IRS Starts Interpreting New Deferred Comp Law

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The Internal Revenue Service has published its first batch of guidance for taxpayers who are trying to comply with the new Internal Revenue Code Section 409A. The section sets complicated new rules for determining when taxpayers can and cannot defer certain types of compensation from taxable income.

Congress included the section when it approved the American Jobs Creation Act of 2004.

The IRS is emphasizing that the first round of guidance, which includes answers to 38 questions, is just the start of its effort to interpret and implement IRC Section 409A.

“The Treasury Department and the Internal Revenue Serviceintend to incorporate the principles of this notice into additional, more comprehensive guidance in 2005,” writes Stephen Tackney, an IRS tax-exempt entities specialist, in IRS Revenue Ruling 2005-1.

Tackney warns taxpayers against basing Section 409A positions on unrealistic expectations about what the IRS might decide in 2005.

When, for example, a taxpayer deals with questions about when a “service recipient” can accelerate payments due under a compensation plan subject to Section 409A, “a taxpayer position based on an expected exception that the taxpayer speculates that the Treasury Department and the [IRS] will adopt in future guidance is not a good faith, reasonable interpretation of the statutory language,” Tackney writes.

He emphasizes that Section 409A does not apply to ordinary employee benefit plans, such as retirement plans that qualify for special tax treatment, health plans, vacation or sick leave programs, disability plans or death benefit plans.

Section 409A also does not apply to bonus plans or other incentive plans designed so that there is a good chance that the “service provider” might lose out on the payment.

But Tackney says Section 409A may apply in situations when the service provider is not an employee of the service recipient.

The section also might apply even if the size of the expected payment could fluctuate due to factors such as the performance of the stock market or the exercise of a contract provision that might let the employer or other service recipient cancel the payment under certain circumstances.

Taxpayers who violate Section 409A could end up having to pay income taxes, interest and an extra 20% tax on the income that was incorrectly excluded from current-year income, Tackney says.


Reproduced from National Underwriter Edition, December 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.