Executive Compensation | Just Tax

§ 409A Permissible Payment Events and Specified Employee Delay (§ 409A(a)(2); Reg. § 1.409A-3(i)(5))

This checklist guides the analysis of when a nonqualified deferred compensation plan may permissibly make payments to a service provider under IRC § 409A(a)(2) and whether a specified employee of a publicly traded corporation must wait six months after separation from service before receiving deferred amounts. Use this checklist when reviewing plan documents, advising on distribution timing, or determining whether a proposed payment trigger complies with § 409A.

Step 1. The Six Permissible Payment Events

"The requirements of this paragraph are met if the plan provides that compensation deferred under the plan may not be distributed earlier than (i) separation from service as determined by the Secretary (except as provided in subparagraph (B)(i)), (ii) the date the participant becomes disabled (within the meaning of subparagraph (C)), (iii) death, (iv) a specified time (or pursuant to a fixed schedule) specified under the plan at the date of the deferral of such compensation, (v) to the extent provided by the Secretary, a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation, or (vi) the occurrence of an unforeseeable emergency." (IRC § 409A(a)(2)(A))

• The six events are exclusive and exhaustive.
  • A nonqualified deferred compensation plan may permit distributions only upon one or more of the six events listed in § 409A(a)(2)(A)(i) through (vi). (IRC § 409A(a)(2)(A))
  • No other event qualifies as a permissible payment trigger. A plan that allows payment upon any other condition fails § 409A(a)(2) in its entirety. (Treas. Reg. § 1.409A-3(a)(1))
  • The plan may designate payment upon the earliest of several permissible events, the latest of several permissible events, or any objectively determinable combination. (Treas. Reg. § 1.409A-3(b))
  • TRAP. A plan that provides for payment upon "retirement" without defining retirement as one of the six permissible events violates § 409A. The term "retirement" is not itself a permissible event.
• The anti-acceleration prohibition constrains all six events.
  • § 409A(a)(3) prohibits any acceleration of the time or schedule of any payment under the plan, except as provided in regulations. (IRC § 409A(a)(3))
  • Treas. Reg. § 1.409A-3(j)(1) provides that except as provided in paragraph (j)(4), a nonqualified deferred compensation plan may not permit the acceleration of the time or schedule of any payment or amount scheduled to be paid pursuant to the terms of the plan, and no such accelerated payment may be made whether or not provided for under the terms of such plan. (Treas. Reg. § 1.409A-3(j)(1))
  • Adding death, disability, or unforeseeable emergency as an earlier alternative payment event is NOT treated as an acceleration. (Treas. Reg. § 1.409A-3(j)(2)) All other additions of earlier events violate the anti-acceleration rule.
• The specified employee six-month delay applies to only one event.
  • Under § 409A(a)(2)(B)(i), the six-month delay applies ONLY to payments triggered by separation from service under § 409A(a)(2)(A)(i). (IRC § 409A(a)(2)(B)(i))
  • The delay does NOT apply to payments triggered by disability, death, fixed date, change in control, or unforeseeable emergency. (Treas. Reg. § 1.409A-3(i)(2)(i))
  • This creates an implicit hierarchy among payment events for specified employees. Plans that use fixed dates or change in control as primary triggers avoid the six-month delay entirely.
  • CAUTION. Do not assume the six-month delay applies to all distributions to specified employees. Verify the specific payment trigger for each deferred amount.

Step 2. Separation from Service

"An employee separates from service with the employer if the employee dies, retires, or otherwise has a termination of employment with the employer." (Treas. Reg. § 1.409A-1(h)(1)(i))

