The release by the Internal Revenue Service and U.S. Treasury Department on April 10 of final regulations respecting the treatment of non-qualified deferred compensation plans has been greeted with broad industry support.
The revised rules, an outgrowth of the American Jobs Creation Act of 2004 and encapsulated in section 409A of the Internal Revenue Code, include provisions that proponents said elucidate proposed regulations unveiled in 2005 and permit greater flexibility in plan design.
In a statement, the American Council of Life Insurers, Washington, said the final regulations and an accompanying notice, 2007-34, respecting the application of Section 409A to split-dollar life insurance arrangements, “provide much needed clarity” on the tax treatment of split-dollar, which the ACLI sought in a previously issued comment letter.
Mark West, director of advanced solutions for Principal Financial Group, Des Moines, Iowa, agreed, adding, “The modifications are in many respects positive and make the practical management of a [deferred compensation] plan simpler or at least more understandable than they were under the proposed regulations.”
The finalized rules, more than 400 pages in length, generally follow the structure of the previously issued proposed regulations but include substantial changes, most of which sources characterized as favorable because they provide additional flexibility in complying with the new rules.
In a statement, the Association for Advanced Life Underwriting, Falls Church, Va., wrote that it is “pleased that Notice 2007-34 did, as we anticipated it would, provide relief for grandfathered split-dollar arrangements by allowing them to be modified to comply with Section 409A without losing grandfathered status under the split-dollar rules. The AALU has been actively pursuing this type of relief for some time.”
With respect to non-grandfathered split-dollar arrangements, the rules provide that death benefit only and collateral assignment-type split-dollar arrangements are generally not subject to 409A, while endorsement method-type split-dollar arrangements may be subject to the rules. The AALU added that it is “pleased that the final 409A regulations designate split-dollar arrangements as a separate category of plans under the plan aggregation rules.”
The final 409A regulations expand the types of commissions that are eligible for a special deferral timing rule; however, the extent to which the modifications would apply to insurance agent renewal commissions remains unclear. The AALU said it is seeking to clarify this issue.
The final regulations also contain modifications and clarifications to rules that apply to stock rights and separation pay plans, which should provide greater flexibility to design such arrangements so they either qualify for an exception or comply with the new rules.
With the retention of the 2008 effective date of final 409A regulations, sources said, plan sponsors may need to do a significant amount of work to bring their plans into compliance by the end of 2007. Executives will, for example, have to make their deferral elections for 2008, and organizations must prepare documentation about deferred comp plans for plan participants.
“It will be hard to write plan documents at the same time you’re doing deferral elections,” said West. “So while the plan document has to be prepared in 8 1/2 months, the reality is that you’ll want to get all the paperwork done in the next 4 to 5 months.”
The AALU described the plan documentation requirements as “relatively reasonable.” The final regulations indicate that plan operations before Jan. 1, 2008, do not necessarily need to be reflected in the plan documents; however, plan sponsors must be able to demonstrate that the plan operations prior to 2008 complied with the transition rules.
The final regulations do not address the calculation and timing of amounts required to be included in income under Section 409A or the reporting or withholding requirements. A spokesperson for the IRS indicated these issues will be addressed in future guidance and that additional transitional relief may be provided.
“Some things remain unanswered, but companies that were waiting to see whether the final regulations remained consistent with the proposed regs now have the benefit of added clarity,” said West. “The Treasury and IRS were responsive to industry suggestions while remaining true to the intent of the 409A legislation. And having these finalized regulations will help in the sales process.”