Client Memorandum. HR Law: Employee Benefits January 2005

Transcription

1 Client Memorandum HR Law: Employee Benefits January 2005 Interpretations with Respect to 457(f) Plans: IRS Guidance Issued Under Code Section 409A Affecting Nonqualified Deferred Compensation Plans Overview: With the release of IRS Notice , nonqualified deferred compensation plan sponsors have the first set of guidance regarding amendments needed to comply with new Code Section 409A. Actions to Take: Plan sponsors should be consulting with their nonqualified deferred compensation plan advisors and reviewing their plans to identify the relevant sections of their plans that will need to be amended. On December 20, 2004, the Internal Revenue Service (the IRS ) issued Notice as the initial tranche of guidance with respect to new Section 409A of the Internal Revenue Code of 1986, as amended (the Code ). The IRS has indicated that it anticipates issuing at least two more tranches during the first half of 2005 (with one specifically providing additional guidance on distribution provisions). According to IRS Notice , taxpayers should note that although Code Section 409A makes a number of fundamental changes, it does not alter or affect the application of any other provision of the Code or common law tax doctrine (in particular, Code Section 457(f)). In other words, deferred compensation not required to be included in income under Code Section 409A may nevertheless be required to be included in income pursuant to the constructive receipt, the cash equivalency, the economic benefit or the assignment of income doctrines. As such, deferred compensation will be taxed at the earliest point in time during which any of these provisions applies. Code Section 409A is generally effective with respect to (i) amounts deferred in taxable years beginning after December 31, 2004, (ii) amounts deferred in taxable years beginning before January 1, 2005 if the plan under which the deferral is made is materially modified after October 3, 2004, and (iii) amounts deferred in taxable years beginning before January 1, 2005, which are unvested as of December 31, Code Section 409A is effective with respect to earnings on amounts deferred only to the extent that Code Section 409A is effective with respect to amounts deferred. Tax-exempt employers need to be aware that Code Section 409A does not mesh perfectly with Code Section 457(f). The Tax-Exempt Practice Group of the HR Law Department of Gardner Carton & Douglas LLP (the Tax-Exempt Practice Group ) believes a key issue, based on informal comments by senior Treasury Department representatives, is that what is or is not a substantial risk of forfeiture for Code Section 409A does not necessarily impact whether a particular structure is or is not a substantial risk of forfeiture for Code Section 457(f). In fact, it appears that certain substantial risk of forfeitures are intended to continue operate as such under Code Section 457(f) with no interference from Code Section 409A. There are clearly questions left to be answered by the Treasury Department as to how certain Code Section 409A provisions should be layered over or applied at the same time as Code Section 457(f) provisions. The Tax- Exempt Practice Group has prepared a number of questions for the Treasury Department regarding inconsistencies and holes in the Code Section 409A guidance for tax-exempt employers with Code Section 457(f) plans. As the Tax-Exempt Practice Group obtains resolution of various Code Section 409A/457(f) issues, the Tax-Exempt Practice Group will share that information with our clients and friends as soon as possible. The following chart outlines the key aspects of the guidance provided under Notice * * * * * If you have any questions concerning the issues highlighted in this client memorandum, please contact: Mary K. Samsa msamsa@gcd.com (312) Joyce L. Meyer jmeyer@gcd.com (312) Dave L. Wolfe dwolfe@gcd.com (312)