• The regulatory definition for employees.
  • An employee separates from service if the employee dies, retires, or otherwise has a termination of employment. (Treas. Reg. § 1.409A-1(h)(1)(i))
  • The employment relationship continues during military leave, sick leave, or other bona fide leave of absence if the period does not exceed six months, or if longer, so long as the individual retains a right to reemployment under an applicable statute or by contract. (Treas. Reg. § 1.409A-1(h)(1)(i))
  • A medically determinable physical or mental impairment expected to result in death or last for a continuous period of not less than six months, causing the employee to be unable to perform the duties of the position or any substantially similar position, permits a 29-month absence period in lieu of six months. (Treas. Reg. § 1.409A-1(h)(1)(i))
• The 20% and 50% rebuttable presumptions for service reduction.
  • Whether a termination of employment has occurred is determined based on whether the facts and circumstances indicate that the employer and employee reasonably anticipated that no further services would be performed after a certain date or that the level of bona fide services would permanently decrease to no more than 20% of the average level of bona fide services performed over the immediately preceding 36-month period. (Treas. Reg. § 1.409A-1(h)(1)(ii))
  • An employee is PRESUMED to have separated from service where the level of bona fide services performed decreases to a level equal to 20% or less of the average level of services performed during the immediately preceding 36-month period. (Treas. Reg. § 1.409A-1(h)(1)(ii))
  • An employee is PRESUMED NOT to have separated from service where the level of bona fide services performed continues at a level that is 50% or more of the average level of services performed during the immediately preceding 36-month period. (Treas. Reg. § 1.409A-1(h)(1)(ii))
  • No presumption applies to a decrease in services to a level that is more than 20% and less than 50% of the average. Facts and circumstances control. (Treas. Reg. § 1.409A-1(h)(1)(ii))
  • A plan may designate in writing a specific percentage between 20% and 50% as constituting a separation from service, provided the reduced level is greater than 20% but less than 50%. (Treas. Reg. § 1.409A-1(h)(1)(ii))
• The anti-abuse rule for phantom consulting arrangements.
  • Where an employee actually or purportedly continues as an employee through an employment agreement under which the service provider agrees to be available to perform services if requested, but the facts and circumstances indicate that the employer and the service provider did not intend for the service provider to provide more than insignificant services, the employee will be treated as having a termination of employment and a separation from service. (Treas. Reg. § 1.409A-1(h)(1)(ii))
  • TRAP. The classic post-retirement consulting arrangement under which a former CEO agrees to provide up to 20 hours of advisory services per year but neither party expects any material services will be performed may be disregarded under this rule. Document genuine service expectations contemporaneously.
• Independent contractor separation rules.
  • An independent contractor is considered to have a separation from service upon the expiration of the contract (or all contracts) under which services are performed if the expiration constitutes a good-faith and complete termination of the contractual relationship. (Treas. Reg. § 1.409A-1(h)(2)(i))
  • An expiration does not constitute a good-faith and complete termination if the service recipient anticipates a renewal of the contractual relationship or the independent contractor becoming an employee. (Treas. Reg. § 1.409A-1(h)(2)(i))
  • A special safe harbor provides that a plan satisfies the separation from service requirement if no amount is paid before a date at least 12 months after the contract expiration and no amount is paid if the service provider performs services during that 12-month period. (Treas. Reg. § 1.409A-1(h)(2)(ii))
• Dual-status and employee-director rules.
  • A service provider who provides services both as an employee and as an independent contractor must separate from service in BOTH capacities to be treated as having separated from service. (Treas. Reg. § 1.409A-1(h)(5))
  • However, if a service provider provides services both as an employee and as a member of the board of directors, the services provided as a director are NOT taken into account in determining whether the service provider has a separation from service as an employee, provided the director arrangements are not aggregated with the employee arrangements under Treas. Reg. § 1.409A-1(c)(2)(ii). (Treas. Reg. § 1.409A-1(h)(5))
  • This means a CEO who resigns as CEO but remains on the board CAN have a separation from service as an employee for purposes of employee NQDC plans.
• Involuntary separation and good reason safe harbor.
  • An involuntary separation from service means a separation due to the independent exercise of the unilateral authority of the service recipient to terminate the service provider's services, other than due to the service provider's implicit or explicit request, where the service provider was willing and able to continue performing services. (Treas. Reg. § 1.409A-1(n)(1))
  • Any characterization of the separation as voluntary or involuntary in the documentation is presumed to properly characterize the nature of the separation, but the presumption may be rebutted where the facts and circumstances indicate otherwise. (Treas. Reg. § 1.409A-1(n)(1))
  • The safe harbor for "good reason" voluntary separations requires six specific conditions. (Treas. Reg. § 1.409A-1(n)(2)(ii))
    1. The separation must occur during a predetermined limited period not to exceed two years following the initial existence of one of six conditions arising without the service provider's consent. (Treas. Reg. § 1.409A-1(n)(2)(ii)(A))
    2. The conditions are listed in Treas. Reg. § 1.409A-1(n)(2)(ii)(A). They include a material diminution in base compensation, a material diminution in authority duties or responsibilities, a material diminution in the authority duties or responsibilities of the supervisor, a material diminution in budget authority, a material change in geographic location, or any other material breach by the service recipient. (Treas. Reg. § 1.409A-1(n)(2)(ii)(A))
    3. The amount, time, and form of payment upon separation must be substantially identical to the amount, time, and form payable due to an actual involuntary separation. (Treas. Reg. § 1.409A-1(n)(2)(ii)(B))
    4. The service provider must provide notice within 90 days of the initial existence of the condition. (Treas. Reg. § 1.409A-1(n)(2)(ii)(C))
    5. The service recipient must be provided at least 30 days to remedy the condition. (Treas. Reg. § 1.409A-1(n)(2)(ii)(C))
    6. The service provider must separate within the two-year window. (Treas. Reg. § 1.409A-1(n)(2)(ii)(A))
  • If the safe harbor is not fully met, a facts-and-circumstances test still applies under Reg. § 1.409A-1(n)(2)(i), but with less certainty.
  • CAUTION. A disability termination where the employee is not willing and able to continue performing services is NOT an involuntary separation from service. (Soto v. Disney Severance Pay Plan, No. 20-4081 (2d Cir. Feb. 16, 2022))
• Payment timing after separation from service.
  • A plan may provide that a payment upon separation from service is to be made at a specified time or pursuant to a fixed schedule that is objectively determinable and nondiscretionary based on the date the separation occurs, provided the schedule is fixed at the time the permissible payment event is designated. (Treas. Reg. § 1.409A-3(b))
  • A plan may also provide that a payment will be made during a designated period not more than 90 days, provided the service provider does not have a right to designate the taxable year of payment. (Treas. Reg. § 1.409A-3(b))
  • EXAMPLE. A plan provides that severance will be paid in a lump sum on the 60th day following separation from service. The separation occurs on March 15. Payment on May 14 (the 60th day) satisfies § 409A because the date is objectively determinable based on the separation date and falls within the 90-day window.

