The IRS has commenced a compliance initiative project (“CIP”) aimed at nonqualified deferred compensation arrangements subject to Section 409A of the Internal Revenue Code (“409A”). Although the project scope is limited, employers with arrangements that may be subject to 409A should take this regulatory action as a prompting to review their arrangements and make any corrections needed to ensure compliance with the law.
409A Audit Project. The IRS project was announced unofficially on May 9, 2014 and will involve limited-scope audits of nonqualified deferred compensation arrangements of no more than fifty employers. These employers have already been selected for the CIP from an existing population of employers that are undergoing employment tax audits based, in part, on the likelihood that they maintain 409A arrangements. An IRS official has indicated that these employers were not selected solely for this CIP. These employers will receive Information Document Requests (“IDRs”) from the IRS focusing on three major aspects of 409A compliance:
- Initial deferral elections. Initial elections to defer compensation and fix the time and manner of payment must generally be made before the taxable year in which the compensation is earned, unless an exception applies.
- Subsequent deferral elections. Subsequent elections to change the time or form of payment generally may not accelerate a distribution, and elections to delay a distribution generally may not take effect for 12 months and must delay the distribution for at least 5 years.
- Distributions. Distributions from 409A arrangements generally may only be made upon a specified date, separation from service, death, disability, change in control, or unforeseeable emergency. There may also be a six-month delay on distributions to “specified employees” of public companies.
The IDRs will ask employers to identify their top ten highly compensated individuals and report whether any of these individuals made deferral elections under, or received distributions from, a 409A arrangement during the years under examination in the employment tax audit. The IRS will then review any such elections and distributions for compliance with the above rules. The IRS will use the project to test compliance with 409A, determine whether the IDRs are effective in gathering information and refine its audit techniques, presumably in preparation for larger-scale 409A audits in the future. An IRS official has indicated that the CIP is expected to be completed within 12 months.
Takeaway for Employers. The limited scope of the project means that the vast majority of employers will not be audited just yet. However, signs are clear that IRS agents are “sharpening their pencils” and ramping up enforcement of 409A compliance. Employers should take this opportunity to review their nonqualified deferred compensation arrangements for documentary and operational compliance with 409A and promptly self-correct any violations under IRS correction programs (which are generally no longer available once an IRS audit has commenced).