Section 409A spells out when affected ‘service providers’ can postpone paying taxes on deferred compensation
The Internal Revenue Service is asking for public comments about treatment of older split-dollar life insurance arrangements in a draft of new rules for nonqualified deferred compensation plans.
The IRS is developing the rules because the American Jobs Creation Act of 2004 created a new section of the Internal Revenue Code, Section 409A, that spells out when employees, independent contractors and other affected “service providers” can postpone paying taxes on deferred compensation.
“Service providers” who violate Section 409A could end up having to pay interest and a 20% penalty along with the regular income tax due on the compensation that was deferred, according to the text of Section 409A.
What Your Peers Are Reading
The proposed Section 409A regulations and the preamble explaining the regulations fill 238 pages.
The lead author of the preamble to the proposed regulations, Stephen Tackney, is the same IRS tax-exempt official who tried to give taxpayers some idea about how Section 409A would work in December 2004, in IRS Revenue Ruling 2005-1.
The revenue ruling consisted of 38 questions and answers about how Section 409A would work.
The IRS plans to let most parts of the proposed 409A regulations take effect Jan. 1, 2007, but it could start applying some provisions to some taxpayers, such as taxpayers who appear to be acting in bad faith, starting in 2006, Tackney writes.
Section 409A does not apply to 401(k) plans, health plans, paid vacation plans or many other benefit plans. It also does not apply to ordinary bonuses or other deferred compensation if there is a substantial risk that the “service provider” will end up not getting the compensation.
Section 409A does apply to supplemental executive retirement plans, discounted stock options, phantom stock, excess benefit plans, and Section 457(f) plans at government and nonprofit employers.
A 401(k) plan is called a “qualified plan” because it qualifies for special tax breaks as a result of falling under the jurisdiction of the Employee Retirement Income Security Act of 1974.
“Nonqualified plans,” such as phantom stock plans, are not ERISA plans, but, in many cases, members of those plans still can use the plans to defer collecting and paying taxes on a portion of their income.