Step 3. Disability

"The term 'disabled' means that a service provider is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months." (Treas. Reg. § 1.409A-3(i)(4)(i)(A))

• The three-pronged regulatory definition.
  • A service provider is disabled if the service provider meets ANY ONE of the following three definitions. (Treas. Reg. § 1.409A-3(i)(4)(i))
    1. The service provider is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months. (Treas. Reg. § 1.409A-3(i)(4)(i)(A))
    2. The service provider is receiving income replacement benefits for a period of not less than three months under an accident and health plan covering employees of the service recipient and the benefits are determined by the service recipient's insurance company or independent third party to be payable due to a physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months. (Treas. Reg. § 1.409A-3(i)(4)(i)(B))
    3. The service provider has been determined to be totally disabled by the Social Security Administration or the Railroad Retirement Board. (Treas. Reg. § 1.409A-3(i)(4)(i)(C))
  • A plan may adopt a definition of disability that is more restrictive than the regulatory definition, provided the plan does not permit payment upon a condition that is less restrictive than any of the three prongs. (Treas. Reg. § 1.409A-3(i)(4)(ii))
  • TRAP. Most group long-term disability plans use an "own occupation" standard for the initial benefit period, which is LESS restrictive than § 409A's "any substantial gainful activity" standard. A plan that uses the LTD plan's definition without verification may violate § 409A if the LTD definition is narrower.
• Disability does NOT trigger the specified employee delay.
  • The six-month specified employee delay under § 409A(a)(2)(B)(i) applies ONLY to separation from service. (IRC § 409A(a)(2)(B)(i))
  • Payments triggered by disability proceed on the plan's normal schedule even for specified employees. (Treas. Reg. § 1.409A-3(i)(2)(i))
  • This creates a planning opportunity. A plan that provides for payment upon the earlier of disability or separation from service will pay immediately upon disability but would delay six months upon separation for a specified employee.
• Coordination with other benefit programs.
  • The 12-month duration requirement for Prong A is distinct from the six-month leave-of-absence rule for separation from service timing under Reg. § 1.409A-1(h)(1)(i). Do not confuse the two periods. (Treas. Reg. § 1.409A-1(h)(1)(i)) (Treas. Reg. § 1.409A-3(i)(4)(i)(A))
  • Workers compensation determinations do NOT automatically satisfy the § 409A disability definition unless the workers comp standard meets one of the three prongs.
  • CAUTION. Mental impairments are explicitly covered by the regulatory definition. Do not assume disability means only physical impairment.

