Michel Vanesse (Parker Poe Adams & Bernstein, LLP)
Michael Hoes (Bank of America)
November 10, 2015
© 2015 Parker Poe Adams & Bernstein LLP
Attorneys and Counselors at Law
Parker Poe Adams & Bernstein LLP
409A Compliance
What is ‘deferred compensation’?
And just what is the IRS looking for?
IRS Launches Limited Audit
 Limited audit on 50 large employers
 Model IDR gives an indication as to areas of focus
Deferral elections (limited to plans where participants
voluntarily elect to defer receipt of compensation); applicable
rules impose strict limitations as to when deferral elections are
appropriately made
 Subsequent re-deferrals (same limit); applicable rules impose
even more severe restrictions on the ability to re-defer
compensation
 Permissible payment triggers (very limited list under applicable
rules);
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IRS Launches Limited Audit (Continued)
 Requires employers to know what is covered by Section 409A
Document production may prove difficult (IRS document
request refers to “all plans, agreements, methods, programs
or other arrangements (such as employment agreements)
maintained by the service recipient that are nonqualified
deferred compensation plans within the meaning of Regulation
§1.409-1(a)”)
 Need to know what is properly excluded from Section 409A to
avoid being over-inclusive
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 Initial step towards more wide-spread enforcement; Need to
prepare
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What We Will Cover Today
 Quick reminder of scope and purpose of Section 409A
 Emphasis on internal procedures and methods to reduce
risk of non-compliance
Self-audits
 Interacting with HR, lines of business and other departments that
may have some decision power for compensation and benefits
 Managing service providers
 Managing participants
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 Q&As
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Section 409A – Basic Requirements
 Regulates the deferral, payment & funding of all deferred
compensation
Legally binding right to compensation that COULD be paid in a
later year
 Even if the right is subject to vesting or other conditions
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 Focuses on timing of deferral (plan input) and on timing and
form of payments (plan output)
 Makes it very hard to make changes once the arrangement is
entered into
 Covers most “service providers” – employees, directors, even
certain independent contractors
 Addresses IRS’s concern over what it perceives as excessive
control by taxpayers over the timing of recognition of income
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Scope of Section 409A
 Not just elective deferrals, but also:
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Equity compensation
Supplemental retirement
Employment agreements
Severance pay
Bonuses
Indemnification/reimbursement agreements
Change-in-control benefits
Perks
 As a result, Section 409A can potentially affect all areas of
compensation.
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Scope of Section 409A (Continued)
 International reach
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Applies to U.S. taxpayers, including U.S. citizens and
permanent residents (green card holders) working abroad
May therefore apply to foreign plans in which U.S. taxpayers
participate
Applicable rules include several exclusions specifically
designed for foreign plans
 As a result, Section 409A can even require coordination with
foreign entities in a controlled group
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Scope of Section 409A (Continued)
 Complex set of rules
Not intuitive
 Many terms of art with definitions that are created specifically for
this provision (stock right, separation from service, change in
control, unforeseeable emergency, etc.)
 Because the scope of Section 409A is so broad, applicable rules
also include many exceptions with very specific requirements

 Need to understand the total compensation & benefits
landscape of each company (including foreign plans)
 Need to monitor on an ongoing basis for changes and
operations
 Need to educate appropriate parties
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Failure to Comply and Sanctions
 A failure can occur as the result of:
Operational failure – the plan is not administered according to
its terms and Section 409A
 Document failure – the plan is not drafted according to
Section 409A
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 No exception for minor violations
 Penalties for noncompliance are severe
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Owed by the service provider
All vested deferred compensation is taxed immediately
Additional 20% tax
Interest for late payment of taxes at the underpayment rate
plus 1%
Plan aggregation
Other potential penalties imposed on the service recipient (for
example, in the event of failure to timely report income)
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Failure to Comply and Sanctions (continued)
 How far back can the IRS go?
Normal application of the statute of limitations
 Generally 3 years
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 But what about ongoing violations?
Need to distinguish among various scenarios
 Statute of limitations may start running in the event of an
accelerated payment in the form of a lump sum
 But an ongoing failure to pay an amount that has become due
may create a violation over multiple years
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Failure to Comply – Not an Employer’s Problem?
 Just because the penalties are imposed primarily on the
service provider (employee) does NOT mean the employer
should not be concerned
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Most 409A-covered arrangements are for executives
Many arrangements are not negotiated and the benefits that
are promised are NOT meant to be subject to the 409A
penalties
Risk of law suits
 Participants are generally not involved in plan operations
Risk of human errors and computer “glitches”
 Expensive gross-ups?
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Self-Audit – How To Prepare for the IRS
 Initial step in the process of achieving Section 409A
compliance includes the creation of a list of all
compensation and benefits arrangements
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Solely for purposes of identifying plans, programs,
agreements and other arrangements, including one-person
agreements (whether they are in writing or not)
May be a complex task in decentralized businesses
 Next step involves an analysis of the design and operations of
each arrangement
Determining Section 409A exclusions or otherwise assessing
compliance
 Goes beyond an analysis of plan documents; operations must
reflect plan terms and comply with all applicable requirements
under Section 409A (can prove time-consuming)
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Self-Audit (Continued)
 Generally requires engagement of multiple (non-legal)
departments in a company
HR
 Line-of-business managers
 Other departments or functions with compensation and
benefits responsibilities
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 May require engagement of outside partners if certain
functions are outsourced
Payroll
 Plan administrators
 Record keepers
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 May reveal different understandings of plan design and
erroneous operations
Need to agree on response
 Plan amendments, corrections of errors
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Self-Audit (Continued)
 Will also require ongoing monitoring after the initial due
diligence phase
Changes in design
 Errors
 Other special situations (hardships, domestic relations orders,
etc.)
