It is not too late for practitioners to assist plan sponsors of “nonqualified deferred compensation plans” (NQDC pension-type plans) to quickly check and correct tax code Section 409A errors before year-end 2018.

Section 409A requires both: (a) form (documentation), and (b) operational (administrative 409A compliance), if a plan is a defined 409A “nonqualified deferred compensation plan.” In the worst case, a participant incurs regular federal income tax, plus a 20 percent excise tax, plus a penalty interest tax of the applicable federal rate plus 1 percent. Any state income and excise tax will also apply. 409A NQDC plans are not covered by the Revenue Procedure 2018-52 Employee Plans Compliance Resolution System for qualified plans. However, the Internal Revenue Service has provided limited formal correction procedures. Quick identification and correction of 409A NQDC errors under these procedures can eliminate or reduce the expense and corrective burdens. A high level list to check plans before year-end 2018 follows.

Author’s Note: This checklist is intended for pension style tax code Section 409A NQDC plans of for-profit companies. It does not currently cover the special rules applicable to tax exempts with Section 457 plans, especially 457(f) “ineligible” plans that are covered by both 457 and 409A. However, practitioners supporting tax exempts may find parts of this checklist helpful, since 457(f) plans may also be covered by 409A.

Operational Errors Checklist

1. Make certain participant vested and nonvested balances in account balance plans are correct. Incorrect participant balance errors are not a 409A error per se (but may point to one). However, if a balance is incorrect it will eventually translate into an incorrect participant distribution and a distribution error under 409A.

Tip: Account balance errors often occur when complex account crediting calculations are involved or when dividends or other special stock crediting events occur (e.g., stock split).

2. Check for a failure to correctly contribute each participant’s voluntary deferral amount for the year. This identified operational error under IRS Notice 2008-113 can easily be corrected with minimal correction steps (and no penalty or reporting) for ALL plan participants if corrected in the same calendar year the deferral contribution error occurred (Dec. 31, 2018).

Tip: This type error frequently occurs in four situations: (1) when there is a percentage salary or base deferral election, and an increase in compensation occurs mid-year mandating an increased deferral contribution that is not reflected by payroll reduction; (2) when there is a simple payroll coding error (e.g., 30 percent instead of 50 percent); (3) when payroll uses the wrong definition of “compensation” from the plan that is subject to a percentage deferral election, especially in a new plan; or (4) when payroll simply fails to transmit an elected contribution of a participant for a period to the record-keeper.

3. Check for a failure to make a Section 409A permissible distributions during the past year. Distributions must be:

(a) made in accordance with a participant’s existing election (including any subsequent elections) and/or the plan document for the amount distributed (e.g., if elected to be paid in installments, not paid in lump sum or vice versa, or paid in the wrong number of installments, if payable in installments);

(b) made in the correct amount so there is no issue of acceleration (too large a payment) or a late payment (too small a payment);

(c) made according to the plan document provisions;

(d) made at the correct time for the type of distribution (also taking into account the subsequent election 5-year set back rule); and

(e) made to otherwise fit within one of the following 409A permissible distribution/accelerated distribution events primarily listed in Treasury Regulation Sections 1.409A-3(i)(1)-(6) and (j)(4)(ii)-(xiv).

Note: Many of these 409A permissible events have unique definitions and requirements that will need to be reviewed.

4. Confirm that no “material modifications” (an improvement in the plan or its benefits) have unintentionally been made to any “grandfathered plan” or portion thereof, either as to administrative procedures (or documentation) during the plan year. Otherwise a loss of grandfathering could occur with immediate taxation.

Tip: A common mistake on a grandfathered plan is to add a provision or allowed a financial hardship or disability withdrawal when there was no provision for it in the grandfathered plan.

5. Confirm that no 409A-prohibited “haircut” distributions have been made (except from a grandfathered portion of a plan that retains such a provision). Section 409A specifically prohibits such a provision allowing a participant’s free ability to accelerate distribution.

6. Make certain that all participant elections to defer for the coming 2019 calendar year on income to be earned using calendar year (and most fiscal year compensation) are completed, received and made final by Dec. 31, 2018. Except for 409A “performance-based compensation” bonuses and certain commission, there are few election timing exceptions for calendar year and fiscal year bonus and other compensation. An untimely election is invalid.

7. Make certain newly eligible plan participants were brought in properly as to plan types under the “aggregation” rule during 2018 and for 2019 plan years. The IRS takes the position that participants must enroll in plans of the same 409A plan type at the same time (e.g., “employee account balance plans”).

8. Encourage certain public sponsors impacted (or likely to be impacted) by the elimination of the deduction under Section 162(m) for “performance based compensation” to identify and maintain any existing grandfathered amounts by adopting revised procedures internally or with their third party administrator and record-keeper. The transition rules generally limit grandfathering to those amounts (account balances or benefits) vested as of the date the legislation was first introduced—Nov. 2, 2017.

Note: Congress also added a new 20 percent excise tax on tax exempt plan sponsors as to employee compensation in excess of $1 million.

Documentation Correction

A. 2018 409A Plan Documentation Review & Corrective Actions—New Plans

1. Review for 409A form errors and amend as necessary new plan documentation created in 2018 before the end of the year. Under the guidelines in Notice 2010-6, Section 10, plan sponsors of new 409A-covered plans are given until Dec. 31 of the first year of the plan to amend and correct the language in their plan documentation without penalty or reporting.

2. Review and amend/conform plan documentation, especially for communication purposes, for IRS 2016 proposed technical amendments to regulations if this was not done in 2016 or 2017.

B. Other Required & Necessary Plan Documentation Modifications to Avoid 409A Errors

1. Correct Section 409A document failures for amounts that have yet to vest and are still subject to a Section 409A substantial risk of forfeiture until the end of the 2018 or will vest sometime in 2019. Based upon the language in Proposed Treas. Reg. Section 1.409A-4 (even as amended on June 22, 2016), correction can still be done. This position is confirmed in IRS Chief Counsel Advice Memorandum 201518013 (Apr. 14, 2015). No corrective penalties or reporting is required.

2. Confirm that all necessary and/or desirable plan documentation modifications have been made to all potential 409A-covered plans as might have been required by plan documentation guidance in IRS Notices 2010-6 and 2010-80 (see above). Even at this late date, ask the question- “Has the plan been amended by legal counsel since Jan. 1, 2009 (effective date for full form and operational compliance with Section 409A)? If not, the plan will need immediate review and likely amendment.

Tip: Some legal commentators believe it is possible to correct outside the IRS formal correction programs. (See e.g., Rosina Barker, 409A Failures: Correcting With and Without the IRS Formal Correction programs, Outline N, 46th Ann. Southern Fed. Tax Institute (Sept. 19-23, 2011) discussing various non-409A correction procedures based upon the logic that Section 409A is additive law.)

3. If not yet done, review and amend the plan documentation as necessary for the revised required ERISA Claims Procedure for disability distributions if the plan provides for distributions upon a disability (also confirm that the plan has been administered according to the new procedures since the April 1, 2018, effective date). ERISA claims procedures do generally apply to NQDC plans, even though NQDC plans (usually designed as exempt “Top Hat” plans) are largely exempt from burdensome ERISA requirements otherwise when properly drafted and administered. This is not a 409A error issue but is still an important plan documentation issue to address in 2018.

Louis R. Richey, JD, is Senior Vice President of the Retirement & Special Products Division and an attorney for Infosys McCamish Systems LLC in Atlanta. He is the compliance legal expert for the company’s executive 409A nonqualified pension, and other welfare benefit administration platforms and business process outsourcing. He may be reached at Louis_Richey@Infosys.com.