Executive Compensation | Just Tax

§ 409A Election Timing Rules (Reg. § 1.409A-2)

This checklist applies the § 409A initial and subsequent deferral-election timing rules under Treas. Reg. § 1.409A-2, covering the general prior-year rule, the performance-based compensation exception, the first-year-of-eligibility rule, and the 12-month and 5-year subsequent-election constraints. Use it whenever a service provider elects to defer compensation or re-defers a scheduled payment under a nonqualified deferred compensation plan.

Step 1. Scope of Coverage and the "Legally Binding Right" Trigger

"A plan provides for the deferral of compensation if, under the terms of the plan and the relevant facts and circumstances, the service provider has a legally binding right during a taxable year to compensation that, pursuant to the terms of the plan, is or may be payable to (or on behalf of) the service provider in a later taxable year." (Treas. Reg. § 1.409A-1(b)(1))

• The § 409A(d)(1) plan definition. § 409A(d)(1) defines a nonqualified deferred compensation (NQDC) plan as any plan that provides for the deferral of compensation, excluding qualified employer plans such as § 401(a) qualified retirement plans, § 403(b) tax-sheltered annuities, § 408(p) SIMPLE IRA plans, § 457(b) eligible deferred compensation plans, and bona fide welfare benefit plans. A plan is an NQDC plan if it covers only one service provider or if no formal written plan document exists.
  • The definition is intentionally broad and captures any arrangement, oral or written, formal or informal, that defers compensation to a later taxable year (§ 1.409A-1(c)(1)).
  • An arrangement that defers compensation through a foreign trust, rabbi trust, or mere unfunded promise to pay is treated as an NQDC plan subject to § 409A.
• The legally binding right test under § 1.409A-1(b)(1). The threshold inquiry for § 409A coverage is whether the service provider has a legally binding right to compensation that is or may be payable in a taxable year later than the taxable year in which the service is performed.
  • A legally binding right arises when the compensation has been earned and the employer is obligated to pay it, even if the obligation is unfunded and unsecured. The right must be enforceable under applicable law. See Rev. Rul. 60-31, 1960-1 C.B. 174 (a mere unsecured promise to pay compensation in a future year does not result in current income inclusion under the economic benefit doctrine, but such promise constitutes deferred compensation subject to § 409A).
  • If the employer retains discretion to reduce or eliminate the compensation, and that discretion is not limited in a manner that is merely illusory, a legally binding right may not exist. However, if the employer's discretion is limited by a pre-existing agreement or if the employer has a past practice of not exercising such discretion, the facts and circumstances may establish a legally binding right despite the nominal discretion.
• The discretion exception and "substantive significance" test. Treasury Regulation § 1.409A-1(b)(1) provides that a service provider does not have a legally binding right to compensation if the employer retains discretion to reduce or eliminate the compensation and that discretion is not limited in any substantive way.
  • Discretion is of substantive significance if it is not merely illusory or limited by a pre-existing agreement. Factors include whether the discretion is exercised in good faith, whether there are objective standards governing the exercise of discretion, and the employer's past practice.
  • If the employer's discretion is subject to objective performance criteria established in writing, the right may still be legally binding if the criteria create an enforceable obligation once satisfied. The presence of subjective discretion alone does not automatically defeat a legally binding right if the employer has effectively committed to pay upon the occurrence of stated conditions.
• The short-term deferral exception under § 1.409A-1(b)(4). Compensation is not treated as deferred compensation subject to § 409A if the service provider receives payment on or before the last day of the applicable 2.5 month period. This period ends on the later of (i) the 15th day of the third month following the end of the service provider's first taxable year in which the right to the amount is no longer subject to a substantial risk of forfeiture, or (ii) the 15th day of the third month following the end of the employer's first taxable year in which the right is no longer subject to a substantial risk of forfeiture.
  • This exception applies automatically if the payment timing meets the 2.5 month deadline. No election or plan provision is required to invoke it.
  • If the plan provides that payment may occur after the 2.5 month period, the arrangement is subject to § 409A in its entirety unless another exception applies. A plan that pays within 2.5 months but also permits later payment under certain conditions does not qualify for the exception.
• Arrangements excluded from NQDC plan coverage. § 409A(d) and the regulations exclude several categories of arrangements from the definition of an NQDC plan.
  • Qualified employer plans under § 401(a), § 403(a), § 403(b), § 408(k), § 408(p), § 457(b), and § 830(b) are excluded. These plans have their own statutory qualification requirements and are not subject to § 409A.
  • Bona fide vacation leave, sick leave, compensatory time, disability pay, and death benefit plans are excluded if they meet the conditions of § 1.409A-1(a)(3). To qualify, the plan must not permit a cash or deferred election and must provide benefits that are substantially similar to those traditionally provided under such plans.
  • Certain foreign plans, certain welfare benefit plans, and employer-provided non-taxable benefits are also excluded from § 409A coverage.
• The independent contractor exception under § 1.409A-1(f)(2). Compensation paid to an independent contractor is not subject to § 409A if the compensation would not be includible in gross income if paid immediately upon vesting.
  • This exception applies only where the service provider is a bona fide independent contractor and not a common law employee. Misclassification of an employee as an independent contractor can result in the arrangement being subject to § 409A without the protections that apply to employee plans.
  • If the independent contractor exception does not apply, the general NQDC rules apply to deferred compensation payable to independent contractors, including the requirement that deferral elections comply with the timing rules of § 1.409A-2(b).

Step 2. The General Rule for Initial Deferral Elections

"In the case of any nonqualified deferred compensation plan, a plan may permit a participant to elect to defer compensation only if the election to defer is made not later than the close of the preceding taxable year." (IRC § 409A(a)(4)(B)(i))