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 Irrespective of the size of the employer, some formalization of
the processes for the adoption and maintenance of
compensation arrangements is beneficial
Education of individuals involved in compensation functions
(including new recruits)
 Safeguards against errors (409A policies, internal tools to spot
issues, internal reporting obligations for problematic designs
or errors, etc.)
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 Should lead to greater cooperation between lines of business
and legal function to avoid mistakes
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Correction of Failures
 Errors will occur despite safeguards
 Unintentional errors (human errors or computer errors)
 Misunderstanding of complex rules
 Types of failures:
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Document errors
Excess deferrals
Insufficient deferrals
Accelerated payments
Delayed payments
Stock rights issues
 Need to identify failures correctly and quickly
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Some errors are not necessarily 409A failures (such as late
payments made in the same calendar year)
increased burden with the passage of time (mistakes can be easy
to correct, if correction is performed quickly after they occur, but
a small error eventually can turn into a full blown violation)
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Correction of Failures (Continued)
 IRS has issued limited correction programs
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Document failures and operational failures
Provide incentives for early detection (the IRS wants companies
to be proactive and perform internal audits regularly)
Limited time window
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Generally not available during an IRS audit
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 Correction under IRS programs is VERY detailed and
requires EXACT compliance
Also not intuitive
 No standardized methodology
 Certain aspects of correction are permissive and not
mandatory
 Depends on the type of error, the timing of the correction, the
individual affected by the error, the amount involved
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Correction of Failures (continued)
 Typical issues to be addressed during correction show a
need for coordinated actions amongst multiple parties
Earnings and losses on benefit accruals
 Time value of money in the event of early payment
 Withholding taxes (repayment of net or gross amounts)
 Reporting obligations
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 Use of the correction program requires the service recipient
to demonstrate that:
Measures have been taken to make sure the failure does not
occur repeatedly, and
 The failure was inadvertent and unintentional
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 May be difficult to demonstrate if the same failure occurs
over multiple years or on multiple occasions
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Participant Communications/Cooperation
 Full correction may require the cooperation of the
affected participant(s)
 Cooperation may be difficult when repayments are required
Need to address difficult situations where the participant may
already have spent the money
 Correction program is rigid – Loans are not allowed
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 Penalties may still apply (on a reduced basis) even if full
compliance with the correction program is achieved
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Participant Communications/Cooperation
(Continued)
 Need to develop standardized responses for similarly
situated employees
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Requires correction process to be fairly centralized
Need to avoid bad precedents, which can create a perception
of discrimination among employees if different responses are
applied to new situations
 Need to develop strategies when dealing with
uncooperative individuals
Are there circumstances where it is okay to decide not to
correct and to deal with full blown 409A violations?
 Is a gross-up for all negative tax consequences ever to be
granted?
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Service Provider Cooperation
 Plan administration can be mostly performed by computer
systems and many failures will be either system-driven or
due to unintentional keystroke errors
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Need to carefully review how systems are programmed to
make sure they reflect plan terms
 If plan administration is outsourced, the service
agreement with the service provider, third-party
administrator or record keeper should be analyzed
carefully
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Erroneous programming
Erroneous data
Erroneous data entry
Standard of liability
Indemnification clauses
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Service Provider Cooperation (Continued)
 The interests of the parties may not be aligned and
the parties may not be equally risk-averse or risk-prone
 Possible disagreement as to whether or not there has
been a failure
 Need to determine measures to take in order to avoid
repeated errors (correction requirement)
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Conclusions
 Is Section 409A the new “ERISA for non-qualified plans”?
 Equally complex
 More severe sanctions (mostly NOT on the employer)
 Similar need for correction programs because of exceedingly
complex compliance requirements and often disproportionate
sanctions
 Need to have a comprehensive view of all compensation
and benefit plans (both domestically and internationally)
 Need to determine compliance or exclusion from scope
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Conclusions
 Need to establish processes for safeguards to minimize
the risk of errors and/or ensure a prompt reaction when
errors do occur
Educate the individuals involved in the design and
implementation of compensation and benefit programs
 Develop tools to spot issues
 Create internal lines of communication
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 Need to partner with other parties involved in
compensation and benefits
May be more difficult in companies that are fairly
decentralized
 Is likely to include outside service providers
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 Need to develop effective communication with
participants
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QUESTIONS???
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Michel Vanesse
Parker Poe Adams & Bernstein
401 South Tryon Street
Charlotte, NC 28202
704.335.9040
michelvanesse@parkerpoe.com
Michael Hoes
Global Compensation & Benefits
Bank of America
214 N. Tryon Street
Charlotte NC 28255
980.386.1624
michael.hoes@bankofamerica.com
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