Step 4. Death

"The requirements of this paragraph are met if the plan provides that compensation deferred under the plan may not be distributed earlier than... (iii) death." (IRC § 409A(a)(2)(A)(iii))

• Death as a payment trigger and beneficiary window.
  • Death is the third enumerated permissible payment event under § 409A(a)(2)(A)(iii). (IRC § 409A(a)(2)(A)(iii))
  • A plan may provide for payment to a beneficiary upon the death of the service provider during a period that begins on the date of death and ends on the last day of the first calendar year after the year of death. (Treas. Reg. § 1.409A-3(i)(1)(ii))
  • The 2016 proposed regulations (REG-147958-07) would expand this window. Taxpayers may rely on the proposed regulations under IRB 2016-28. (REG-147958-07, 81 Fed. Reg. 40572 (June 22, 2016))
• The death exception to the specified employee six-month delay.
  • If a specified employee dies during the six-month delay period following separation from service, payment may be made immediately upon death. (IRC § 409A(a)(2)(B)(i)) (Treas. Reg. § 1.409A-3(i)(2)(i))
  • This is the ONLY exception to the six-month delay. No other event overrides the delay. (Treas. Reg. § 1.409A-3(i)(2)(i))
  • If death occurs after the six-month period has already expired, the payment is simply made on the originally scheduled date.
  • EXAMPLE. A specified employee separates from service on January 15. The six-month delay expires on July 15. If the employee dies on March 1, the plan may pay immediately upon death rather than waiting until July 15.
• Acceleration to beneficiaries and payment-event-creates-payment-event.
  • Under Reg. § 1.409A-3(j)(1), payment made in accordance with plan provisions pursuant to which payment is required to be made on an accelerated schedule as a result of an intervening event that is a permissible payment event is NOT treated as an impermissible acceleration. (Treas. Reg. § 1.409A-3(j)(1))
  • This means if a plan provides that installment payments to a service provider accelerate to a lump sum upon the service provider's death, the acceleration is permitted if elected at initial deferral or through a compliant subsequent deferral election. (Treas. Reg. § 1.409A-3(j)(1))
  • The 2016 proposed regulations extended this rule to beneficiaries. If a beneficiary dies after receiving payments due to the service provider's death, remaining payments may accelerate to the beneficiary's successor. (REG-147958-07)
  • A change in beneficiary identity is permitted at any time without acceleration, provided the time and form of payment are unaffected. (Treas. Reg. § 1.409A-3(j)(3))
• Estate tax and income in respect of a decedent.
  • Deferred compensation is includible in the decedent's gross estate under IRC § 2039. (Estate of Bahen v. United States, 305 F.2d 827 (Ct. Cl. 1962))
  • The beneficiary recognizes income under IRC § 691(a) when receiving payments after the service provider's death but may deduct the estate tax attributable to the deferred compensation under IRC § 691(c).
  • Year-of-death payments are subject to FICA withholding and reported on both Form W-2 and Form 1099-MISC. Payments in subsequent years are not subject to FICA and are reported on Form 1099-MISC only. (Rev. Rul. 86-109, 1986-2 C.B. 150)

Step 5. Fixed Date and Scheduled Payments

"The requirements of this paragraph are met if the plan provides that compensation deferred under the plan may not be distributed earlier than... (iv) a specified time (or pursuant to a fixed schedule) specified under the plan at the date of the deferral of such compensation." (IRC § 409A(a)(2)(A)(iv))

