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Compliance Deadline for Nonqualified Deferred Compensation
Our friends at Global Tax Network MN, LLC, have been kind enough to provide us with the following information regarding Internal
Revenue Code Section 409A.
Internal Revenue Code Section 409A (“Section 409A”) was enacted as part of the American Jobs Creation Act of 2004 to address
nonqualified deferred compensation plans. Section 409A provides new rules regulating the timing and form of elections, as well as
distributions, of “deferred compensation,” including certain non-qualified pension programs.
The IRS has issued final regulations
regarding the application of Section 409A in terms of definitions and covered arrangements, deferral elections, and permissible
payments. Deferred compensation plans must be amended to reflect the final regulations on or before January 1, 2009. However,
plans must currently operate in compliance with the final regulations during 2008 in order to establish a reasonable, good faith
interpretation of the statute.
In regards to your Foreign Service Employee (FSE) population, you must do the following, prior to January 1, 2009,
to remain in compliance with the law:
- Have a written tax equalization policy which clearly identifies the timing for making the payments and recording of tax
equalization settlements and other tax payments;
- If you already have a tax equalization policy in place, have your tax/legal consultants review, identify, and make necessary
amendments to all compensation arrangements potentially subject to Section 409A;
- Further, we recommend that Company consider reviewing verbiage in the applicable documents to help ensure compliance
with Section 409A; sample documents which might be amended include;
- Long-term international assignment policy
- Short-term international assignment policy
- Current assignment letters
- Future assignment letters
- Repatriation letters
- Extension of assignment letters
Analysis:
Section 409A requires, with some exceptions, companies that receive personal services from a U.S. tax-paying employee to:
- Document, in advance of the services, any arrangement used to defer receipt of any of the compensation earned by the
worker and follow specific rules when making any elections to further defer that compensation
- Document, in advance, when such deferred compensation can be paid and follow strict rules that limit the circumstances
under which the worker can be paid such deferred compensation
- Limit the types of funding arrangements that can be used to make payment
Further, Section 409A provides that amounts deferred under nonqualified deferred compensation plans are includible in income to
the extent not subject to a substantial risk of forfeiture and not previously included in income, unless these arrangements meet the
requirements of Section 409A.
Failure to comply with Section 409A comes with a heavy cost. Not only is the deferred amount taxable, but the tax on this
compensation is increased by:
- Interest on earlier deferrals that have to be immediately recognized, and
- An amount equal to 20 percent of the compensation required to be included.
Complying with Section 409A rules involves special challenges for multinational companies that employ U.S. citizens and/or resident
aliens. Section 409A applies to U.S. employees working abroad and U.S. citizens and resident aliens who are taxed on their
worldwide income.
The United States employs a worldwide tax system under which U.S. citizens and U.S. resident individuals generally are taxed on all
income, whether derived in the United States or abroad. Compensation earned by a U.S. expatriate or resident alien is subject to
U.S. tax laws regardless of the jurisdiction in which the compensation is earned. Therefore, the deferral of such compensation will be
subject to Section 409A.
Fortunately, Section 409A final regulations contain numerous exceptions that permit U.S. citizens, resident aliens working abroad,
and non-resident alien individuals working within the United States to accrue benefits under non-complying foreign plans without
becoming subject to the Section 409A sanctions. However, where no exception applies, it will be necessary to amend the foreign
arrangement to comply with the Section 409A requirements in order to avoid Section 409A sanctions.
Take inventory
The impending December 31, 2008 deadline requires that you take inventory of your nonqualified deferred compensation plans. You
should take inventory of compensation arrangements extended to your global workforces—specifically, arrangements that may have
the effect of deferring compensation subject to U.S. taxes, e.g., tax equalization settlements, contributions to foreign pension plans,
stock options, etc. Employers need to determine whether compensation arrangements they have with their employees (i.e.,
individual arrangements or group plans, written plans or unwritten arrangements, funded or unfunded arrangements) will be
adversely affected by Section 409A.
Immediate action advised
It is recommended that, at a minimum, the following steps should be undertaken by multinational and non-US companies to
determine whether a deferred compensation arrangement is subject to Section 409A:
- Review and identify all compensation arrangements potentially subject to Section 409A and, in particular, review all plans
that defer compensation or could defer compensation payable to an employee outside his/her respective home country.
- Review expatriate agreements to ascertain if the company is responsible for Section 409A taxes arising from a tax
equalization arrangement and make any requisite changes to the arrangement to rectify this situation.
- Review retirement plans maintained by non-US companies that covers individuals working in the US, but who are neither US
citizens nor residents, to confirm that they qualify for the “broad-based retirement plan” exemption.
- Monitor and review expatriate and global mobility programs to confirm that any change in the residency status of a nonresident
alien who ultimately moves to the US does not result in a breach of Section 409A.
Any concerns about the impact of these regulations on your business should be addressed as soon as possible. We are available to
assist you with any work required to amend your expatriate and global mobility programs (i.e., long-term international assignment
policy, short-term international assignment policy, current assignment letters, future assignment letters, repatriation letters,
extension of assignment letters, etc.).
We encourage you to review the article entitled The International Implications of IRC Section 409A and Its Impact on Multinational
Companies which was published in the magazine Benefits and Compensation International and sets out the implications of Section
409A and its impact on multinational companies as well as sets out a plan of action for companies to follow; that article can be found
at: http://www.faegre.com/showarticle.aspx?Show=5458.
As the ramifications of noncompliance with 409A can be significant, we are advising that every business should have a Section 409A
checkup.
Please feel free to contact your Global Tax Network representative (or contact your representative at TheMIGroup or Global Tax
Network MN, LLC at help@globaltaxnetwork.com) if you have any questions.
Circular 230: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in our communication was
not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalty or (ii) promoting, marketing or recommending to
another party any transaction or matter addressed herein.
Our advice in our communication is limited to the conclusions specifically set forth herein and is based on the completeness and accuracy of the facts
and assumptions as stated. Our advice may consider tax authorities that are subject to change, retroactively and/or prospectively. Such changes could
affect the validity of our advice. Our advice will not be updated for subsequent changes or modifications to applicable law and regulations, or to the
judicial and administrative interpretations thereof.
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