Warning to NQDC Plan Sponsors: The IRS May Be Coming

May 15, 2014 (PLANSPONSOR.com) – The Internal Revenue Service (IRS) has launched an audit initiative aimed at compliance with the rules for nonqualified deferred compensation plans under Code Section 409A.

According to a Benefits Brief from Groom Law Group, based in Washington, D.C., a series of audits of a “limited scope” are underway. The IRS will assess what further steps, if any, to take after the results of those audits are in.

Groom says “employers should seriously consider self-auditing plans subject to Code Section 409A for operational and plan document compliance.” To prepare for a potential audit on Section 409A issues, the firm lists some key areas for nonqualified deferred compensation plan sponsors to review:

Initial deferral elections. The general rule is that an employee may elect to defer compensation only if the election is made before the year the compensation is earned. However, there are exceptions that permit elections to be made at a later date. At the time an election is made to defer compensation, the time and form of distribution for the compensation must also be documented.

Subsequent deferral elections. Subsequent elections to change the time or form of payment originally established are permitted only where (1) the election does not take effect for 12 months, and (2) the payment generally must be deferred for at least five years from the date payment would otherwise have been made.

Distribution triggers. Payments may only be made upon a fixed date or upon one of five "trigger" events: (1) a separation from service, (2) death, (3) disability, (4) change in control, or (5) unforeseeable emergency. A plan may provide for distributions upon the earlier of, or the later of, two or more specified permissible events.

Key employees. Key employees of public companies (generally, up to the top 50 highest paid officers) may not receive distributions for six months if a payment is triggered by their separation from service.

No acceleration of payments. Generally, the time of payment may not be accelerated except as permitted under regulations. Some useful exceptions exist, including for domestic relations orders, limited cash-outs, and payment of FICA taxes.

Funding restrictions. Nonqualified plan benefits may not be funded through an offshore trust or a trust that becomes off-limits to a company's creditors in the event of financial troubles for the company.

The Groom Benefits Brief is here.