• The statutory baseline under § 409A(a)(4)(B)(i). § 409A(a)(4)(B)(i) provides that a plan may permit a participant to elect to defer compensation only if the election is made no later than the close of the preceding taxable year. This statutory rule establishes the outer boundary for initial deferral elections. A plan may impose an earlier deadline, but may not permit elections after the close of the preceding taxable year unless a specific exception applies.
  • The statute applies to compensation for services to be performed in a future taxable year. An election to defer compensation that has already been earned or that relates to services already performed cannot satisfy the general rule.
  • The statutory rule is mandatory. A plan provision that permits later initial elections, without satisfying an exception, causes the entire plan to fail § 409A.
• The regulatory "before-the-year-before" rule under § 1.409A-2(a)(5). Treasury Regulation § 1.409A-2(a)(5) restates and clarifies the statutory rule by providing that the initial deferral election must be made on or before the last day of the taxable year of the service provider immediately preceding the service provider's first taxable year in which any services are performed with respect to which compensation may be deferred under the plan.
  • For calendar-year taxpayers, this means the election deadline is December 31 of the year before services begin. For fiscal-year taxpayers, the deadline is the last day of the fiscal year preceding the fiscal year of service.
  • The election must be made before the service provider begins performing any services that could give rise to compensation eligible for deferral under the plan. If the service provider begins performing services before making the election, the general rule cannot be satisfied for compensation attributable to those services.
• Compensation covered by a timely initial election. An initial deferral election under the general rule applies only to compensation attributable to services performed after the election is made. Compensation earned for services performed before the election effective date cannot be deferred under this rule.
  • If a service provider begins employment mid-year but made a timely election before the year began, the election covers compensation earned for the entire year of service, because all services are performed in the taxable year after the election.
  • If a service provider begins employment mid-year without a prior election in place, the general rule cannot be used to defer compensation for services performed before any election is made. The first-year eligibility exception of Step 3 or another exception must apply.
• The irrevocability requirement. An initial deferral election must be irrevocable once the deadline for making the election has passed. The plan document must specify that elections are irrevocable, and the service provider must not have any right to revoke or modify the election after the deadline except through a subsequent deferral election that satisfies the requirements of Step 6.
  • A plan that permits revocable elections or that allows participants to change their initial election without satisfying the subsequent election requirements violates § 409A.
  • Irrevocability means the service provider cannot later elect to receive the compensation in cash rather than as deferred compensation, cannot change the timing of payment, and cannot change the form of payment, unless a subsequent election that satisfies § 1.409A-2(b)(1) is made.
• Written plan document requirement under § 1.409A-1(c)(3)(ii). The plan must be established and maintained pursuant to a written plan document that complies with the requirements of § 409A and the regulations. The written document must specify the timing rules for deferral elections, including the deadline for initial elections and any exceptions.
  • § 1.409A-1(c)(3)(i) requires that the written plan document contain all material terms, including the payment events upon which distributions may be made and the timing of deferral elections.
  • § 1.409A-1(c)(3)(ii) requires that the plan be administered in accordance with the written document. Operational failures to follow the written plan document are treated as § 409A violations.
  • The plan document should specify the default payment event and form of payment if the participant fails to make a valid election.
• TRAP. Late initial elections are not permitted for ongoing plans. A participant who fails to make a timely initial deferral election before the year of service cannot later make an initial election for compensation attributable to services in that year unless the participant qualifies for the first-year eligibility exception, the performance-based compensation exception, or another applicable exception.
  • A common error is allowing a new employee to make a deferral election within 30 days of hire when the employee was previously eligible to participate in the plan or another aggregated plan. This results in a § 409A violation for all deferred amounts. See Step 3 on aggregation rules.
  • Another common error is permitting a participant to make a "prospective" election after the year has begun to defer compensation for services to be performed in the remainder of the year. Such elections violate the general rule and trigger § 409A penalties on all deferred amounts under the plan.

Step 3. The First Year of Eligibility Exception (30-Day Rule)

"In the case of an individual who first becomes eligible to participate in a nonqualified deferred compensation plan during a taxable year, [the general rule] shall not apply with respect to compensation which may be deferred under such plan if the election to defer is made before the close of the 30th day following the date the individual first becomes eligible." (IRC § 409A(a)(4)(B)(ii))

• The statutory first-year eligibility exception. § 409A(a)(4)(B)(ii) permits a service provider who first becomes eligible to participate in an NQDC plan to make an initial deferral election within 30 days after becoming eligible. This exception overrides the general rule that requires elections before the preceding taxable year ends. The exception is available only once per plan and applies only to compensation for services performed after the election is made.
  • The statutory exception is narrowly construed. Treasury Regulation § 1.409A-2(a)(6) imposes additional requirements beyond the statutory text, including a 24-month look-back rule and aggregation rules that limit its availability.
  • The 30-day period begins on the date the service provider first becomes eligible to participate in the plan, not on the date of hire or the date the service provider is notified of eligibility.
• Regulatory requirements under § 1.409A-2(a)(6). Treasury Regulation § 1.409A-2(a)(6) specifies that the exception applies only if the service provider was not eligible to participate in the plan (or any other plan that is required to be aggregated with the plan under § 1.409A-1(c)(2)) at any time during the 24-month period ending on the date the service provider first becomes eligible to participate in the current plan.
  • The 24-month look-back prevents an employee from terminating participation and then re-qualifying as newly eligible within two years. If the employee was eligible at any time during the 24 months, the exception does not apply.
  • The plan must designate the date on which eligibility begins. If the plan does not specify an eligibility date, the first day of the plan year in which the service provider meets the plan's eligibility requirements is the eligibility date.
• Who qualifies as "newly eligible". A service provider is newly eligible only if the service provider was not previously eligible to participate in the plan or any aggregated plan. This includes service providers who were previously eligible but declined to participate, service providers who previously participated and then ceased participation, and service providers who were eligible under a predecessor plan.
  • A service provider who becomes eligible due to a promotion, change in job classification, or satisfaction of a waiting period may qualify as newly eligible if the service provider was not previously eligible under the plan or any aggregated plan within the 24-month look-back period.
  • A service provider who becomes eligible upon a change in control, corporate transaction, or plan spin-off may or may not qualify, depending on whether the service provider was eligible under the predecessor or aggregated plan within the 24-month look-back.
• Compensation covered by the first-year eligibility election. An election made under the first-year eligibility exception applies only to compensation attributable to services performed after the election is made. Compensation earned for services performed before the election date cannot be deferred under this exception.
  • If the newly eligible service provider makes the election on day 15 of the 30-day window, compensation earned for services performed during the first 14 days cannot be deferred under this exception.
  • The plan may (but is not required to) provide that compensation earned during the portion of the taxable year before the election is made will be paid in cash and not eligible for deferral.
• TRAP. Previously eligible employees who declined participation are NOT newly eligible. A service provider who was previously eligible to participate in the plan but elected not to participate is not treated as newly eligible upon a subsequent decision to participate. The 24-month look-back rule in § 1.409A-2(a)(6) applies to eligibility, not actual participation.
  • This is one of the most common § 409A errors. Employers frequently treat an employee who was eligible in a prior year but did not enroll as a "new participant" eligible for the 30-day rule. This treatment causes a plan-wide violation.
  • To avoid this trap, the plan administrator must maintain records of eligibility dates for all service providers, not just those who actually enroll.
• TRAP. Sign-on bonuses generally cannot be deferred under this exception. A sign-on bonus or hiring bonus paid at the commencement of employment is typically compensation for services performed before the bonus is paid, and often relates to services performed before the 30-day election window. Because the first-year eligibility exception only covers services performed after the election, a sign-on bonus generally cannot be deferred under this exception unless the bonus is expressly contingent on services performed after the election date.
  • If the sign-on bonus is paid as an inducement to accept employment and is not contingent on future services, it is earned upon payment (or upon acceptance of employment) and cannot be deferred under any election timing rule because there is no future service to which the deferral can attach.
  • If the sign-on bonus is subject to a clawback or repayment requirement that constitutes a substantial risk of forfeiture under § 1.409A-1(d)(1), deferral may be possible if the bonus vests and becomes payable after the election date, provided the bonus is contingent on services performed after the election.
• The aggregation rule under § 1.409A-1(c)(2). All plans that are sponsored by the same service recipient and that are operated with a single document or that have coordinated deferral features are treated as a single plan for purposes of the newly eligible determination. If a service provider was eligible under any aggregated plan within the 24-month look-back period, the service provider is not newly eligible under the current plan.
  • § 1.409A-1(c)(2) requires aggregation of all NQDC plans of the same service recipient that permit deferral elections. Plans that have different deferral features or that cover different groups of service providers may also be aggregated if they are part of a single plan for administrative purposes.
  • Cross-reference to Step 9. A failure to properly aggregate plans and identify previously eligible service providers can result in a plan-wide § 409A violation, triggering immediate income inclusion, the 20% penalty, and premium interest for all affected participants.

