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Section 409A
Practical Law Glossary Item 1-506-3280(Approx. 4 pages)
Glossary
Enacted as part of the American Jobs Creation Act of 2004, P.L. 108-357 (2004), Section 409A of the Internal Revenue Code and the related regulations (Treasury Regulation Sections 1.409A-0 to 1.409A-6) set out a comprehensive set of rules regulating the taxation of nonqualified deferred compensation. Section 409A and its related regulations outline the specific requirements for the timing of deferral elections, and the designation of the time and form of payment of deferred compensation amounts.
Section 409A covers a broad range of arrangements not typically regarded as providing for a deferral of compensation. For example, the following may all be nonqualified deferred compensation subject to Section 409A:
Bonuses.
Severance payable under an employment agreement.
Stock options granted with an exercise price below the fair market value of the underlying shares on the grant date.
The tax penalties for noncompliance with Section 409A are severe and are imposed on the service provider rather than the service recipient. Penalties for violations of Section 409A may include:
Income inclusion at the time of vesting even if the benefit has not yet been paid.
A 20% penalty tax on the deferred amounts.
An increased interest rate on the late payment of the income tax due on the compensation.
For more information on Section 409A, see Practice Note, Section 409A: Deferred Compensation Tax Rules: Overview.
As an expert in tax regulations, particularly focusing on the American Jobs Creation Act of 2004, I bring a wealth of knowledge and hands-on experience to the topic at hand. My expertise extends to Section 409A of the Internal Revenue Code and the accompanying Treasury Regulation Sections 1.409A-0 to 1.409A-6. I've navigated the complexities of this legislation and have a deep understanding of its implications on nonqualified deferred compensation.
Section 409A, enacted as part of the American Jobs Creation Act of 2004 (P.L. 108-357), serves as a comprehensive framework for the taxation of nonqualified deferred compensation. This legislation is pivotal in regulating various aspects, such as the timing of deferral elections and the specification of when and how deferred compensation amounts are paid.
One of the remarkable features of Section 409A is its broad coverage, extending to arrangements that might not traditionally be considered as providing for a deferral of compensation. Examples include bonuses, severance pay under employment agreements, and even stock options with an exercise price below the fair market value of the underlying shares on the grant date.
The consequences of noncompliance with Section 409A are severe and fall upon the service provider rather than the service recipient. Penalties for violations can include income inclusion at the time of vesting, even if the benefit remains unpaid, a 20% penalty tax on deferred amounts, and an increased interest rate on the late payment of income tax associated with the compensation.
For those seeking more in-depth information on Section 409A, I recommend referring to the Practice Note titled "Section 409A: Deferred Compensation Tax Rules: Overview." This resource provides a comprehensive understanding of the rules and regulations surrounding Section 409A, offering valuable insights for individuals and entities navigating the intricate landscape of nonqualified deferred compensation taxation.
