDC.  These arrangements may be with employees or non-employees (e.g., independent contractors, consultants, or directors).  In general, arrangements under which an employee or other service provider has a legally binding right during a taxable year to receive compensation that is (or may be) payable in a later taxable year may constitute NQDC that is subject to Section 409A.  See the below checklist of common types of NQDC arrangements.

2. Work with legal counsel to review each NQDC arrangement to identify provisions that will need to be changed to take advantage of any available exception or to comply with Section 409A (e.g., time and form of payment, mandatory payment within short-term deferral period to take advantage of exception, removal of haircut withdrawal provisions, changes to definition of change of control and disability) and prepare amendments to NQDC arrangements as necessary.  For NQDC arrangements not in writing, work with legal counsel to prepare written documents setting forth the terms of the arrangement that comply with Section 409A.

3. Consider adopting a universal policy setting forth the methods and procedures that will be used to determine the "specified employees" that will apply to all NQDC arrangements of the employer and each of its controlled group members.

4. In reviewing NQDC arrangements for any necessary amendments, consider taking advantage of any final opportunities to make any changes to payment elections or other transitional relief

5. Obtain any necessary approval from the board of directors or the compensation committee for new NQDC arrangements or amendments to existing NQDC arrangements.  Be sure to leave enough time for all necessary approvals.

6. Work with legal counsel to review and revise employee communications, enrollment forms, election forms, and similar ancillary documents so that they comply with Section 409A and are consistent with the corresponding NQDC arrangement.

7. Communicate any changes in the terms of the arrangements that have been or need to be made to any affected employees, officers, directors, or independent contractors.  Employers may need to obtain the consent of employees, officers, directors, or independent contractors to modify existing NQDC arrangements.  Negotiations may be necessary in certain cases.  Be sure to leave enough time for all necessary consents and any negotiations.

8. Review administrative and operational procedures in place for NQDC arrangements. If necessary, coordinate with HR and payroll departments to make sure the arrangements are being operated in compliance with Section 409A and in accordance with their terms and that appropriate payroll codes are in place for reporting of amounts subject to Section 409A, if applicable.  Review of operational procedures will also help employers assess whether the IRS correction program for certain unintentional operational failures is available.

9. Work with legal counsel to evaluate any securities laws implications arising from necessary or desired amendments, including whether shareholder approval will be required, whether amendments give rise to any 8-K or other required reporting.  If an offering under a plan is registered under a Form S-8 with the Securities and Exchange Commission, work with legal counsel for any necessary revisions to the plan prospectus.

10. Watch for additional IRS guidance, including regarding reporting and withholding applicable to NQDC.

NQDC Arrangements

Common types of NQDC arrangements that may be subject to Section 409A include:

□    Salary and bonus plans, as well as other traditional nonqualified deferred compensation plans

□    Employment agreements

□    Offer letters

□    Consulting arrangements

□    Reimbursement arrangements

□    Severance arrangements

□    Bonus/incentive plans (including LTIPs)

□    Stock options

□    Stock appreciation rights

□    Phantom stock

□    Post-retirement benefits

□    Change in control agreements

□    Retention arrangements

□    Supplemental executive retirement plans ("SERPs")

□    Excess benefit plans

□    Director deferred compensation arrangements

□    Tax equalization agreements

□    Tax-gross up provisions

□    Section 457(f) plans

□    Split-dollar life insurance arrangement