• The objectively determinable and nondiscretionary requirement.
  • A plan may provide that a payment upon a permissible payment event is to be made in accordance with a schedule that is objectively determinable and nondiscretionary based on the date the event occurs. (Treas. Reg. § 1.409A-3(b))
  • The schedule must be fixed at the time the permissible payment event is designated. (Treas. Reg. § 1.409A-3(b))
  • A plan may also provide that a payment is to be made during a designated period not more than 90 days, provided the service provider does not have a right to designate the taxable year of payment. (Treas. Reg. § 1.409A-3(b))
  • TRAP. A provision stating that payment will be made "within 90 days following the event, as determined by the Compensation Committee in its sole discretion" violates § 409A because the timing is not objectively determinable. Replace with "on or before the 90th day following the event."
• The designated taxable year and installment schedules.
  • A plan may provide that a payment is to be made in a designated taxable year or pursuant to a fixed schedule of payments in designated taxable years. (Treas. Reg. § 1.409A-3(i)(1)(i))
  • Installment payments may be treated as a single payment or as separate payments for subsequent deferral election purposes, depending on plan design. (Treas. Reg. § 1.409A-2(b)(2)(A))
  • The anti-toggle rule under Treas. Reg. § 1.409A-3(c) prohibits a plan from providing both a lump sum and an installment alternative where the service provider can elect the form at any time. The form must be fixed at deferral or elected under subsequent deferral rules.
• Subsequent deferral elections for fixed dates.
  • § 409A(a)(4)(C) permits a subsequent deferral election if three conditions are met. (IRC § 409A(a)(4)(C))
  • Treas. Reg. § 1.409A-2(b)(1) provides the three requirements for a valid subsequent deferral election.
    1. The election may not take effect until at least 12 months after the date on which the election is made. (Treas. Reg. § 1.409A-2(b)(1)(i))
    2. In the case of a payment not due to disability, death, or unforeseeable emergency, the election must delay payment for a period of not less than five years from the date the payment would otherwise have been made. (Treas. Reg. § 1.409A-2(b)(1)(ii))
    3. In the case of a payment due to a permissible payment event, the election must be made not less than 12 months before the date the payment event occurs. (Treas. Reg. § 1.409A-2(b)(1)(iii))
  • TRAP. All three conditions must be satisfied simultaneously. An election made 18 months before a fixed date that delays payment only 3 years fails because the 5-year rule is not met.
  • EXAMPLE. A participant with a fixed payment date of December 31, 2028, wishes to delay to December 31, 2034. The election must be made on or before December 31, 2027 (12 months before the original payment date) AND the new date must be at least 5 years after the original date (on or after December 31, 2033).
• Fixed dates and the specified employee delay.
  • The six-month specified employee delay does NOT apply to fixed-date payments. (IRC § 409A(a)(2)(B)(i))
  • However, if a fixed date happens to fall during the six-month delay period following a separation from service, the payment is still made on the fixed date because the delay applies only to payments "by reason of" separation from service. (Treas. Reg. § 1.409A-3(i)(2)(i))
  • CAUTION. If a plan provides for payment on the earlier of a fixed date or separation from service, and the fixed date occurs first, payment is made on the fixed date even for a specified employee. But if separation from service occurs first, the six-month delay applies.

Step 6. Change in Control Events

"To the extent provided by the Secretary, a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation." (IRC § 409A(a)(2)(A)(v))

