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IRS Begins Audit of Deferred Compensation Plans Subject to Section 409A

Written by Jessica Catlow

The IRS announced at recent bar association meeting that it is commencing a formal compliance initiative program (CIP) of selected employers and their deferred compensation arrangements that are subject to Section 409A of the Internal Revenue Code.

By way of background, Section 409A applies to non-qualified deferred compensation arrangements and contains very specific rules regarding the ability of an employer, employee or other service provider to defer the payment of compensation, such as severance, to later tax years. Compensation that is deferred under agreements that are subject to Section 409A and are not documented or operated in a manner compliant with the rules may be immediately includable in the employee or service provider’s income even though the amount has not been actually paid to the employee, and subject to an additional 20% tax and penalty interest.

The CIP will focus on larger employers and the 10 highest paid employees of those selected employers. Although the IRS’ focus on selected employers is narrow now, many tax practitioners expect that the IRS will eventually broaden its scope as it sharpens its audit techniques and educates itself regarding the most common areas of non-compliance. As a result, we recommend that employers ensure that as they enter into new compensation arrangements with employees or other service providers, those plans or agreements are reviewed by counsel to ensure they are either drafted in a manner to be exempt from Section 409A or comply with Section 409A to the extent not exempt.

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