Heed New Rules on Deferred Compensation

In a new Notice issued in September (Notice 2007-78), the IRS granted a partial reprieve for employers struggling to meet new requirements relating to nonqualified deferred compensation agreements. This is an important new development for construction firms and other business operations providing benefits to members of the management team.

Significantly, the new Notice extends the deadline for formalizing documentation of deferred compensation plans for one year—from December 31, 2007 to December 31, 2008.

Background: Under a tax law enacted in 2004, strict requirements are imposed on deferred compensation arrangements. For example, employees are not entitled to receive benefits unless a specified event occurs (e.g., termination of employment, death or disability or a specified future date for payment). In addition, employees must make an initial election concerning payment of benefits, Failure to do so could result in current taxation to the employee.

The new rules are extremely complex. To provide some much-needed guidance, the IRS has issued a series of instructions the last few years, including the release of long-awaited final regulations. Among other requirements, the final regulations required employers to create written plan documents before January 1, 2008.

Now the new Notice provides that a nonqualified deferred compensation plan will not be treated as being in violation of the rules for failing to provide written documentation if

• the plan is in operational compliance; and

• the plan is amended by December 31, 2008, to comply retroactive to January 1, 2008.

Despite this relief, a construction firm with a deferred compensation plan should take steps to ensure compliance under the final regulations. Following are two key areas to focus on.

1. Time and form of payment: Unless an exception in the final regulations applies, if there have been deferrals of compensation under a plan as of January 1, 2008, the plan must designate, in writing, a “compliant time and form of payment.” Furthermore, under Notice 2007-78, amounts deferred after December 31, 2007, and before January 1, 2009, will be in violation of the rules unless the plan designates, in writing, a compliant time and form of payment by the applicable deadline. The new Notice details how to designate a compliant time and form of payment.
2. Voluntary compliance program: The IRS announced that it expects in the near future to establish a limited voluntary compliance program that will allow certain unintentional operational failures to be corrected in the same tax year. This will avoid application of taxes and penalties. The IRS also anticipates that the voluntary program will permit other correction methods that will result in only limited amounts becoming subject to tax and penalties.

Late-breaking news: In another new Notice (Notice 2007-86), the IRS has pushed back the deadline for complying with the final regulations until December 31, 2008. This late change was in response to comments from practitioners about the complexity of the rules.

Obviously, this is a highly technical area of the law. Seek professional assistance when it is appropriate.

December 2007