• Congressional directive and regulatory framework.
  • Congress mandated that Treasury issue guidance on change in control events within 90 days of enactment of § 409A. (Pub. L. 108-357, § 885(e), Oct. 22, 2004, 118 Stat. 1640)
  • Treas. Reg. § 1.409A-3(i)(5) defines exactly three types of permissible change in control events. No other event qualifies. (Treas. Reg. § 1.409A-3(i)(5)(i))
  • The occurrence of the event must be objectively determinable, and any certification requirement must be strictly ministerial and not involve any discretionary authority. (Treas. Reg. § 1.409A-3(i)(5)(i))
  • TRAP. A plan provision stating that "the Board may determine in its discretion that a change in control has occurred" violates § 409A. The certifying person must apply objective criteria without subjective judgment.
• Type 1. Change in ownership of a corporation.
  • A change in ownership occurs on the date that any one person, or more than one person acting as a group, acquires ownership of stock that, together with stock already held, constitutes MORE THAN 50% of the total fair market value OR total voting power of the stock. (Treas. Reg. § 1.409A-3(i)(5)(v)(A))
  • The threshold is strictly more than 50%. Exactly 50% does not trigger the event. (Treas. Reg. § 1.409A-3(i)(5)(v)(A))
  • The test is alternative. FMV or voting power suffices. Both are not required. (Treas. Reg. § 1.409A-3(i)(5)(v)(A))
  • If a person or group already owns more than 50%, acquiring additional stock does NOT cause a new change in ownership. (Treas. Reg. § 1.409A-3(i)(5)(v)(A))
  • A plan may specify a higher percentage than 50%, but not lower, provided the higher percentage is set forth in the plan no later than the date by which the time and form of payment must be established under Treas. Reg. § 1.409A-2. (Treas. Reg. § 1.409A-3(i)(5)(v)(A))
• Type 2. Change in effective control of a corporation.
  • A change in effective control occurs only on either of two dates under Treas. Reg. § 1.409A-3(i)(5)(vi)(A).
    1. The 30% voting power test. The date any one person, or more than one person acting as a group, acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition) ownership of stock possessing 30% or more of the total voting power. (Treas. Reg. § 1.409A-3(i)(5)(vi)(A)(1))
    2. The majority board turnover test. The date a majority of members of the corporation's board of directors is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of the board before the date of the appointment or election. (Treas. Reg. § 1.409A-3(i)(5)(vi)(A)(2))
  • For the board turnover test, "corporation" refers solely to the relevant corporation for which no other corporation is a majority shareholder (generally the ultimate parent). (Treas. Reg. § 1.409A-3(i)(5)(vi)(A)(2))
  • The 30% threshold was reduced from 35% in Notice 2005-1 to 30% in the final regulations. (Notice 2005-1, 2005-1 C.B. 274) (Treas. Reg. § 1.409A-3(i)(5)(vi)(A)(1))
  • A plan may specify a higher percentage than 30% or a higher board turnover threshold than majority, provided the threshold is set forth in the plan by the applicable deadline. (Treas. Reg. § 1.409A-3(i)(5)(vi)(A))
• Type 3. Change in ownership of a substantial portion of assets.
  • A change in ownership of a substantial portion of assets occurs on the date that any one person, or more than one person acting as a group, acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition) assets with a total gross fair market value equal to or more than 40% of the total gross fair market value of all assets immediately before the acquisition. (Treas. Reg. § 1.409A-3(i)(5)(vii)(A))
  • The threshold is 40% or more. Exactly 40% qualifies. (Treas. Reg. § 1.409A-3(i)(5)(vii)(A))
  • Gross fair market value means value determined WITHOUT regard to any liabilities associated with the assets. (Treas. Reg. § 1.409A-3(i)(5)(vii)(A))
  • A deemed asset sale under IRC § 338 is NOT treated as a sale or disposition of assets for this purpose under the 2016 proposed regulations. (REG-147958-07, 81 Fed. Reg. 40572 (June 22, 2016))
  • A transfer of assets to a related person is not treated as a change in ownership of assets. Related persons include an entity controlled by the corporation, a shareholder of the corporation, an affiliate of the corporation, or a beneficiary of the corporation. (Treas. Reg. § 1.409A-3(i)(5)(vii)(B))
  • A plan may specify a higher percentage than 40%, provided the threshold is set forth in the plan by the applicable deadline. (Treas. Reg. § 1.409A-3(i)(5)(vii)(A))
• Attribution rules and persons acting as a group.
  • Ownership is determined under the attribution rules of IRC § 318(a), modified so that any stock subject to an option is treated as outstanding and owned by the option holder. (Treas. Reg. § 1.409A-3(i)(5)(iii))
  • Persons acting as a group are determined consistent with the rules of Treas. Reg. § 1.409A-3(i)(5)(v)(B), (vi)(D), and (vii)(C). (Treas. Reg. § 1.409A-3(i)(5)(v)(B))
  • EXAMPLE. If three unrelated private equity firms each acquire 20% of a target's stock in a coordinated transaction, they may be treated as a group and the acquisition constitutes a change in ownership.
• Coordination with § 280G golden parachute rules.
  • § 409A change in control and § 280G change in control are NOT the same. Critical divergences exist.
    • § 409A uses a 50% ownership threshold. § 280G uses a 50% ownership threshold but with different attribution rules.
    • § 409A uses a 30% effective control threshold. § 280G uses a 20% ownership threshold for its safe harbor.
    • § 409A uses a 40% asset threshold. § 280G uses a one-third (33.33%) asset threshold.
    • § 409A definitions are plan-by-plan. § 280G applies on an affiliated group basis.
    • § 409A CIC definitions are rebuttable only through plan drafting. § 280G CIC definitions are rebuttable through shareholder vote.
  • CAUTION. A plan that copies the § 280G definition into a § 409A plan document may inadvertently use thresholds that are too low for § 409A purposes or include subjective elements that violate § 409A's objectively determinable requirement.

Step 7. Unforeseeable Emergency

"The term 'unforeseeable emergency' means a severe financial hardship to the participant resulting from an illness or accident of the participant, the participant's spouse, or a dependent (as defined in section 152(a)) of the participant, loss of the participant's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant." (IRC § 409A(a)(2)(B)(ii)(I))

