Treasury and IRS Release Long-Awaited Guidance on Deferred Compensation Rules under Code Section 409A — Certain Actions Necessary Before Year-End

On September 29, the Treasury Department and the IRS issued comprehensive proposed guidance for implementing and administering non-qualified deferred compensation plans, which are governed by section 409A of the Internal Revenue Code. Section 409A, added to the Code by the American Jobs Creation Act of 2004, resulted in sweeping changes to the taxation of non-qualified deferred compensation. Section 409A imposes restrictions on deferral elections, distribution elections, distribution events and acceleration of payments. Failure to comply with section 409A will result in immediate taxation of the deferred amounts, an additional penalty of 20%, and the assessment of additional interest.

The newly released proposed regulations incorporate and expand upon the guidance provided under IRS Notice 2005-1 and extend certain key transition deadlines set forth in Notice 2005-1. Specifically, the guidance extends until December 31, 2006 the period for plan sponsors to amend plan documents to conform to the section 409A requirements and for employees to amend their payment distributions (for payments not otherwise payable in 2006). Plan sponsors must continue to operate their plans in good faith compliance with the proposed regulations and Notice 2005-1 until the regulations are finalized.

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