Step 4. The Performance-Based Compensation Exception

"In the case of compensation that is attributable to services performed by a service provider over a period of at least 12 months, [the general rule] shall not apply if the election is made no later than 6 months before the end of such period." (IRC § 409A(a)(4)(B)(iii))

• The statutory performance-based compensation exception. § 409A(a)(4)(B)(iii) permits a deferral election to be made up to 6 months before the end of the performance period for performance-based compensation attributable to services performed over a period of at least 12 months. This exception allows later elections than the general rule because the compensation amount is not ascertainable until the performance period ends.
  • The exception applies only if all six regulatory requirements are satisfied. A failure to satisfy any one requirement means the general rule applies and the election must have been made before the year of service began.
  • The exception is most commonly used for annual bonuses, long-term incentive awards, and equity compensation that vests based on performance criteria.
• Regulatory requirements under § 1.409A-2(a)(7). Treasury Regulation § 1.409A-2(a)(7) imposes six cumulative requirements that must all be satisfied for compensation to qualify as performance-based compensation eligible for the later election deadline.
  • The requirements are designed to ensure that the compensation is truly contingent on future performance and that the amount is not ascertainable at the time of election. If any requirement is not met, the exception does not apply.
  • The 6-month deadline is measured from the end of the performance period, not from the payment date. For a calendar-year performance period ending December 31, the election deadline is June 30.
• The definition of performance-based compensation under § 1.409A-1(e)(1). Performance-based compensation is compensation the amount of which, or the entitlement to which, is contingent on the satisfaction of pre-established organizational or individual performance criteria relating to a performance period of at least 12 consecutive months.
  • The performance criteria must be established in writing by the compensation committee or the board of directors no later than 90 days after the commencement of the performance period. Criteria established after the 90-day deadline do not satisfy this requirement.
  • The performance criteria must state the specific performance goals that must be satisfied and the formula for computing the compensation payable upon satisfaction of those goals. Discretionary adjustments after the fact can destroy the performance-based character of the compensation.
• The six cumulative requirements. All six requirements must be satisfied for the performance-based compensation exception to apply.
  • 12-month performance period. The compensation must be attributable to services performed over a period of at least 12 consecutive months. A performance period of less than 12 months does not qualify, even if the compensation is contingent on performance criteria.
  • Pre-established criteria. The performance criteria must be established in writing before the service provider begins performing services toward satisfaction of the criteria, or no later than 90 days after the commencement of the performance period. The criteria must be sufficiently specific that a third party could determine whether the criteria have been satisfied.
  • Substantial uncertainty. The outcome of the performance criteria must be substantially uncertain at the time the criteria are established. If the attainment of the performance goals is virtually assured at the time they are established, the compensation is not performance-based.
  • Continuous service. The compensation must be contingent on the service provider performing services continuously from the date the criteria are established through the date the criteria are satisfied or the performance period ends. A new hire who joins mid-year generally cannot satisfy this requirement for a full-year performance period because the service provider did not perform services from the beginning of the period.
  • Not ascertainable at election deadline. The compensation must not be readily ascertainable at the time the deferral election is made. If the amount becomes substantially certain before the 6-month election deadline, the exception does not apply and the general rule requires an earlier election.
  • Organizational or individual criteria. The performance criteria must relate to the performance of the organization, a business unit, or the individual service provider. Criteria based on subjective evaluations or board discretion do not qualify unless the criteria are pre-established and objective.
• CAUTION. New hires often fail the continuous service requirement. A service provider who is hired after the commencement of the performance period generally cannot defer compensation under the performance-based compensation exception for that performance period because the service provider was not providing continuous services from the beginning of the period.
  • If the plan provides for a separate performance period that begins on or after the hire date and extends for at least 12 months, the exception may apply to compensation attributable to that later performance period.
  • An employer may inadvertently violate § 409A by allowing a mid-year hire to make a deferral election under the performance-based exception for the current calendar-year bonus cycle. The election is invalid because the continuous service requirement is not met.
• CAUTION. Compensation that becomes substantially certain before the election deadline loses the exception. If the performance criteria are satisfied, or if the outcome becomes substantially certain, before the 6-month election deadline, the compensation is no longer performance-based for purposes of the exception.
  • For example, if a performance goal based on EBITDA is achieved in August and the election deadline is September 30 (6 months before December 31 year-end), the compensation is ascertainable and the exception does not apply. The service provider should have made the election under the general rule or the first-year eligibility exception.
  • This issue commonly arises when performance periods are front-loaded or when performance goals are achieved early in the period due to unusual events such as acquisitions or market movements.

Step 5. Elections as to Time and Form of Payment

"A participant in a nonqualified deferred compensation plan may elect the time and form of payment of the deferred compensation only if the election is made in accordance with regulations prescribed by the Secretary." (IRC § 409A(a)(4)(A))

