IRS Announces New Program to Audit 409A Compliance
SUMMARY: The IRS is getting ready to ramp up enforcement of Section 409A (§409A) compliance with respect to non-qualified deferred compensation arrangements. This new compliance initiative project (“CIP”) for §409A will focus on fifty large companies. However, this foreshadows a much broader §409A enforcement initiative.
The Service plans to issue Information Document Requests (“IDRs”) to about 50 large employers. These initial IDRs will request documents regarding deferred compensation elections and payouts. The IRS informally indicated that these would focus on three issues: 1) initial deferral elections, 2) subsequent changes in deferral elections and, 3) timing of payouts. Requested data will initially be limited to the top 10 highest paid employees in each company. Information gained from the first 50 audits will be used by the IRS to target future §409A audit and enforcement activity.
FACTS: As a reminder, §409A governs the tax treatment of non-qualified deferred compensation and retirement plans which are often funded by corporate owned life insurance. However, the rules of §409A have been broadly interpreted by regulations to impact almost every type of compensation arrangement including employment, severance and change in control agreements, short- and long-term equity, incentive and bonus plans and other contingent compensation arrangements.
On May 9 of this year, an IRS attorney informed the American Bar Association Taxation Section that the IRS is beginning a CIP focused on §409A compliance. The recently announced CIP is quite narrow (50 large employers; 10 highest paid employees at each) but is intended as the first phase of a much larger §409A enforcement initiative.
§409A is complicated, confusing and often ambiguous. Many employers had hoped that the IRS would issue clearer guidance before beginning broad enforcement initiatives. §409A creates special complications, because actions of the employer can cause large tax liabilities for its employees—often key executives. Employer noncompliance in both documentation and administration can lead to harsh results for employees. These include accelerated taxes and excise taxes (generally full, immediate income inclusion, a 20% additional federal tax and interest during the deferral period of all vested amounts; and, sometimes, additional state tax liability.) It is not yet clear how the IRS might use information from the planned employer audits to assert claims against employees.
RELEVANCE: We do not yet know the scope of the IDRs planned under the newly announced CIP. The IRS previously released draft §409A IDRs that require employers to provide detailed information regarding deferred compensation, plans, payments made and deferral elections. Prior draft IDRs also required employers to take legal positions on whether particular arrangements were covered by §409A, and to identify any violations of §409A. This requires key tactical decisions to be made very early in the audit process. Employers being audited need to be very careful regarding the information provided and the legal positions taken to avoid generating tax liability for their employees.
The IRS has issued a corrections procedure which allows for less harsh treatment when documentary or administrative errors are self-discovered and voluntarily disclosed. However, taxpayers are generally ineligible for this program if the issues are disclosed after an audit begins. Therefore, this is a good opportunity for employers, both large and small, to make sure all of their compensation arrangements are in compliance with §409A.
§409A compliance of our clients’ non-qualified deferred compensation plans (NQDCP) are of the upmost importance to Mezrah Consulting. However, please contact Mezrah Consulting if you have any questions regarding the §409A compliance of your NQDCP. We will continue to keep you updated regarding the IRS’ enforcement of §409A. Your business and confidence are appreciated.
Source: AALU (Ended 2020) & Marla Aspinwall of Loeb & Loeb, LLP.
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Mezrah Consulting, based in Tampa, Florida, is a national executive benefits and compensation consulting firm specializing in plans for sizable publicly traded and privately held companies. For more than 30 years, we have focused on the design, funding, implementation, securitization and administration of nonqualified executive benefit programs, and have advised more than 300 companies throughout the U.S.
As a knowledge-based and strategy-driven company, we offer clients highly creative
and innovative solutions by uncovering value and recognizing risks that other firms typically do not see. Custom nonqualified benefit plans are administered through our affiliate mapbenefits®, a proprietary cloud-based plan technology platform that provides enterprise plan administration for nonqualified plans, including reporting and functionality for plan participants and plan sponsors.
