4119 / What requirements apply to a 501(c)(9) trust ("VEBA") that provides severance pay arrangements?
IRC Section 409A creates requirements governing whether and when employees are to be taxed on deferred compensation. Under the general rule, if a nonqualified deferred compensation plan fails to meet certain requirements regarding distributions, acceleration of benefits, and interest on tax liability payments (Q 3541) or is not operated in accordance with such requirements, all compensation deferred under the plan for the taxable year and all preceding taxable years is includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income.1
Plans providing for severance pay, or for separation pay, as it officially is labeled by the IRS, are not excluded from the definition of nonqualified deferred compensation plan (unlike bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefits).2
Final 409A regulations state that a separation pay plan does not provide for a deferral of compensation to the extent the plan is:
(1) a collectively bargained separation pay plan;
(2) separation pay due to an involuntary separation from service or participation in a window program;
(3) a foreign separation pay plan; or
(4) a reimbursement or certain other separation payments.3
A plan that provides separation pay only due to an involuntary separation does not provide for a deferral of compensation under 409A if the plan meets the following requirements:
(1) The separation pay does not exceed two times the lesser of (x) the sum of the employee's annualized compensation based on the annual pay rate for services provided to the employer for the taxable year preceding the taxable year in which the employee had a separation from service, or (y) the maximum amount that may be taken into account under a qualified plan under IRC Section 401(a)(17) ($360,000 in 2026) for the year in which the employee had a separation from service.4
(2) The plan provides that the separation pay must be paid no later than the last day of the second taxable year following the taxable year in which the separation from service occurred.5
A window program is a program established by an employer, in connection with an impending separation from service, to provide separation pay where it is made available by the employer for a limited period of time (no longer than 12 months) to employees who separate from service during that period or to service providers who separate from service during the period under specified circumstances.6
Final regulations became effective April 17, 2007, with transition relief extended to December 31, 2008.7 For further explanation of IRC Section 409A, see Q 3541.
1. IRC § 409A(a)(1).
2. IRC § 409A(d). See also Treas. Reg. §§ 1.409A-1(a)(5), 1.409A-1(b)(9)(i).
3. Treas. Reg. §§ 1.409A-1(b)(9)(ii), 1.409A-1(b)(9)(iii), 1.409A-1(b)(9)(iv), 1.409A-1(b)(9)(v). See also Treas. Reg. §§ 1.409A-1(m), 1.409A-1(n).
4. Notice 2025-67.
5. Treas. Reg. § 1.409A-1(b)(9)(iii).
6. Treas. Reg. § 1.409A-1(b)(9)(vi).
7. Notice 2007-86, 2007-46 IRB 990.