2 Definition of nonqualified deferred compensation plan Definition of service recipient A nonqualified deferred compensation plan is any plan that provides for the deferral of compensation other than: tax-qualified plans (as described in Code Sections 401(a) (with a Section 501(a) trust), 403(a), 403(b), 408(k) or 408(p)); a bona fide vacation leave, sick leave, compensatory time, disability pay or death benefit plan; any eligible Code Section 457(b) arrangement; Code Section 415(m) excess benefit arrangements for governmental entities; and Archer Medical Savings Accounts, Health Savings Accounts or any other medical reimbursement arrangements. NOTE: Application of Code Section 409A is not limited to arrangements between an employer and an employee. Code Section 409A also may apply to arrangements between a service recipient and an independent contractor and arrangements between a partner and partnership. The service recipient is: the person for whom services are performed; and all persons with whom such person would be considered a single employer under Code Section 414(b) (controlled group of corporations) or Code Section 414(c) (partnerships, proprietorships, etc., which are under common control). Code Section 409A does apply to: Code Section 451 plans (including deferral arrangements contained in individual employment agreements); Code Section 457(f) arrangements for tax-exempt and governmental entities (including deferral arrangements contained in individual employment agreements); Stock Options in which the exercise price was less than fair market value ( FMV ) on the date of grant; Stock Appreciation Rights (SARs) in which the exercise price was less than FMV on the date of grant; Phantom Stock Plans to the extent they provide a deferral of compensation; Restricted Stock Units to the extent they provide a deferral of compensation; Supplemental Executive Retirement Plans (SERPs) (whether defined benefit or defined contribution types) that restore amounts to participants to which they are otherwise limited under tax-qualified retirement plans by application of IRS statutory limits (potentially including those that are nonelective); and Any other arrangement that includes a deferral of income feature. NOTE: Code Section 409A does not apply to Code Section 423 plans, incentive stock options subject to Code Section 422, or nonqualified stock options with an exercise price of at least FMV on the date of grant. Controlled group rules apply in determining who is the service recipient. 2

3 Definition of a service provider Until the IRS issues further guidance, a service provider for purposes of Code Section 409A includes: an individual; a personal service corporation (as defined in Code Section 269A(b)(1)); a noncorporate entity that would be a personal service corporation if it were a corporation; a qualified personal service corporation (as defined in Code Section 448(d)(2)); or a noncorporate entity that would be a qualified personal service corporation if it were a corporation. Code Section 409A does not apply to arrangements between taxpayers in which all of the taxpayers use the accrual method of accounting. Code Section 409A does not apply to arrangements between a service provider and a service recipient if: the service provider is actively engaged in the trade or business of providing substantial services, other than as an employee or as a director of a corporation; and the service provider provides such services to two or more service recipients to whom the service provider is not related and who are not related to one another. The Treasury Department and the IRS intend to issue additional guidance addressing types of service providers not subject to Code Section 409A. 3

4 What constitutes a plan? Application of aggregation rules A plan includes any agreement, method or arrangement, including an agreement, method or arrangement that applies to only one person or individual. Whether or not the plan is governed by ERISA is irrelevant for Code Section 409A purposes. Code Section 409A is applied as if: a separate plan or plans is/are maintained for each service provider; all compensation deferred with respect to a particular service provider under an account balance plan (as defined in Code Regulation Section (v)(2)- 1(c)(1)(ii)(A)) is treated as deferred under a single plan; all compensation deferred with respect to a particular service provider under a nonaccount balance plan (as defined in Code Regulation Section (v)(2)- 1(c)(2)(i)) is treated as deferred under a separate single plan; and all compensation deferred with respect to a particular service provider under a plan, which is neither an account balance plan nor nonaccount balance plan is treated as deferred under a separate single plan. A severance plan is either an account balance plan or a nonaccount balance plan, depending on how the benefits are calculated. A plan may be adopted unilaterally by the service recipient (such as a defined benefit SERP) or may be negotiated among or agreed to by the service recipient and one or more service providers (such as a Code Section 457(f) deferred compensation plan). Account Balance Plan: Refers to a plan in which the amounts deferred for a period equal the principal amount credited to the employee s account for the period, increased or decreased by any income attributable to the principal amount through the date such amounts constitute wages. Nonaccount Balance Plan: Refers to a plan in which the amounts deferred for a period equal the present value of the additional future payment or payments to which the employee has obtained a legally binding right under the plan during that period (such as a defined benefit SERP). Other: Refers to a plan in which the amounts deferred for a period relate to items such as discounted stock options, SARs or other equitybased compensation. 4

