INDEX TO SECTION 409A
Major Changes For Deferred Compensation
Questions and Answers on Section 409A
Special Problems of Severance Pay
Reporting Deferred Compensation

1. What is a "plan" providing for the "deferral of compensation"?

   A "plan" includes any arrangement covering employees, directors, board members, trustees and certain independent contractors (referred to as "service providers").

   A plan provides for the "deferral of compensation" to the extent that it creates a legally binding right to have compensation earned by a service provider in one taxable year (but not actually or constructively received or included in income) paid in a future taxable year.

   A plan providing for the deferral of compensation includes severance agreements, but does not include "separation pay arrangements".

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2. What is a "separation pay" arrangement?

   A separation pay arrangement does not to provide for a deferral of compensation and may be either: (1) collectively bargained; or (2) not collectively bargained.

   Collectively Bargained Arrangements. Must provide for separation pay only upon: (1) actual involuntary separation from service; or (2) pursuant to a window program.

   • Must be included in a collective bargaining agreement that included good faith bargaining between adverse parties as to separation pay.

   Non-Collectively Bargained Arrangements

   • Must provide for separation pay only upon: (1) actual involuntary separation from service; or (2) pursuant to a window program; and

   • Limit the amount of separation pay to the lesser of: (1) the employee's total annual compensation; or (2) twice the limit described in section 401(a)(17) of the Internal Revenue Code ($220,000 in 2006); and

   • All payments must be paid no later than December 31 of the second calendar year following the year during which the separation from service occurred.

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3. What is "Separation from Service"?

   Separation from service includes: (1) death, (2) retirement; or (3) termination of employment. Does not include military leave, sick leave, or bona fide leave of absence of less than six months, unless re-employment is guaranteed by statute or contract.

   Whether there has been a "termination of employment" is a factual determination. The provision of "insignificant" services under a consulting agreement, for example, is permitted.

   • Presumption of separation from services where rate of compensation and actual compensation is no more than 20% of former compensation for three preceding years.

   • Presumption of no separation from service if rate of compensation and actual compensation exceeds 50% of former compensation for three preceding years.

   Independent contractors have a separation from services upon expiration of contract (or, if multiple contracts, all contracts) if the expiration is a "good faith and compete termination of the contractual relationship".

   • No good faith and complete termination if any expectation of renewal or renewal contingent on need for services or availability of funds.

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4. What is a "window program"?

   A "window" program is any program that provides separation pay for employees who leave during a limited period of time (no greater than one year) or under certain circumstances.

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5. What is "separation pay"?

   Separation pay is defined as compensation conditioned on a separation from service.

   May include reimbursements that may be excluded from gross income (e.g., of business expenses, pursuant to an accountable plan), reasonable outplacement expenses, moving expenses, and medical expenses.

   • Reimbursements may only paid for a "limited period of time, defined as ending on December 31 of the second calendar year following the year of separation.

   • Limited opportunity for reimbursements beyond a limited period of time if "de minimis" (less than $5,000).

   Special rule for medical expenses/COBRA premiums

   • Employees may reimburse medical expenses incurred by their employees during the "limited period of time" described above (either directly or pursuant to a medical expense reimbursement plan). Note: Practical considerations may make this impossible to administer because the reimbursement must occur within the limited period of time and most plans are structured on a claims incurred basis.

   • Employers may reimburse their employees' COBRA or health insurance premiums for a "limited period of time".

   • Employees may pay their employees' COBRA or health insurance premiums, but the payment is a deferral of compensation subject to 409A.

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6. What if I do not have "separation pay"?

   If severance agreement does not qualify as "separation pay", or if payments or reimbursements are made outside the "limited period of time" or for more than de minimis amounts, then agreement likely provides for deferred compensation and is subject to section 409A of the Internal Revenue Code.

   Highlights of section 409A:

   • Employees must elect to defer compensation in advance.

   • Distributions limited to one of six statutorily defined "events of distribution" (separation from service, fixed schedule, retirement, disability, death, change in control).

   • Cannot permit employees to accelerate receipt of benefits by changing elections or form of payment.

   • Limited opportunities to make further deferrals.

   • Must have a six-month delay for officers of public companies.

   Note: Tax-exempt organizations are subject to special rules.