In the world of nonqualified deferred compensation, there’s a new sheriff in town named 409A. It took a while for this law to make itself clear, but at the end of this coming year, it unquestionably is the law of the land. If employers want to avoid running afoul of the law, the coming weeks are key to reviewing and implementing proper procedures for their deferred compensation plans.

Internal Revenue Code (IRC) 409A became law in 2004, but because of the need for regulations and further clarifications, the Internal Revenue Service provided employers with several compliance extensions. Most of the extensions were set to expire this year. On September 10, 2007, the IRS issued Notice 2007-78, which provided some limited relief.

The basic rules established by this notice were two-fold: (1) The deadline for achieving documentary compliance was extended from December 31, 2007 to December 31, 2008; and (2) eligibility for this extended deadline was limited to those plans that designate in writing prior to January 1, 2008 a compliant time and form of payment for benefits subject to 409A.

Surrendering to significant pressure from the legal community for more time to comply, the IRS issued Notice 2007-86 on October 22, 2007. This notice generally extends the transitional period for compliance with the final regulations to December 31, 2008. The notice also confirms that the U.S. Treasury Department and the IRS expect to issue guidance regarding a correction program as soon as possible.

A day later, the IRS released Notice 2007-89, which provides interim guidance on reporting and wage withholding requirements for calendar year 2007 with respect to deferrals of compensation and amounts includible in gross income under ?409A. For all intents and purposes, employers have until the end of 2008 to bring their nonqualified deferred compensation plans into compliance, and they are exempt from having to report in 2007 the amount of deferrals (that are not subject to tax under section 409A) that occur in 2007. This does not exempt employers from reporting 409A violations; and they obviously still need to report actual deferred compensation payouts.

These notices should not be interpreted as a blanket extension. Consider, for example, the value of deciding what distribution options will be available in the 409A compliant plan this year. If the election is made before the end of 2007, it can affect distribution events that occur in 2008. If companies wait until 2008, the election will only affect events that occur in 2009 and after. Financial advisors can play a key role in assuring that employers know what must (or ought to) be done now and what can wait.

IRC 409A was passed as part of the American Jobs Creation Act in 2004. The more than 4-year delay between the passage of the law and the effective date for compliance is a testament to the complexity of the law and the need for knowledgeable support and advice. Employers need to review their plans, bring them into compliance where needed and move on.

It is important to get the process started now. Even though the IRS extended compliance yet another year, one may assume that their charity will not be extended any further. Chart 1 shows some of the key items the employer needs to address this coming year. In essence, this is the year in which employers can clean up the operation of their nonqualified deferred compensation plans and employees can change their distribution options. Chart 2 shows some of the key items that can wait pending further clarification from the IRS.

Consider this example: Success Corp. has had a voluntary nonqualified deferred compensation plan since 2000. The company has been following the rules under IRC 409A in good faith in the past two years, but it has not brought its actual nonqualified deferred compensation plan document into compliance.

In the coming year, Success Corp. must take several steps. First, the company should review its overall plan to determine if it is accomplishing the company’s goals. The transition rules are complex, so it is vital that the company work with qualified counsel in determining how the rules specifically apply to the firm.

The company’s plan document has a haircut provision (which is no longer allowed for benefits subject to 409A), yet the provision doesn’t leverage some of the distribution options that are available under 409A, such as change of control. This is the year in which the company should decide on distribution changes required by the law as well as distribution options that should be added.

The company should also consider the advantages and disadvantages of running its plans as two plans (one that is grandfathered under 409A and one that is subject to 409A) or as one new plan compliant with 409A. Once the employer determines how it wants the plan to work in light of IRC 409A, it should notify plan participants of their distribution options.

Participants in a nonqualified deferred compensation plan can change their distribution selections in 2008 to match their long-term personal financial goals. Since 409A has very strict anti-acceleration provisions, it is important that the participant consider how the account should be distributed.

Say, for example, Sheila has $100,000 in deferred compensation. She may want this compensation distributed in a lump sum if she dies or if she leaves Success Corp before age 60; however, Sheila wants a 10-year payout if she retires at age 60 or after. Assuming the plan will allow these distribution options, she needs to make these elections during the open compliance period established by IRS Notice 2007-86. This is somewhat akin to an open enrollment period for deferred compensation plans, and the period is over after December 31, 2008.

Success Corp’s plan is a somewhat vanilla deferred compensation plan. 409A, its regulations, and the various notices deal with other issues that may affect more complex plans. For example, some plans link distribution options to the company’s qualified plan. This raises new issues the company and its advisors must consider. Each plan needs individual review.

With the extension of a year for compliance, it is tempting to assume that there is significant time to work on the plan, its design and its documentation. This could be a costly mistake. If the company delays working on its plan and does not make the necessary changes by the compliance date, the plan could be found to be out of compliance, causing the participants to be subjected to very steep tax penalties.

Further, the participants will be bound to distribution decisions that no longer fit their financial goals. In contrast, by making the key decisions and taking the appropriate steps in a timely fashion, Success Corp can have a deferred compensation plan that continues to meet its needs; and the firm’s participants can be happy with a plan that helps to reward and retain them. In fact, it may be best to encourage clients to get all the plan design decisions made before the end of 2007, and then operate their plan in good faith compliance with the final regulations starting on January 1, 2008.

The good news is the IRS has provided additional time to bring deferred compensation plans into compliance. This news, however, must be tempered with an understanding that further extensions are highly unlikely and it will take time to comply. The time to start the process is now!

Steve Parrish, JD, CLU, ChFC, RHU, is a national advanced solutions consultant of Principal Financial Group, Des Moines, Iowa. He can be reached at .