5 What constitutes a deferral of compensation? A plan provides for the deferral of compensation only if, under the terms of the plan and based on the facts and circumstances: the service provider has a legally binding right during a taxable year to the compensation; the compensation has not been actually or constructively received and included in gross income; and under the terms of the plan, the compensation will be payable to the service provider in a later year. The term deferral of compensation includes any reference to income (whether actual or notional) attributable to such compensation or such income. Property received by a service provider from a plan maintained by a service recipient does not constitute a deferral of compensation merely because such property: is not includible in income (under Code Section 83) in the year of receipt because the property is nontransferable and subject to a substantial risk of forfeiture; or is includible in income solely due to a valid Code Section 83(b) election. A plan under which a service provider obtains a legally binding right to receive property (whether or not the property is restricted property) in a future year may provide for the deferral of compensation and, thus, may constitute a nonqualified deferred compensation plan. There is no deferral of compensation when: the compensation may be unilaterally reduced or eliminated by the service recipient after the services creating the right to the compensation have been performed; the compensation is merely paid after the last day of the service provider s taxable year, pursuant to the timing arrangements under which the service recipient normally compensates service providers for services performed during a payroll period (e.g., year-end bonus); and absent an election to otherwise defer the payment to a later period, at all times, the terms of the plan require payment by, and an amount is actually or constructively received by the service provider by, the later of: v the date that is 2½ months from the end of the service provider s first taxable year in which the amount is no longer subject to a substantial risk of forfeiture; or v the date that is 2½ months from the end of the service recipient s first taxable year in which the amount is no longer subject to a substantial risk of forfeiture. 5

6 What constitutes a substantial risk of forfeiture? Compensation is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial. A condition related to a purpose of the compensation must relate to the service provider s performance for the service recipient or the service recipient s business activities or organizational goals (e.g., the attainment of a prescribed level of earnings, equity value or a liquidity event). Any addition of a substantial risk of forfeiture after the beginning of the service period to which the compensation relates, extension of a period during which compensation is subject to a substantial risk of forfeiture, in either case whether elected by the service provider, the service recipient or other person, is disregarded for purposes of determining whether such compensation is subject to a substantial risk of forfeiture. An amount is not subject to a substantial risk of forfeiture merely because the right to the amount is conditioned, directly or indirectly, upon the refraining from performance of services. An amount will not be considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the amount subject to a substantial risk of forfeiture (ignoring earnings) is materially greater than the amount the recipient otherwise could have elected to receive. NOTE: Treasury Department representatives have stated that Code Section 409A vesting does not equate to taxability to the participant. NOTE: The IRS expressly provides that it will evaluate whether the possibility of forfeiture is substantial in the case of rights to compensation granted to a service provider by the service recipient corporation, in which the service provider owns a significant amount of the total combined voting power or value of all classes of stock of the service recipient corporation or of its parent corporation (as compared to that held by all other stockholders). In other words, if the service provider effectively has control of the service recipient, a substantial risk of forfeiture will not be found. Extension of a period during which compensation is subject to a substantial risk of forfeiture is the rolling vesting concept used under Code Section 457(f) plans. As such rolling vesting will not constitute a substantial risk of forfeiture for Code Section 409A purposes (although it may still qualify as such for Code Section 457(f) purposes). Additionally, Code Section 457(f) will govern taxation of deferred amounts. Conditioning forfeiture on whether a person refrains from performance of services relates to the use of a noncompete concept. As such, noncompetes will not constitute a substantial risk of forfeiture for Code Section 409A purposes (although they may still qualify as such for Code Section 457(f) purposes). Additionally, Code Section 457(f) will govern taxation of deferred amounts. Notice provides that salary deferrals, generally, may not be made subject to a substantial risk of forfeiture (e.g., more is needed than just the deferral itself), although the basis for this rule is unclear where payment of the amount is at risk. This provision is likely to be the subject of taxpayer comments. 6