• The requirement that elections specify both time and form. Treasury Regulation § 1.409A-2(a)(8) requires that an initial deferral election specify both the time at which payment will be made and the form in which payment will be made. An election that specifies only the timing but not the form, or only the form but not the timing, does not satisfy § 409A.
  • The permissible forms of payment include a single lump sum, installments over a specified period, or annuity payments. The plan must specify which forms are available and any conditions applicable to each form.
  • If the plan offers multiple forms and the participant fails to elect a form, the plan must specify the default form of payment. The default must be set forth in the plan document before the deferral election is made.
• The six permissible payment events under § 409A(a)(2)(A) and § 1.409A-3(a). A plan may provide for payment of deferred compensation only upon one or more of six specified events. A payment made upon any other event violates the anti-acceleration rule of Step 7.
  • Separation from service. Payment upon the service provider's separation from service as defined in § 1.409A-1(h). For specified employees of publicly traded corporations, payment upon separation from service must be delayed for six months after separation. See § 409A(a)(2)(B)(i) and § 1.409A-3(i)(2).
  • A specified time or fixed schedule. Payment at a date certain, such as January 1 of the third year following the year of deferral, or upon attainment of a specified age. The date must be objectively determinable and specified in the plan or the election.
  • Death. Payment upon the death of the service provider. A plan may also provide for payment to a beneficiary after the service provider's death.
  • Disability. Payment upon the service provider's disability as defined in § 1.409A-3(i)(4). The regulatory definition requires either (i) inability to engage in substantial gainful activity by reason of a medically determinable physical or mental impairment expected to result in death or last at least 12 months, or (ii) the service provider is receiving income replacement benefits for at least three months under an employer plan.
  • Change in control. Payment upon a change in the ownership of the corporation, a change in the effective control of the corporation, or a change in the ownership of a substantial portion of the assets of the corporation. The definitions are specified in § 1.409A-3(i)(5).
  • Unforeseeable emergency. Payment upon an unforeseeable emergency as defined in § 1.409A-3(i)(3). An unforeseeable emergency is a severe financial hardship resulting from an illness or accident of the participant, the participant's spouse, or a dependent, loss of property due to casualty, or other similar extraordinary and unforeseeable circumstances beyond the control of the participant.
• The specified time or fixed schedule requirement. A plan may provide for payment at a specified date or pursuant to a fixed schedule, such as quarterly installments beginning on the third anniversary of the deferral. The specified time must be objectively determinable on the date of the initial deferral election.
  • A plan that provides for payment "at the discretion of the committee" or "when the participant requests" does not satisfy the specified time requirement and violates § 409A.
  • A fixed schedule must be described with sufficient specificity that the payment dates can be determined in advance. A schedule of "annual installments for 10 years beginning at retirement" is sufficient if retirement is defined as separation from service.
• The separation from service and six-month delay for specified employees. Under § 409A(a)(2)(B)(i) and § 1.409A-3(i)(2), a plan may provide for payment upon separation from service. However, if the service provider is a specified employee of a publicly traded corporation, payment upon separation from service must be delayed for six months after the separation date.
  • A specified employee is defined in § 1.409A-1(i) as an employee who is an officer with compensation greater than the adjusted limit under § 416(i)(1)(A)(i) ($230,000 for 2025, indexed for inflation), a 5% owner, or a 1% owner with compensation greater than $150,000. The determination is made as of the identification date (generally December 31) and applies for the 12-month period beginning on the first day of the fourth month following the identification date.
  • The six-month delay applies only to payments upon separation from service, not to payments upon other events. If a plan provides for payment upon the earlier of separation from service or age 65, and the specified employee separates before age 65, the six-month delay applies. If the specified employee attains age 65 while employed, the six-month delay does not apply.
• EXAMPLE. A properly structured initial election. Participant P is a calendar-year taxpayer employed by Corporation C. On December 15, 2024, P makes an initial deferral election for 2025 compensation under C's NQDC plan. The election specifies that (i) 50% of P's 2025 salary will be deferred, (ii) payment will be made upon P's separation from service, and (iii) payment will be in the form of a single lump sum. Because the election was made before the end of the preceding taxable year (2024), specifies the compensation to be deferred, and designates both the time and form of payment, the election satisfies § 409A(a)(4)(B)(i) and § 1.409A-2(a)(5).
  • If P separates from service on March 15, 2030, and P is a specified employee as of the identification date, payment must be delayed until September 15, 2030, unless the plan specifies a later date.
  • If P is not a specified employee, payment is made on March 15, 2030, or as soon as administratively practicable thereafter, provided the plan so specifies.

Step 6. Subsequent Deferral Elections Under § 1.409A-2(b)

Step 6A. The Three-Requirement Framework

"[A plan may permit a participant to make a subsequent deferral election] provided that such election may not take effect until at least 12 months after the date on which the election is made and such election requires that the payment be deferred for a period of not less than 5 years from the date such payment would otherwise have been made." (IRC § 409A(a)(4)(C))

• The statutory framework for subsequent elections. § 409A(a)(4)(C) permits a participant to change a previous deferral election only if the change satisfies three cumulative requirements. Treasury Regulation § 1.409A-2(b)(1) elaborates on these requirements and adds specificity. All three requirements must be satisfied simultaneously. A change that satisfies only one or two requirements violates § 409A.
  • The subsequent election rules apply to any change in the time or form of payment, including a change from a lump sum to installments, a change from payment at age 65 to payment at age 70, or a change from payment upon separation to payment upon death.
  • A subsequent election that accelerates payment to an earlier date is generally prohibited under the anti-acceleration rule of Step 7, even if the three requirements are satisfied.
• Requirement 1. The 12-month waiting period under § 1.409A-2(b)(1)(i). The subsequent election must not take effect until at least 12 months after the date the election is made. If the election is made on March 1, 2025, the change cannot take effect before March 1, 2026.
  • The 12-month waiting period applies from the date of the election, not from the date the election is submitted or received. The plan should specify how the election date is determined.
  • If the original payment date would occur within the 12-month waiting period, the subsequent election is invalid because it cannot satisfy the 12-month delay requirement.
• Requirement 2. The 5-year delay under § 1.409A-2(b)(1)(ii). The subsequent election must delay the payment for at least 5 years from the date payment would otherwise have been made. If the original election provided for payment on January 1, 2030, the subsequent election must provide for payment no earlier than January 1, 2035.
  • The 5-year delay is measured from the originally scheduled payment date, not from the date of the subsequent election. If the original payment date is January 1, 2027, and the subsequent election is made on March 1, 2025, the new payment date must be no earlier than January 1, 2032.
  • The 5-year delay applies to each payment in a series of installment payments unless the plan provides otherwise. See Step 6C on installment payment treatment.
• Requirement 3. The 12-month advance election for scheduled payments under § 1.409A-2(b)(1)(iii). If the payment event is a specified time or fixed schedule, the subsequent election must be made at least 12 months before the date the first scheduled payment would otherwise be made. If the first payment is scheduled for January 1, 2030, the subsequent election must be made on or before December 31, 2028.
  • This requirement does not apply to subsequent elections that change the payment event from a specified time to separation from service, death, disability, or change in control. The 12-month advance election applies only when the original payment event is a specified time or fixed schedule.
  • If the subsequent election is made after the 12-month deadline, the election is invalid even if it satisfies the other two requirements.
• The three requirements must be satisfied simultaneously. A valid subsequent election must satisfy all three requirements at the same time. An election that satisfies the 12-month waiting period and the 5-year delay but is made within 12 months of the first scheduled payment is invalid.
  • A plan that permits subsequent elections without ensuring all three requirements are met violates § 409A. The plan document should include administrative procedures to verify compliance with each requirement.
  • Cross-reference to Step 9. An invalid subsequent election is treated as an operational failure that can trigger immediate income inclusion, the 20% penalty, and premium interest for the affected participant.

Step 6B. The 5-Year Delay Exception for Death, Disability, and Unforeseeable Emergency

• The exception for death, disability, and unforeseeable emergency under § 1.409A-2(b)(1)(ii). Treasury Regulation § 1.409A-2(b)(1)(ii) provides that the 5-year delay requirement does not apply to a subsequent election that changes the payment event to death, disability, or an unforeseeable emergency. The subsequent election must still satisfy the 12-month waiting period and, if applicable, the 12-month advance election requirement.
  • This exception acknowledges that death, disability, and unforeseeable emergencies are unplanned events and that requiring a 5-year delay would frustrate the purpose of allowing payment upon such events.
  • A subsequent election to change the payment event to separation from service or a change in control does not qualify for this exception and must satisfy the full 5-year delay requirement.
• Requirements that still apply. A subsequent election that changes the payment event to death, disability, or unforeseeable emergency must still satisfy the 12-month waiting period of § 1.409A-2(b)(1)(i).
  • If the original payment event is a specified time or fixed schedule, the subsequent election must also be made at least 12 months before the first scheduled payment date under § 1.409A-2(b)(1)(iii).
  • The exception applies only to the 5-year delay requirement. It does not permit acceleration of payment to an earlier date in violation of the anti-acceleration rule.