• The statutory and regulatory definition.
  • An unforeseeable emergency is a severe financial hardship to the service provider resulting from. (Treas. Reg. § 1.409A-3(i)(3)(i)) (IRC § 409A(a)(2)(B)(ii)(I))
    1. An illness or accident of the service provider, the service provider's spouse, the service provider's beneficiary, or the service provider's dependent (as defined in § 152, without regard to § 152(b)(1), (b)(2), and (d)(1)(B)).
    2. Loss of the service provider's property due to casualty (including the need to rebuild a home following damage not otherwise covered by insurance).
    3. Other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the service provider.
  • The regulatory definition adds "beneficiary" as a qualifying person, reflecting the Pension Protection Act of 2006 amendment under § 826. (Treas. Reg. § 1.409A-3(i)(3)(i))
• Explicit exclusions and examples.
  • The purchase of a home and the payment of college tuition are NOT unforeseeable emergencies. (Treas. Reg. § 1.409A-3(i)(3)(i))
  • Examples that MAY qualify include imminent foreclosure of or eviction from the primary residence, medical expenses (including non-refundable deductibles and prescription drug costs), and funeral expenses of a spouse, beneficiary, or dependent. (Treas. Reg. § 1.409A-3(i)(3)(i))
  • Rev. Rul. 2010-27, 2010-27 I.R.B. 28, provides three illustrative examples.
    1. Water damage to a home not covered by insurance qualifies as an unforeseeable emergency.
    2. Funeral expenses of a non-dependent adult child do NOT qualify (but would qualify if the child were a dependent).
    3. Credit card debt accumulated over several years does NOT qualify because it is not beyond the control of the service provider.
• The three conditions that must be exhausted.
  • A distribution on account of unforeseeable emergency may not be made to the extent that the emergency is or may be relieved through any of the following three sources. (Treas. Reg. § 1.409A-3(i)(3)(i)) (IRC § 409A(a)(2)(B)(ii)(II))
    1. Reimbursement or compensation from insurance or otherwise.
    2. Liquidation of the service provider's assets, to the extent the liquidation would not itself cause severe financial hardship.
    3. Cessation of deferrals under the plan.
  • The regulation adds "cessation of deferrals under the plan" as a third condition not explicitly stated in the statute but incorporated by the Secretary's regulatory authority. (Treas. Reg. § 1.409A-3(i)(3)(i))
  • The determination is made prospectively. If insurance is expected to cover the expense, the distribution should be reduced or denied. (Treas. Reg. § 1.409A-3(i)(3)(i))
• The amount limitation.
  • Distributions because of an unforeseeable emergency must be limited to the amount reasonably necessary to satisfy the emergency need. (Treas. Reg. § 1.409A-3(i)(3)(ii))
  • The amount may include amounts necessary to pay any Federal, state, local, or foreign income taxes or penalties reasonably anticipated to result from the distribution. (Treas. Reg. § 1.409A-3(i)(3)(ii))
  • The determination is NOT required to take into account amounts available from a qualified employer plan (including any loan) or from another nonqualified deferred compensation plan. (Treas. Reg. § 1.409A-3(i)(3)(ii))
  • The plan administrator must take into account any additional compensation that becomes available if the plan provides for cancellation of a deferral election upon payment due to an unforeseeable emergency. (Treas. Reg. § 1.409A-3(i)(3)(ii))
• Plan administrator discretion.
  • A service provider may retain discretion with respect to whether to apply for a payment upon an unforeseeable emergency. (Treas. Reg. § 1.409A-3(i)(3)(iii))
  • A service recipient may retain discretion with respect to whether to make a payment available under the plan due to an unforeseeable emergency. (Treas. Reg. § 1.409A-3(i)(3)(iii))
  • Neither the service provider's decision not to apply nor the service recipient's decision not to make payment constitutes a subsequent deferral election. (Treas. Reg. § 1.409A-3(i)(3)(iii))
  • CAUTION. While discretion is permitted, the payment event itself must be objectively determinable. A plan that states "the Administrator may pay upon an unforeseeable emergency in its sole discretion" violates § 409A because the trigger is not objective. The discretion applies only to whether a demonstrated emergency warrants payment.
• Cancellation of deferral elections.
  • Under Treas. Reg. § 1.409A-3(j)(4)(viii), a plan may provide for cancellation of a service provider's deferral election due to an unforeseeable emergency. (Treas. Reg. § 1.409A-3(j)(4)(viii))
  • The cancellation is treated as a permissible acceleration, not a subsequent deferral election. (Treas. Reg. § 1.409A-3(j)(4)(viii))
  • Notice 2020-50 extended similar relief to coronavirus-related distributions. (IRS Notice 2020-50, 2020-35 I.R.B. 317)

Step 8. Specified Employee Definition and Identification

"In the case of any specified employee, the requirement of subparagraph (A)(i) is met only if distributions may not be made before the date which is 6 months after the date of separation from service (or, if earlier, the date of death of the employee). For purposes of the preceding sentence, a specified employee is a key employee (as defined in section 416(i) without regard to paragraph (5) thereof) of a corporation any stock in which is publicly traded on an established securities market or otherwise." (IRC § 409A(a)(2)(B)(i))