7 Acceleration of payment is permitted upon a Change in Control. What constitutes a Change in Control? A plan may permit a payment upon the occurrence of: a change in the ownership of the corporation, generally occurs when any one person (or more than one person acting as a group) acquires ownership of corporate stock constituting more than 50% of the total fair market value or total voting power of stock of such corporation; a change in effective control of the corporation, generally occurs when any one person (or more than one person acting as a group) acquires (during the 12-month period ending on the date of the most recent acquisition by such person) ownership of corporate stock constituting 35% or more of the total voting power of stock of such corporation, or when a majority of the board of directors is replaced during a 12-month period and such new appointments are not supported by a majority of the members of the current board; or a change in the ownership of a substantial portion of the assets of the corporation, generally occurs when any one person (or more than one person acting as a group) acquires (during the 12-month period ending on the date of the most recent acquisition by such person) assets from the corporation that have a gross fair market value of at least 40% of the total gross fair market value of all assets of such corporation immediately prior to such acquisitions. To qualify as a Change in Control, the occurrence of the events listed above must be objectively determinable, and any requirement that any other person, such as a plan administrator or board of directors compensation committee, certifies the occurrence of the Change in Control must be strictly ministerial and not involve any discretionary authority. A payment will be treated as occurring upon a Change in Control event if the right to the payment arises due to the corporation s exercise of discretion under the terms of the plan to terminate the plan and distribute the compensation deferred thereunder within 12 months of the Change in Control event. A plan may provide for payment on any Change in Control event, but need not provide for payment on all such events. NOTE: The rules pertaining to Changes in Control are very complicated with specific nuances. A full analysis of these rules is beyond the scope of this summary. Consequently, please consult your legal advisor regarding the full application of these new rules to your independent fact situation. NOTE: By providing discretion to corporations to terminate a plan within 12 months following a Change in Control, the IRS has given corporations flexibility in making decisions as to whether to retain nonqualified deferred compensation plans after such events rather than making those key decisions ahead of time (or predetermining this and building it into plan documents). 7

8 CONTINUED: Acceleration of payment is permitted upon a Change in Control. What constitutes a Change in Control? In general, a Change in Control event must relate to: the corporation for whom the participant is performing services at the time of the Change in Control event; the corporation that is liable for the payment of the deferred compensation (or all corporations liable, if more than one); or a majority shareholder of one of the two above categories (or any corporation in a chain in which each corporation is a majority shareholder of another corporation in the chain ending in a corporation of one of the two above categories). When determining whether a Change in Control has occurred, the attribution rules of Code Section 318(a) apply. NOTE: The rules pertaining to Changes in Control are currently drafted from a corporate standpoint. Informal comments made by Treasury Department representatives indicate that taxpayers cannot, by analogy, apply these rules to Limited Liability Companies, Partnerships or Tax-Exempt Entities. It is currently unclear whether a Tax-Exempt Entity could use the new controlled group rules (based on board control) provided for in the proposed Code Section 403(b) regulations for making any such Change in Control determinations. NOTE: The rules pertaining to Changes in Control are very complicated with specific nuances. A full analysis of these rules is beyond the scope of this summary. Consequently, please consult your legal advisor regarding the full application of these new rules to your independent fact situation. 8