Step 6C. The Definition of "Payment" for Subsequent Elections

• The general rule under § 1.409A-2(b)(2)(i). For purposes of the subsequent election requirements, the term "payment" generally means each separately identified amount to which the service provider is entitled. A single sum payment is one payment. Each installment in a series of installment payments is treated as a separate payment unless the plan provides otherwise.
  • The general rule allows a service provider to make a subsequent election as to a single installment in a series without affecting the other installments, provided the election satisfies the three requirements.
  • If the plan does not designate how installment payments are treated, the default rule of § 1.409A-2(b)(2)(iii) applies.
• The installment payment default rule under § 1.409A-2(b)(2)(iii). Treasury Regulation § 1.409A-2(b)(2)(iii) provides that if a plan provides for installment payments and does not designate whether the installment series is treated as a single payment or as separate payments, the installment series is treated as a single payment for purposes of subsequent elections.
  • This means that a subsequent election to change the timing of one installment in an undesignated series is treated as an election to change the entire series. The 5-year delay must be measured from the first scheduled installment, and the 12-month advance election must be made before the first scheduled installment.
  • This default rule can significantly limit a participant's flexibility to make subsequent elections regarding installment payments.
• Critical planning point. Designation in writing at the time of initial deferral. A plan may provide that each installment in a series is treated as a separate payment by so designating in the plan document and in the participant's initial deferral election. This designation must be made in writing at the time of the initial deferral election.
  • If the plan and the election form clearly state that each installment is a separate payment, a participant may subsequently elect to change the timing of a single installment without affecting the others, provided the three requirements are satisfied with respect to that installment.
  • This designation is a critical planning tool for participants who want maximum flexibility to make subsequent elections regarding installment payments. Practitioners should ensure that the plan document and election forms include this designation for any plan offering installment payments.
• TRAP. Failure to designate means the entire installment series is a single payment. If the plan does not designate installment payments as separate payments at the time of the initial deferral election, the entire installment series is treated as a single payment.
  • This means that a participant who wants to delay a single installment must satisfy the 5-year delay requirement measured from the first scheduled installment, not from the installment being changed. If the first installment is scheduled for January 1, 2027, the subsequent election must provide for payment no earlier than January 1, 2032, even if the participant is only seeking to change the timing of the fifth installment.
  • This trap is particularly problematic for plans that offer a series of annual installment payments beginning at retirement. Participants often assume they can change individual installments, but without the proper designation, the entire series is locked in.

Step 7. The Anti-Acceleration Rule and Permitted Exceptions

"The requirements of this paragraph are met if the plan does not permit the acceleration of the time or schedule of any payment under the plan, except as provided in regulations by the Secretary." (IRC § 409A(a)(3))

• The statutory prohibition on acceleration. § 409A(a)(3) prohibits a plan from permitting the acceleration of the time or schedule of any payment. This prohibition applies to all NQDC plans and is absolute except for the specific exceptions enumerated in the regulations.
  • Treasury Regulation § 1.409A-3(j)(1) restates the prohibition and clarifies that an acceleration includes any change that causes a payment to be made at an earlier date than originally scheduled, any change that adds a new payment event that is earlier than the originally scheduled event, and any change that shortens the period over which installment payments are made.
  • The anti-acceleration rule applies to all payments under the plan, not just payments to the participant who requested the acceleration. A plan amendment that accelerates payments for all participants is an acceleration violation.
• What constitutes acceleration under § 1.409A-3(j)(1). Treasury Regulation § 1.409A-3(j)(1) identifies several actions that constitute impermissible acceleration.
  • Changing the payment event from a later event to an earlier event, such as changing from payment at age 65 to payment upon the earlier of age 65 or separation from service, is an acceleration.
  • Shortening the period over which installment payments are made, such as changing from 10 annual installments to 5 annual installments, is an acceleration even if the first payment date does not change.
  • Adding a new payment trigger that could result in payment at an earlier time, such as adding an unforeseeable emergency withdrawal provision that did not exist in the original election, is an acceleration.
  • A plan amendment that permits participants to elect to accelerate payments is itself an acceleration violation, even if no participant actually makes such an election.
• Permitted acceleration exceptions under § 1.409A-3(j)(4). Treasury Regulation § 1.409A-3(j)(4) enumerates specific exceptions to the anti-acceleration rule. These exceptions are narrowly construed and apply only in the specific circumstances described.
  • Domestic relations orders. A payment may be accelerated to comply with a domestic relations order, as defined in § 414(p)(1)(B), that assigns a right to deferred compensation to a spouse, former spouse, child, or other dependent. The payment must be made to the person specified in the order.
  • Conflicts of interest and ethics laws. A payment may be accelerated to comply with a requirement under federal, state, local, or foreign ethics or conflicts of interest law. The acceleration must be necessary to comply with the specific legal requirement, and the law must mandate divestiture or disclosure that cannot be satisfied without acceleration.
  • De minimis cashouts. A payment may be accelerated if the present value of the total deferred compensation balance does not exceed the § 402(g) limit for the year (for 2024, $23,000). The cashout must include all amounts deferred under the plan and all aggregated plans.
  • FICA tax payments. A payment may be accelerated to the extent necessary to pay FICA taxes on the deferred compensation. The payment may not exceed the amount of FICA taxes due and the income taxes resulting from the FICA payment.
  • Income tax payments due to § 409A inclusion. A payment may be accelerated to the extent necessary to pay income taxes due as a result of a § 409A inclusion. The payment may not exceed the amount of income taxes due on the includible amount.
  • Plan termination and liquidation. A payment may be accelerated upon the termination and liquidation of the plan under § 1.409A-3(j)(4)(ix), provided the termination meets the requirements for a limited termination or a termination upon a change in control.
• Elections to accelerate distributions under § 1.409A-2(d). Treasury Regulation § 1.409A-2(d) provides that a participant may not elect to accelerate the time or schedule of any payment under an NQDC plan. This prohibition applies to elections, agreements, or other actions that have the effect of accelerating a payment.
  • A participant may not waive a requirement that must be satisfied before payment is made if the waiver would result in an earlier payment. For example, a participant may not waive a requirement that payment is contingent on the participant providing consulting services for two years after separation if the waiver would result in earlier payment.
  • A participant may not elect to receive a payment in a form other than the elected form if the new form would result in an earlier payment. For example, a participant may not elect to receive a lump sum in lieu of installments if the lump sum would be paid earlier than the first installment.
• CAUTION. Any modification that adds an earlier payment trigger is a violation. A plan amendment or participant election that adds a payment event that is earlier than the originally scheduled payment event constitutes an impermissible acceleration, even if the new event is one of the six permissible payment events.
  • For example, if a plan provides for payment at age 65 and is amended to provide for payment upon the earlier of age 65 or separation from service, the amendment violates the anti-acceleration rule because separation from service could occur before age 65.
  • Similarly, if a plan provides for payment upon disability and is amended to provide for payment upon the earlier of disability or a change in control, the amendment violates the rule because a change in control could occur before disability.

