3544 / What are the minimum plan documentation requirements for a private nonqualified deferred compensation plan under IRC Section 409A?
As to Section 409A:
1. The plan must be in writing, but there are no IRS prototype plans available as is the case for qualified plans. In effect, a plan is in violation of Section 409A if it is a covered arrangement but not in writing. However, the plan may be in more than one document, such as a plan and joinder agreement. The IRS will currently not issue letter rulings in regard to 409A.1
This also suggests that plans claiming exception from 409A ought to be in writing to make the exception from coverage clear if audited. There are indications that the IRS auditors are asking for an identification of those plans that are covered and those claiming a 409A coverage exception to include the relevant exception and justification in pre-audit requests.2
2. The plan must state either the amount of the deferred compensation or the method for calculating the amount and the plan also must state the time and form of payment distribution, which would include:
a. all of the Section 409A rules for elections (and appropriate timing) to defer on salary, commissions, performance-based compensation bonuses, and nonperformance-based compensation bonuses, and newly eligible participants as applicable (see Q 3545 and Q 3546); and
b. all of the Section 409A permissible distributions, “earlier of” sequencing, and a prohibition against all other non-Section 409A distributions and accelerations (see Q 3547).
3. The plan must contain all the unique definitions (e.g., “separation from service”) and key terminology (e.g., “leave of absence”) from Section 409A that apply to the plan, including the special plan termination rules.
4. The plan should contain a “Section 409A interpretation clause” defining undefined, ambiguous, or missing plan definitions and other language consistent with Section 409A.
5. The plan should include the Section 409A compliant timing for distribution following a permissible distribution event.
6. The plan should state the inclusion or prohibition of permitted Section 409A acceleration events (e.g., domestic relations orders).
7. The plan should state the requirements for a voluntary plan termination by the employer.
8. The plan should include an indemnification provision that either accepts or refuses the responsibility of the employer for any Section 409A violations and the adverse tax consequences that may result.
9. The plan should state whether it will allow subsequent elections and whether a series of installment payments shall be treated as a single distribution or a series of individual distributions for purposes of the plan, and subsequent elections to extend deferral.
10. The plan should include a provision for a delay of the payment start date for six calendar months when there is a separation from service of “specified employees,” including the desired optional “catch-up” treatment (the provision is required if the plan is sponsored by a publicly-traded company; the provision is conditional (or unnecessary) if the sponsor is a closely-held company or tax-exempt organization).
11. The plan should include a prohibition provision against crediting interest on any participant accounts during any period that the plan sponsor is not in compliance with the minimum funding requirements for any qualified defined benefit pension plan.
12. The plan optionally may include a provision for:
a. the very limited Section 409A right of the employer to offset participant liabilities to the employer against a participant’s account, unless extended in the normal course of business as outlined in Section 409A, which should be clearly documented if this very narrow exception to the rule will be relied upon;
b. accelerated cash-outs for certain allowed small amounts (those amounts less than the annual 402(g)(1)(b) amount) upon a separation from service; and
c. automatic cancellation of a participant’s deferral election for the balance of the plan year upon a request for an “unforeseeable emergency” request.
As to continuing prior law:
1. The plan should contain a provision in which the employer contractually agrees to pay deferred amounts at a future date as additional compensation, or employees contractually voluntarily agree with the employer to reduce current salary.3
2. The plan must provide that participants only have the status of general unsecured creditors of the employer in bankruptcy and that the plan constitutes mere promise-to-pay benefits by the employer in the future.
3. The plan also should state that it is the intention of the parties that it be unfunded for tax (and ERISA) purposes.
4. The plan should prohibit and void the anticipatory assignment of the benefits by a participating employee.
5. The plan should include any provisions necessary to designate and comply with controlling state law requirements.
1. Rev. Proc. 2019-3.
2. During early audits, several counsel shared pre-audit IRS written requests online at various tax blogs in the past several years, and generally suggested the wisdom of a written plans, even if claiming an exception to 409A coverage. This remains good advice to document the claimed exception for the sponsor and for the IRS in case of an audit of all its various plans.
3. Rev. Rul. 69-650, 1969-2 CB 106.