9 Acceleration of payments A plan may not permit the acceleration of the time or schedule of any payment under the plan unless: the service recipient waives or accelerates the satisfaction of a condition constituting a substantial risk of forfeiture applicable to such deferral of compensation (provided the requirements of Code Section 409A are otherwise satisfied); the payment is made to an individual other than the plan participant to satisfy a domestic relations order (as defined in Code Section 414(p)(1)(B)); the payment is required to comply with a certificate of divestiture (as defined in Code Section 1043(b)(2)); the plan is also subject to Code Section 457(f) and payment is needed by the individual to pay income taxes due upon a vesting event (assuming the amount is no more than an amount equal to the income tax withholding required to be remitted); the plan provides for cashout of de minimis payments to participants, so long as: v the payment completely terminates the participant s interest in the plan; v the payment is made on or before the later of December 31 of the calendar year of the participant s separation from service or the date 2½ months after the participant s separation from service; and v the payment is not greater than $10,000; or the payment is required to pay FICA tax imposed under Code Sections 3101 and 3121(v)(2) on compensation deferred under the plan. NOTE: Treasury Department representatives have stated that providing for payment under a plan upon the earlier of various events (such as death, disability or retirement) would not be an impermissible acceleration of payment under Code Section 409A. The requirement under Code Section 409A to apply the aggregation rules (to all account balance plans and to all nonaccount balance plans) does not apply when providing for the acceleration of payments. As such, any acceleration provision would be applied plan by plan. Plans may be amended to provide for de minimis cashout payments not only prospectively but also with respect to previously deferred amounts. v Determination of whether an amount is de minimis is made at the time the amounts are payable. The Treasury Department and IRS will issue guidance on whether payments under a plan upon the later of various events are permissible or not. 9

10 Effective date of deferral Determining amounts considered to be deferred compensation prior to January 1, 2005 An amount is considered deferred before January 1, 2005 if: the service provider has a legally binding right to be paid the amount; and the right to the amount is earned and vested. A right to an amount is earned and vested only if the amount is not subject to a substantial risk of forfeiture or a requirement to perform further services. Nonaccount Balance Plans: The amount of compensation deferred before January 1, 2005 equals the present value as of December 31, 2004 of the amount to which the participant would be entitled under the plan if the participant voluntarily terminated service without cause on December 31, 2004 and received full payment of benefits from the plan on the earliest date possible under the plan following termination of service (to the extent the benefit is earned and vested as of December 31, 2004). Account Balance Plans: The amount of compensation deferred before January 1, 2005 equals the portion of the participant s account balance as of December 31, 2004, which is earned and vested. Earnings: Earnings on amounts deferred under a plan before January 1, 2005 include only income (whether actual or notional) attributable to the amounts deferred under a plan as of December 31, 2004 or such income. Amounts to which the service provider does not have a legally binding right before January 1, 2005 (e.g., because the service recipient retains discretion to reduce the amount) will not be considered deferred before January 1, Amounts to which the service provider has a legally binding right before January 1, 2005, but the right is subject to a substantial risk of forfeiture or a requirement to perform further services after December 31, 2004, are not considered deferred before January 1, 2005 (and therefore are subject to Code Section 409A). NOTE: For Code Section 409A purposes, rolling vesting and covenants not to compete (which are used under Code Section 457(f) plans) do not constitute substantial risks of forfeitures. Treasury Department representatives have informally stated that Code Section 457(f) plans are not grandfathered for purposes of Code Section 409A (mainly because vesting will be determined in accordance with Code Section 83(b)). For present value purposes, the actuarial assumptions under the plan are used to the extent they are reasonable; otherwise, reasonable actuarial assumptions must be used. Additionally, the requirement under Code Section 409A to apply the aggregation rules (to all account balance plans and to all nonaccount balance plans) does not apply to nonaccount balance plans when applying actuarial assumptions. Earnings on amounts deferred under a plan before January 1, 2005 include: notional interest earned on amounts deferred in an account balance plan as of December 31, 2004; and for a nonaccount balance plan, any increase, due solely to the passage of time, in the present value of future payments to which the service provider has obtained a legally binding right, over the present value of such amounts before January 1,