Step 8. Separation Pay Elections and Special Timing Rules

• The arms-length negotiation exception for separation pay. Compensation paid upon or after separation from service that is the result of bona fide, arms-length negotiations between the service provider and the service recipient may be deferred under special timing rules. The negotiations must occur at or after the time of separation and must relate to compensation that would not otherwise be deferred.
  • The exception applies only to separation pay that is not part of the regular NQDC plan. If the separation pay is part of the plan, the general election timing rules apply.
  • The exception requires that the negotiations be truly arms-length. A pre-existing agreement that specifies the terms of separation pay is not the result of arms-length negotiations at the time of separation.
• Involuntary separation from service and "good reason" requirements under § 1.409A-1(n). Treasury Regulation § 1.409A-1(n) defines involuntary separation from service for purposes of determining when payment upon involuntary separation is permissible. A separation is involuntary if the service recipient terminates the service relationship, or if the service provider terminates the relationship for "good reason" that meets the regulatory requirements.
  • For a "good reason" resignation to qualify as an involuntary separation, the resignation must result from one or more specified conditions that are set forth in writing no later than the date of the initial deferral election. The conditions must relate to actions taken by the service recipient that materially and adversely affect the service provider's employment relationship.
  • The service provider must provide notice to the service recipient within a specified period (not to exceed 90 days) after the condition arises, and the service recipient must have a cure period (not less than 30 days) to remedy the condition.
• TRAP. Good reason resignation must be specified in writing at the time of initial deferral. If the plan permits payment upon involuntary separation from service including a "good reason" resignation, the conditions that constitute "good reason" must be specified in writing no later than the date the participant makes the initial deferral election.
  • A plan that allows the participant and employer to agree on "good reason" conditions at the time of separation violates § 409A because the agreement at separation effectively constitutes a late deferral election.
  • Practitioners should ensure that the plan document or the participant's initial deferral election includes a detailed list of the conditions that constitute "good reason," such as a material reduction in base salary, a material reduction in duties or responsibilities, a required relocation of more than 50 miles, or a material breach of the employment agreement.
• The short-term deferral exception for separation pay conditioned on a release under § 1.409A-1(b)(4)(ii). Treasury Regulation § 1.409A-1(b)(4)(ii)(B) provides that compensation is not treated as deferred compensation subject to § 409A if the service provider becomes entitled to the compensation only upon separation from service and the payment is conditioned on the service provider executing a release of claims, complying with a non-compete, or satisfying a similar condition, provided the release or covenant can be satisfied and the payment can be made within the short-term deferral period or comply with a non-compete or similar covenant.
  • The exception applies only if the release or covenant can be satisfied and the payment can be made within the short-term deferral period (2.5 months after the end of the taxable year of separation). If the release or covenant period extends beyond the short-term deferral period, the compensation is deferred compensation subject to § 409A.
  • This exception is commonly used for separation pay that is conditioned on the execution of a release of claims. If the release must be executed within 45 days after separation and the payment is made within 60 days after the release is executed, the compensation may qualify for the exception.
• The ad hoc bonus election exception. An ad hoc bonus that is not part of a regular bonus program and that is not performance-based compensation may be deferred under a special election timing rule if the bonus is not earned until the date it is awarded. If the employer has complete discretion to award or not award the bonus, and the bonus is not part of a plan or arrangement that creates a legally binding right, the bonus may be deferred if the election is made before the bonus is awarded.
  • This exception is narrow and applies only to truly discretionary bonuses. A bonus that is part of a regular program, that is based on pre-established criteria, or that the employer has a past practice of awarding, does not qualify.
  • The election must be made before the bonus is awarded and before the service provider has a legally binding right to the bonus. An election made after the bonus is announced or after the employer commits to pay the bonus is too late.

Step 9. Consequences of Non-Compliance with Election Timing Rules

"If at any time during a taxable year a nonqualified deferred compensation plan... fails to meet the requirements of paragraphs (2), (3), and (4), or is not operated in accordance with such requirements, all compensation deferred under the plan for the taxable year and all preceding taxable years shall be includible in gross income for the taxable year." (IRC § 409A(a)(1)(A)(i))

• Immediate income inclusion under § 409A(a)(1)(A)(i). If an NQDC plan fails to comply with the election timing requirements of § 409A(a)(4), all amounts deferred under the plan for the taxable year and all prior taxable years are includible in the participant's gross income for the taxable year in which the failure occurs. This inclusion applies to all deferred amounts, not just the amounts attributable to the failed election.
  • The income inclusion applies even if the amounts are not yet vested or are subject to a substantial risk of forfeiture. The normal rules of § 83 that defer taxation until vesting do not apply to § 409A failures.
  • The income inclusion applies to all amounts deferred under the plan and all aggregated plans. See the taint rule discussion below.
• The 20% additional tax under § 409A(a)(1)(B)(i). In addition to regular income tax, a participant who has a § 409A inclusion must pay an additional tax equal to 20% of the amount required to be included in gross income. This tax is a penalty and is not deductible.
  • The 20% tax applies to the full amount includible under § 409A(a)(1)(A)(i), including amounts that were previously taxed or that would have been taxed in the current year even without the § 409A failure.
  • The 20% tax is reported on Form 1040 and is not subject to withholding. The participant is responsible for making estimated tax payments to cover the additional tax.
• The premium interest tax under § 409A(a)(1)(B)(ii). The participant must also pay interest at the underpayment rate under § 6621 plus 1 percentage point on the amount of the § 409A inclusion. The interest is calculated from the date the compensation should have been includible in gross income if the plan had not been a deferred compensation plan.
  • For amounts deferred in prior years, the interest is calculated from the date the compensation would have been paid if it had not been deferred. This can result in a significant interest charge for long-term deferrals.
  • The premium interest is not deductible. The rate is the federal short-term rate plus 3 percentage points (the standard underpayment rate) plus an additional 1 percentage point, for a total of the federal short-term rate plus 4 percentage points.
• The taint rule and plan aggregation under § 1.409A-1(c)(2). Treasury Regulation § 1.409A-1(c)(2) requires that all NQDC plans of the same service recipient that are aggregated for purposes of the newly eligible determination in Step 3 are also aggregated for purposes of the income inclusion rule. A failure in one aggregated plan can trigger income inclusion for all amounts deferred under all aggregated plans.
  • The taint rule means that a single election timing failure in one plan can cause all deferred amounts under all plans to be immediately includible in income, subject to the 20% penalty and premium interest.
  • Plans that are not aggregated are treated separately. A failure in one non-aggregated plan does not trigger income inclusion for amounts deferred under another non-aggregated plan.
• Only affected participants are taxed under § 409A(a)(1)(A)(ii). § 409A(a)(1)(A)(ii) provides that the income inclusion applies only to participants for whom the plan fails to meet the requirements of § 409A. Participants who are not affected by the failure do not have income inclusion.
  • However, because of the aggregation rule, a failure that affects the plan as a whole can trigger income inclusion for all participants in the plan, not just the participant who made the failed election.
  • A plan-wide failure, such as a plan amendment that permits late elections for all participants, affects all participants and triggers income inclusion for all.
• CAUTION. One small failure can trigger taxation of the entire plan balance. Because of the aggregation rule and the plan-wide nature of many election timing failures, a single administrative error can result in immediate taxation of all deferred amounts for all participants.
  • For example, if a plan administrator allows one newly hired employee to make a late initial election under the first-year eligibility exception when the employee was previously eligible under an aggregated plan, the entire plan fails for that employee. If the plan is aggregated with other plans, the failure can trigger income inclusion for all amounts deferred under all aggregated plans for that employee.
  • Practitioners should implement robust administrative procedures to verify eligibility and election timing for every deferral election.
• State tax consequences. Several states have enacted additional penalties for § 409A failures. California imposes an additional 5% penalty on § 409A inclusions under AB 1173, which adds California Revenue and Taxation Code § 17581.5. This penalty is in addition to the federal 20% penalty and applies to California residents.
  • Other states may have similar penalties or may conform to the federal § 409A rules. Practitioners should check the laws of the state in which the participant resides.
  • The state penalties are generally not deductible for federal or state income tax purposes.

