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IRS Issues Limited Section 409A Relief to Pay Income Taxes on Pre-2009 Section 457A Deferrals

The Internal Revenue Service (the “IRS”) has issued Notice 2017-75 (the “Notice”), which provides certain limited relief from the strict requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), in order to pay income taxes on deferrals attributable to services performed before 2009 that are required to be included in gross income under Section 457A[1].

Section 457A

Section 457A generally provides that any compensation that is deferred under a “nonqualified deferred compensation plan” of a “nonqualified entity” is includible in gross income when there is no substantial risk of forfeiture of the rights to such compensation. Under Section 457A, the term “nonqualified deferred compensation plan” generally includes any plan or arrangement pursuant to which a service provider has a legally binding right to compensation during a taxable year that is or may be payable to the service provider in a later taxable year. A “nonqualified entity” is generally defined as (i) any foreign corporation unless substantially all of its income (i.e., at least 80%) is (a) effectively connected with the conduct of a trade or business in the United States, or (b) subject to a comprehensive foreign income tax, or (ii) any partnership (domestic or foreign) unless substantially all of its income (i.e., at least 80%) is allocated to persons other than (a) foreign persons with respect to whom such income is not subject to a comprehensive foreign income tax, and (b) tax exempt organizations.

Section 457A generally only applies to deferred amounts attributable to services performed after December 31, 2008.  Any deferred amounts attributable to services performed before January 1, 2009, to the extent not includible in gross income in a taxable year beginning before 2018, are required to be included in gross income in the later of (a) the last taxable year beginning before 2018, or (b) the taxable year in which there is no substantial risk of forfeiture of the rights to such compensation (“Pre-2009 457A Deferrals”).

Section 409A

Section 409A provides strict rules in regards to when amounts deferred under a Section 409A-covered nonqualified deferred compensation plan may be paid and requires the applicable plan document to include the applicable payment date or schedule.  Section 409A generally prohibits deviation from the applicable payment date or schedule by prohibiting the acceleration or further deferral of the time of payment.  Deferred amounts that were earned and vested prior to December 31, 2004 are generally grandfathered and not subject to Section 409A, unless the applicable plan is materially modified.

The Notice

In the Notice, the IRS states its intent to issue regulations providing that a Section 409A-covered plan will not fail to meet the requirements of Section 409A solely because payments of deferred amounts under the plan are accelerated in an otherwise impermissible manner in order to pay income taxes on Pre-2009 457A Deferrals that are required to be included in gross income under Section 457A.  The IRS also noted that such regulations will provide that any change in the time or form of payment of a Section 409A-grandfathered amount to pay such income taxes will not be considered a “material modification” of the applicable plan or arrangement that would otherwise forfeit the grandfathered treatment of amounts deferred under the plan.

The relief to be provided in the regulations will apply only to the extent that the amount accelerated is not more than an amount equal to the Federal, state, local and foreign income tax withholding that would have been remitted by an employer if there had been a payment of wages equal to the income includible under Section 457A.

The Notice makes clear that taxpayers may rely on the relief described therein until the regulations are finalized.


[1] All Section references herein are to the Code, unless otherwise noted.

© 2020 Proskauer Rose LLP.

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About this Author

Adam W. Scoll, Tax, Private Investment Funds Attorney, Proskauer, law firm
Senior Counsel

Adam W. Scoll is a senior Associate in the Tax Department and a member of the Private Investment Funds Group. He has been practicing in the field of employee benefits and executive compensation law since 2001.

Adam has provided guidance to clients on a wide variety of matters in the areas of employee benefits and executive compensation, including the investment of plan assets, the implementation of employee benefit plans, employee benefit issues in mergers and acquisitions, the awarding of equity-based compensation, and the negotiation and drafting of employment agreements and...

617-526-9486
Ira G. Bogner, Tax, Employee Benefits, ERISA, Attorney, Proskauer, Law firm
Partner

Ira G. Bogner is Chair of the firm’s Tax Department and a member of the Employee Benefits, Executive Compensation & ERISA Litigation Group.

Ira has provided guidance to clients on a wide variety of matters in the areas of employee benefits and executive compensation, including the investment of plan assets, the implementation of employee benefit plans, employee benefit issues in mergers and acquisitions, the awarding of equity-based compensation, and the negotiation and drafting of employment agreements and severance arrangements.

212-969-3947
Amanda Nussbaum, Tax Attorney, Proskauer Rose Law Firm
Partner

Amanda H. Nussbaum is a Partner in the Tax Department and also is a member of the Private Investment Funds Group. Her practice concentrates on planning for and the structuring of domestic and international private investment funds, including venture capital, buyout, real estate and hedge funds, as well as advising those funds on investment activities and operational issues. She also represents many types of investors, including tax-exempt and non-U.S. investors, with their investments in private investment funds.

212-969-3642