11 When is a plan materially modified? CONTINUED When is a plan materially modified? A plan is materially modified if a benefit or right existing as of October 3, 2004 is enhanced or a new benefit or right is added. A benefit enhancement or addition is a material modification whether it occurs pursuant to an amendment to the plan or the service recipient s exercise of discretion under the terms of the plan. The amendment of a plan to bring the plan into compliance with the provisions of Code Section 409A will not be treated as a material modification. The adoption of a new arrangement (such as a new plan document) or the grant of an additional benefit under an existing arrangement after October 3, 2004 is presumed to constitute a material modification. This presumption is rebuttable by demonstration that the adoption of the arrangement or new grant is consistent with the service recipient s historical compensation practices. Grant of an additional benefit under an existing arrangement that consists solely of the deferral of additional compensation not otherwise provided under the plan as of October 3, 2004, will be a material modification of the plan only as to the additional deferred compensation. Amending an arrangement to: stop future deferrals under the plan; or terminate the arrangement and distribute the amounts of deferred compensation (for inclusion in taxable income in the year of termination of the plan) is not a material modification of the plan. It is not a material modification for a participant to exercise a right permitted under the plan as in effect on October 3, It is not a material modification for a service recipient to exercise discretion over the time and manner of payment of a benefit to the extent such discretion is provided under the terms of the plan as of October 3, NOTE: Nonqualified deferred compensation plans that have a haircut provision in effect as of October 3, 2004, can, under the new guidance, still permit participants to exercise that right with respect to grandfathered pre-january 1, 2005 deferrals (plus earnings). Also, plans that allow participants to elect or change the form of distribution up to 12 months prior to retirement will be able to continue that practice on grandfathered deferrals (plus accumulated earnings). The requirement under Code Section 409A to apply the aggregation rules (to all account balance plans and to all nonaccount balance plans) does not apply when analyzing whether a material modification has occurred. As such, any material modification would be analyzed plan by plan. The amendment or exercise of discretion under the terms of a plan that enhances an existing benefit or right or adds a new benefit or right will be considered a material modification even if the enhanced or added benefit would be permitted under Code Section 409A. The reduction of an existing benefit is not a material modification. The adoption of a new plan subject to Code Section 409A will not constitute a material modification. The freezing of an existing plan which is not subject to Code Section 409A will not constitute a material modification. Additionally, any amendment to terminate a plan and distribute the deferred compensation must occur on or before December 31,

12 Good faith compliance with Code Section 409A on and after January 1, 2005 A plan will not be treated as violating Code Section 409A only if: the plan is operated in good faith compliance with the provisions of Code Section 409A and IRS Notice during the calendar year 2005; and the plan is amended on or before December 31, 2005 to conform to the provisions of Code Section 409A with respect to amounts subject to Code Section 409A. A plan will be treated as operated in good faith compliance during the calendar year 2005 if: it is operated in accordance with the terms of IRS Notice ; and to the extent an issue is not addressed in Notice , a good faith, reasonable interpretation of Code Section 409A, and, to the extent not inconsistent therewith, the plan s terms, provided that the plan sponsor does not exercise discretion under the terms of the plan, or, provided further, that a participant does not exercise discretion with respect to that participant s benefits, in a manner that causes the plan to fail to meet the requirements of Code Section 409A. For amounts subject to Code Section 409A, the plan may be amended to provide for new payment elections with respect to amounts deferred prior to the election and the election will not be treated as a change in the form and timing of a payment under Code Section 409A(a)(4), provided that the plan is so amended and the participant makes the election on or before December 31, A plan that provides severance pay benefits and is either collectively bargained or covers no service providers who are key employees (as defined in Code Section 416(i)) will not be required to comply with Code Section 409A for calendar year 2005 with respect to such severance benefits. Plan sponsors have until December 31, 2005 to amend nonqualified deferred compensation plans subject to Code Section 409A to comply with those new rules. In the interim, plans must be operated in good faith compliance with Code Section 409A. NOTE: This applies to deferrals subject to Code Section 409A. Grandfathered deferrals may be operated in accordance with current procedures. Severance plans are exempted from application of Code Section 409A for calendar year 2005, but such plans must be amended to be in compliance with Code Section 409A by December 31, The IRS will issue additional guidance governing severance arrangements covered by Code Section 409A. 12