Step 10. IRS Correction Programs for Election Timing Failures

Step 10A. Notice 2008-113 Operational Failure Corrections

• Same-year correction under Section IV of Notice 2008-113. If an operational failure is corrected in the same taxable year in which it occurs, there is no income inclusion and no penalties. The correction must be made by reversing the failed transaction and placing the participant in the same position as if the failure had not occurred.
  • A same-year correction is available only if the failure is discovered and corrected before the end of the taxable year. For calendar-year taxpayers, the deadline is December 31.
  • The correction must be inadvertent and unintentional. A deliberate failure to comply with § 409A cannot be corrected under this program.
• Next-year correction under Section V of Notice 2008-113. If an operational failure is corrected in the taxable year following the year of failure, there is no income inclusion if the participant is not a "currently insiders" as defined in the notice. A currently insider is a corporate officer, director, or 10% owner.
  • The next-year correction is available only for non-insiders. Insiders must use the limited amount correction or the general correction method.
  • The correction must be made by including the correct amount in the participant's income in the year it should have been included and by adjusting the deferred amount accordingly.
• Limited amount correction under Section VI of Notice 2008-113. If the failed amount does not exceed the lesser of the participant's annual includible compensation or two times the § 402(g) limit for the year, the correction results in inclusion of only the failed amount, plus the 20% additional tax, but no premium interest.
  • The limited amount correction is available only if the failure relates to a single deferral election and the amount is within the limit. Multiple failures may not be aggregated for this purpose.
  • The 20% tax applies to the failed amount even though the correction is made under the program.
• Other failures within 2 years under Section VII of Notice 2008-113. For other operational failures that are corrected within 2 years of the failure, the correction results in inclusion of the failed amount, plus the 20% additional tax, but no premium interest.
  • This correction method is available for failures that do not qualify for the same-year, next-year, or limited amount corrections.
  • The 2-year period begins on the date of the failure.
• Requirements for all corrections under Notice 2008-113. All corrections under Notice 2008-113 must satisfy the following requirements.
  • The failure must be inadvertent and unintentional. A pattern or practice of failures indicates intentional noncompliance.
  • The plan must not be under IRS examination at the time of correction. If the plan comes under examination after correction, the correction is valid if it was made in good faith.
  • The employer must take commercially reasonable steps to prevent similar failures in the future.

Step 10B. Notice 2010-6 Document Failure Corrections

• Correction before operation affected under Notice 2010-6. If a document failure is discovered and corrected before any participant's tax liability is affected, there is no income inclusion. A document failure is a plan provision that does not comply with § 409A, such as a provision that permits late elections.
  • The correction must be made by amending the plan to bring it into compliance and by operating the plan in accordance with the corrected provisions.
  • This correction is available only if no participant has relied on the faulty provision or has been affected by it.
• Correction after operation affected under Notice 2010-6. If a document failure is discovered after a participant's tax liability has been affected, the correction results in inclusion of either 50% or 25% of the affected amount, depending on the type of failure.
  • For failures relating to payment events, the inclusion is 50% of the affected amount. For failures relating to election timing, the inclusion is 25% of the affected amount.
  • The reduced inclusion is available only if the correction is made within a specified period and the failure was inadvertent.
• First plan of type exception. Notice 2010-6 provides an exception for the first plan of a particular type sponsored by an employer. If the employer has not previously sponsored an NQDC plan of the same type, the correction requirements are less stringent.
  • The first plan exception applies separately to account balance plans, non-account balance plans, and separation pay plans.
  • The exception is available only for the first plan of each type, not for subsequent plans.
• Transition relief. Notice 2010-6 and Notice 2010-80 provided transition relief that allowed employers to correct document failures through December 31, 2012. This transition relief has expired.
  • Employers that did not correct document failures before the expiration of the transition relief must now correct failures under the standard correction methods.
  • Practitioners should verify that all document failures were corrected before the transition relief expired.

Step 10C. When Corrections Are Unavailable

• IRS examination. The correction programs are not available if the plan is under IRS examination at the time of correction. An examination includes an audit, a request for information, or any other contact from the IRS that indicates the plan is under review.
  • If a plan comes under examination after a correction is made, the correction is generally valid if it was made in good faith and in accordance with the notice requirements.
  • Employers should correct failures as soon as they are discovered to avoid losing the correction opportunity due to an examination.
• Intentional failures. The correction programs are available only for inadvertent and unintentional failures. A failure that is deliberate, willful, or part of a pattern of noncompliance cannot be corrected under the programs.
  • A pattern or practice of election timing failures indicates intentional noncompliance. A single isolated failure is more likely to be treated as inadvertent.
  • The employer must demonstrate that it has procedures in place to prevent failures and that the failure was an anomaly.
• Pattern or practice of violations. A pattern or practice of § 409A violations disqualifies the plan from the correction programs. A pattern or practice exists if there are multiple failures of the same type within a short period, or if the employer has a history of noncompliance.
  • Two or more failures of the same type within a 3-year period may be treated as a pattern or practice.
  • Employers should maintain records of all corrections and the steps taken to prevent future failures.
• After 2-year deadline. The correction programs generally require that failures be corrected within 2 years of the failure date. Failures that are not corrected within 2 years cannot be corrected under the standard programs.
  • The 2-year period begins on the date of the failure, not on the date the failure is discovered.
  • Late corrections may still be made, but they do not prevent income inclusion and penalties.