13 Deferral Elections A plan adopted before December 31, 2005 may be amended to allow a participant during all or part of calendar year 2005 to terminate participation in the plan or cancel a deferral election with regard to amounts deferred subject to Code Section 409A, without causing the plan to fail to conform to Code Section 409A with respect to amounts deferred after December 31, The above will only apply if: v the amendment is enacted and effective on or before December 31, 2005; and v the amounts subject to the termination or cancellation are includible in income of the participant in the taxable year in which the amounts are earned and vested. The opportunity to terminate participation in a plan or to cancel a deferral election does not have to be offered to all plan participants. A termination or cancellation may be made with respect to elective or nonelective deferred compensation and may be undertaken by the service recipient or at the election of the participant. Not all or nothing. Although participants can cancel their 2005 deferral election, such revocation is not an all or nothing provision. That is the cancellation option can be applied to only a portion of the participant s deferred compensation with respect to the 2005 election by lowering the amount of the deferrals for the period (without the complete elimination of deferrals). This provision is voluntary on the part of the plan sponsor. A plan does not have to provide this capability. The requirement under Code Section 409A to apply the aggregation rules (to all account balance plans and to all nonaccount balance plans) does not apply when applying the transition relief for deferral elections. This provides flexibility to a plan sponsor to adjust its plans as necessary (by terminating the plan or canceling deferral elections) in its own favor for complying with Code Section 409A. 13

14 CONTINUED Deferral Elections With respect to plans in existence on or before December 31, 2004, deferral elections made on or before March 15, 2005 will be treated as in compliance with Code Section 409A. The March 15, 2005 date will be effective so long as the compensation to which the deferral election related has not been paid or become payable at the time of election. A nonqualified deferred compensation plan will be treated as in existence on December 31, 2004 only if a written plan document: v identifies a specific amount or type of compensation that is subject to the plan and not otherwise payable at the time of the deferral election; and v provides that a participant in the plan may elect to defer the compensation beyond the taxable year in which the amount otherwise would have been payable. The same rule regarding prospectivity of deferral elections still applies. Consequently, note that a deferral election made on March 15, 2005 will only apply to amounts earned after that date; however, the new deferral election rules relating to Code Section 409A will not apply for the 2005 calendar year in this situation. It is recommended to make 2005 deferral elections as soon as possible before March 15, This provision indicates that a written plan document needs to be in place on December 31, v Query: Q&A-21 of IRS Notice specifically does not provide that the aggregation rules do not apply (as do the other Q&As where applicable). Consequently, if the aggregation rules do apply, can it be interpreted that so long as the plan sponsor has one nonqualified deferred compensation plan of the same type (be it account balance or nonaccount balance plan) in existence on December 31, 2004, then technically, the plan sponsor has a written plan document in place? v Query: Q&A-21 provides the ability to make deferral elections until March 15, Is it also reasonable to assume that plan sponsors might have until March 15, 2005 (or to the later date of December 31, 2005) to put in place their new Code Section 409A nonqualified plans document where the plan sponsor froze the pre nonqualified deferred compensation plan? Regardless, the plan itself must be in full compliance with the new Code Section 409A rules no later than December 31, NOTE: Treasury Department representatives have informally stated that they will provide flexibility to employers creating new Code Section 409A plan documents (with a corresponding freeze of a pre-2005 grandfathered plan) for purposes of arguing that a new plan document does exist (e.g., Board resolutions freezing the grandfathered plan and providing that a new Code Section 409A plan shall be created means there is a plan document in place (the plan has been approved) by December 31, 2004 so in existence on that date). NOTE: Treasury Department representatives have informally stated that regardless of when a 2005 deferral election is made, participants will have until December 31, 2005 to perfect their elections regarding time and manner of payment with respect to their 2005 deferral elections. See Payment Elections below. 14