Step 11. Coordination with Other Code Sections

• § 162(m) and the TCJA "forever a covered employee" rule. § 162(m) limits the deduction for compensation paid to covered employees to $1 million per year. The TCJA amended § 162(m) to eliminate the performance-based compensation exception and to provide that once an employee is a covered employee for any taxable year beginning after December 31, 2016, the employee remains a covered employee for all future years.
  • Notice 2018-68, 2018-41 I.R.B. 601, provides transition guidance on the TCJA amendments to § 162(m). The notice clarifies that the "forever a covered employee" rule applies to all deferred compensation paid to a former covered employee, even if the compensation was earned before the employee became a covered employee.
  • A deferral election that defers compensation beyond the date the participant becomes a covered employee may result in the loss of the deduction under § 162(m). Practitioners should coordinate § 409A deferral elections with § 162(m) planning.
• § 280G golden parachute and § 4999 excise tax interaction. § 280G disallows a deduction for excess parachute payments, and § 4999 imposes a 20% excise tax on the recipient of excess parachute payments. A payment upon a change in control that is contingent on the change in control may be a parachute payment under § 280G.
  • A deferral election that provides for payment upon a change in control may trigger § 280G and § 4999 if the payment, together with other payments contingent on the change in control, exceeds three times the participant's base amount.
  • Practitioners should structure deferral elections to minimize the risk of § 280G and § 4999 exposure, such as by providing for payment upon a change in control only if the payment does not constitute a parachute payment.
• § 3121(v)(2) FICA special timing rule and non-duplication rule. § 3121(v)(2) provides a special timing rule for FICA tax purposes that allows deferred compensation to be treated as wages for FICA purposes at the later of when the services are performed or when the amount is no longer subject to a substantial risk of forfeiture.
  • The non-duplication rule provides that if an amount is taken into account for FICA purposes under the special timing rule, it is not taken into account again when paid. This rule prevents double FICA taxation.
  • A § 409A failure that triggers income inclusion does not automatically trigger FICA inclusion. FICA taxes are due only if the amount was not previously taken into account under the special timing rule.
• § 83(b) elections and RSUs. A § 83(b) election allows a service provider to include the value of property subject to a substantial risk of forfeiture in income at the time of transfer rather than at vesting. However, a § 83(b) election cannot be made with respect to a restricted stock unit (RSU) because an RSU is a mere unfunded promise to pay stock in the future and is not a transfer of property within the meaning of § 83.
  • An attempt to make a § 83(b) election with respect to an RSU is invalid and does not affect the timing of income inclusion. The compensation is deferred compensation subject to § 409A unless it qualifies for the short-term deferral exception.
  • Practitioners should advise clients that RSUs are subject to § 409A (or the short-term deferral exception) and that § 83(b) elections are not available.
• § 409A(b) offshore rabbi trust and financial health trigger rules. § 409A(b) imposes additional restrictions on NQDC plans that use offshore rabbi trusts or that provide for payment upon the employer's financial distress.
  • An offshore rabbi trust arrangement, where assets are held outside the United States and are restricted from use by the employer, triggers immediate income inclusion under § 409A(b)(1).
  • A financial health trigger, where payment is accelerated upon a decline in the employer's financial condition, is generally prohibited under § 409A(b)(2) and (3).
  • These rules are in addition to the election timing rules and apply independently of whether the plan satisfies § 409A(a).
• Rev. Rul. 60-31 (unfunded promise to pay). Rev. Rul. 60-31, 1960-1 C.B. 174, holds that an unfunded, unsecured promise to pay compensation in a future year is not current compensation for federal income tax purposes. The service provider does not have a current economic benefit because the promise is merely the employer's personal obligation.
  • Rev. Rul. 60-31 is the foundational authority for NQDC arrangements. However, § 409A overrides the common law rules of constructive receipt and economic benefit for deferred compensation and imposes its own strict requirements.
  • A plan that satisfies the common law rules of Rev. Rul. 60-31 may still violate § 409A if it does not comply with the election timing, payment event, and anti-acceleration requirements.

Step 12. Documentation and Reporting Obligations

• Written plan document requirements under § 1.409A-1(c)(3). Treasury Regulation § 1.409A-1(c)(3) requires that every NQDC plan be established and maintained pursuant to a written plan document. The document must contain all material terms of the plan, including the eligibility requirements, the timing rules for deferral elections, the permissible payment events, and the default time and form of payment.
  • § 1.409A-1(c)(3)(i) requires that the written document be in place by the date the plan is established. A plan that is operated without a written document violates § 409A from the date of its inception.
  • § 1.409A-1(c)(3)(ii) requires that the plan be administered in accordance with its written terms. Operational deviations from the written document are § 409A violations.
  • § 1.409A-1(c)(3)(iii) requires that the plan document specify the payment events upon which distributions may be made. A plan that permits distributions upon events other than the six permissible events violates § 409A.
• Form W-2 Box 12 Code Z for § 409A income. An employer must report all amounts includible in income under § 409A on Form W-2, Box 12, using Code Z. This includes amounts that are currently includible because of a § 409A failure and amounts that are includible because of a permissible payment event.
  • Code Z reports the total amount includible under § 409A, including both the compensation amount and any earnings thereon. The amount reported in Code Z is also included in Box 1 (wages) for income tax withholding purposes.
  • The employer must issue Form W-2 with Code Z by January 31 of the year following the year of inclusion.
• Form 1099-MISC Box 14 for non-employees. For non-employee service providers, includible § 409A amounts are reported on Form 1099-MISC, Box 14. The reporting requirements for non-employees are similar to those for employees, but the forms differ.
  • Box 14 reports the total amount includible under § 409A for non-employees. The amount is also reported in Box 7 (nonemployee compensation) if it is subject to self-employment tax.
  • The payer must issue Form 1099-MISC by January 31 of the year following the year of inclusion.
• Notice 2008-115 reporting guidance. Notice 2008-115 provides guidance on the reporting of § 409A amounts. The notice clarifies that Code Z is used for all § 409A inclusions, including inclusions due to plan failures, permissible distributions, and plan terminations.
  • The notice also provides guidance on reporting earnings on deferred amounts. Earnings that are includible under § 409A are reported in Code Z along with the principal amount.
  • Employers must maintain records sufficient to support the amounts reported in Code Z in the event of an IRS examination.
• Employer withholding obligations. An employer must withhold federal income tax on amounts includible under § 409A. However, the employer is not required to withhold the 20% additional tax or the premium interest tax. These taxes are the participant's responsibility and are reported on the participant's individual income tax return.
  • The employer must withhold federal income tax at the supplemental wage rate (currently 22% for supplemental wages up to $1 million) on § 409A inclusions.
  • The employer must also withhold state and local income taxes as required by applicable law.
• Publication 957 reporting back pay to SSA. IRS Publication 957 provides guidance on reporting back pay and deferred compensation to the Social Security Administration (SSA). An employer must report § 409A inclusions to the SSA if the inclusions constitute wages for FICA purposes.
  • The employer must file Form W-2 with the SSA by the applicable deadline, including the Code Z amount in Box 12.
  • If the § 409A inclusion relates to a prior year, the employer may need to file a corrected Form W-2 for the prior year.
• Retention of election forms and deferral agreements. An employer must retain all deferral election forms, deferral agreements, and plan amendments for the duration of the deferral period plus at least 7 years after the final payment is made. These records are essential for demonstrating compliance with § 409A in the event of an IRS examination.
  • Election forms should be retained in their original form, with evidence of the date received and the date approved.
  • Plan amendments should be retained with evidence of the effective date and the date communicated to participants.
• Annual specified employee identification process. An employer must identify its specified employees annually as of the identification date (generally December 31) and must apply the specified employee determination for the 12-month period beginning on the first day of the fourth month following the identification date.
  • The employer must maintain records of the specified employee determination, including the methodology used and the employees identified.
  • A publicly traded employer that fails to identify its specified employees may violate the six-month delay requirement and trigger § 409A penalties.
• EXAMPLE. Reporting timeline for a § 409A inclusion. Participant P has a § 409A inclusion of $100,000 in 2024 due to an election timing failure. The employer must (i) include the $100,000 in P's Form W-2, Box 1 (wages), (ii) report the $100,000 in Box 12, Code Z, (iii) withhold federal income tax at the supplemental wage rate, (iv) issue Form W-2 to P by January 31, 2025, and (v) file Form W-2 with the SSA by March 31, 2025 (or earlier if e-filing). P must report the $100,000 inclusion on P's 2024 Form 1040, pay the 20% additional tax ($20,000) on Schedule 2, and pay the premium interest tax calculated from the date the compensation should have been included. The employer is not required to withhold the $20,000 additional tax or the premium interest tax.