15 Deferral Elections for Bonus Compensation Payment Elections Mirror Plans Deferral elections relating to performance-based compensation (which is based on services performed over a period of at least 12 months) must be made no later than 6 months preceding the end of the performance period. Guidance is still to be issued by the Secretary of the Treasury and the IRS setting forth the requirements for compensation to qualify as performance-based compensation. In the interim, bonus compensation refers to compensation where: the payment of the compensation or the amount of the compensation is contingent on the satisfaction of organizational or individual performance criteria; and the performance criteria are not substantially certain to be met at the time a deferral election is submitted. As long as certain specified criteria are met, bonus compensation may include payments based upon subjective performance. Payment election for deferrals subject to Code Section 409A that are made on or before December 31, 2005 are not treated as a change in the time and form of election. For periods ending on or before December 31, 2005, an election as to the timing and form of payment under a nonqualified deferred compensation plan that is controlled by a payment election made by the participant under a tax-qualified plan will not violate Code Section 409A so long as the determination of the timing and form of the payment is made in accordance with the terms of the nonqualified deferred compensation plan as of October 3, 2004 that governs such payment. The Treasury Department and the IRS anticipate that guidance, once issued on performance-based compensation, will outlive requirements which are more restrictive than those currently outlined here (as summarized from IRS Notice ). NOTE: For 2004 bonus amounts payable in calendar year 2005, the requirement that deferral elections relating to bonus payments be made 6 months preceding the end of the performance period will not override the more flexible transition rule providing that deferral elections for 2005 compensation can be made by March 15, Consequently, bonus deferral elections for 2004 bonus can be made, so long as not yet paid out or earned (i.e., determined), by March 15, This provision gives participants flexibility in calendar year 2005 to elect distribution events without the effect of the 5-year delay in payment or the 12-month advance election requirement. NOTE: For calendar year 2005, any such change in time and form will also not trigger a violation of the prohibition on acceleration of payment. Consequently, employers should use calendar year 2005 to permit participants to fix their payment elections without fear of trigger Code Section 409A penalties. This provision appears to confirm previous informal IRS comments that mirror plans tying timing and form of payment between a nonqualified deferred compensation plan and a qualified plan will need to be redesigned for periods after December 31,

16 Information Reporting on Form W-2 and 1099-MISC Wage Withholding The primary item to note is that the information reporting requirements are not effective for amounts actually deferred in calendar years beginning before January 1, The 2005 Form W-2 has been released which provides for a new Code Z in Box 12 indicating that it should be used by employers to identify income recognized due to participation in a nonqualified deferred compensation plan that fails to meet Code Section 409A. The IRS will be issuing additional guidance on information reporting and we will keep you apprised of new developments as information is made available. The IRS will be issuing additional guidance on wage withholding and we will we will keep you apprised of new developments as information is made available. Not a current issue for plan sponsors until the calendar year 2005 information reports are due. 16

17 EMPLOYEE BENEFITS Carol C. Abing (414) Kathleen O Connor Adams (312) koconnor_adams@gcd.com Marla B. Anderson (312) manderson@gcd.com Vicki L. Beckenbaugh (312) vbeckenbaugh@gcd.com Elizabeth R. Binder (202) ebinder@gcd.com Kimberly J. Boggs (414) kboggs@gcd.com Gregory K. Brown (312) gkbrown@gcd.com Barbara A. Cronin (312) bcronin@gcd.com Gary W. Howell (312) ghowell@gcd.com Jonathan E. Hyun (312) jhyun@gcd.com Ann M. Kim (312) akim@gcd.com Tina M. Kuska (312) tkuska@gcd.com David R. Levin (202) dlevin@gcd.com Howard J. Levine (312) hlevine@gcd.com Joyce L. Meyer (312) jmeyer@gcd.com Sarah Bassler Millar (312) smillar@gcd.com Carrie Roberts Rivera (312) crivera@gcd.com Michael D. Rosenbaum (312) mrosenbaum@gcd.com Heather Heath Ryan (312) hryan@gcd.com Mary K. Samsa (312) msamsa@gcd.com Kathleen Sheil Scheidt (312) kscheidt@gcd.com Lori L. Shannon (312) lshannon@gcd.com Robert J. Simandl (414) rsimandl@gcd.com Timothy J. Stanton (312) tstanton@gcd.com Carol Hines Wacaser (312) cwacaser@gcd.com David L. Wolfe (312) dwolfe@gcd.com