• The statutory specified employee definition.
  • A specified employee is a key employee as defined in § 416(i), DISREGARDING § 416(i)(5), of a corporation any stock in which is publicly traded on an established securities market or otherwise. (IRC § 409A(a)(2)(B)(i))
  • The phrase "without regard to paragraph (5) thereof" means the special rule in § 416(i)(5) for certain terminated employees is disregarded for 409A purposes. (IRC § 409A(a)(2)(B)(i))
  • The "established securities market or otherwise" standard incorporates the definition in Treas. Reg. § 1.897-1(m), which includes national securities exchanges, foreign exchanges, and certain over-the-counter markets. (Treas. Reg. § 1.409A-1(i)(1))
• Key employee categories under § 416(i)(1)(A).
  • A key employee means an employee who, at any time during the plan year, is. (IRC § 416(i)(1)(A))
    1. An officer of the employer having annual compensation greater than the indexed dollar amount. (IRC § 416(i)(1)(A)(i))
    2. A 5-percent owner of the employer. (IRC § 416(i)(1)(A)(ii))
    3. A 1-percent owner of the employer having annual compensation from the employer of more than $150,000. (IRC § 416(i)(1)(A)(iii))
  • For officers, no more than 50 employees (or, if lesser, the greater of 3 or 10% of the employees) shall be treated as officers. (IRC § 416(i)(1)(A)(i))
  • The $130,000 officer threshold is indexed for inflation under § 415(d). The $150,000 threshold for 1% owners is NOT indexed. (IRC § 416(i)(1)(A))
  • The indexed amounts are $215,000 for 2024 and $230,000 for 2025. (IRS Notice 2023-75, 2023-40 I.R.B. 581) (IRS Notice 2024-80, 2024-35 I.R.B. 466)
• Officer definition and numerical limitations.
  • Whether an individual is an officer is determined based on all facts, including the source of authority, the term for which elected or appointed, and the nature and extent of duties. (Treas. Reg. § 1.416-1, Q&A T-13)
  • The term "officer" means an administrative executive who is in regular and continued service. An employee who merely has the title of an officer but not the authority is not considered an officer. An employee who does not have the title but has the authority of an officer IS an officer. (Treas. Reg. § 1.416-1, Q&A T-13)
  • The numerical limitation for officers is determined as follows. (Treas. Reg. § 1.416-1, Q&A T-14)
    • If more than 500 employees, maximum 50 officers.
    • If 30 to 500 employees, maximum is 10% of all employees (rounded up to the next integer).
    • If fewer than 30 employees, maximum is 3 officers.
  • If more officers meet the compensation threshold than the maximum, select those with the largest annual compensation during the 12-month period ending on the identification date. (Treas. Reg. § 1.416-1, Q&A T-14)
  • TRAP. Banks and financial institutions with many "Vice Presidents" may have few true "officers" under this test. Conversely, a senior manager without an officer title may qualify if they exercise officer-level authority.
• Compensation definition for specified employee identification.
  • The default definition of compensation is Treas. Reg. § 1.415(c)-2(a), applied as if the service recipient were not using any safe harbor in § 1.415(c)-2(d), any elective special timing rules in § 1.415(c)-2(e), or any elective special rules in § 1.415(c)-2(g). (Treas. Reg. § 1.409A-1(i)(2))
  • A service recipient may elect to use any available definition of compensation under § 415, provided the definition is applied consistently to all employees for purposes of identifying specified employees. (Treas. Reg. § 1.409A-1(i)(2))
  • This default definition includes items like taxable income from nonqualified stock option exercises and restricted stock vesting, which can cause significant year-to-year volatility in officer rankings. (Treas. Reg. § 1.415(c)-2(a))
  • Many employers elect to use W-2 wages (the § 1.415(c)-2(d)(3) safe harbor) for administrative simplicity, but this election must be binding on all plans. (Treas. Reg. § 1.409A-1(i)(2)) (Treas. Reg. § 1.409A-1(i)(8))
• Identification date and effective date mechanics.
  • The default specified employee identification date is December 31. (Treas. Reg. § 1.409A-1(i)(3))
  • A service recipient may designate any other date as the identification date, provided the same date is used with respect to all nonqualified deferred compensation plans and any change may not be effective for at least 12 months. (Treas. Reg. § 1.409A-1(i)(3))
  • The default specified employee effective date is the first day of the fourth month following the identification date. (Treas. Reg. § 1.409A-1(i)(4))
    • EXAMPLE. With a December 31 identification date, the effective date is April 1. Key employees identified during the calendar year ending December 31 are treated as specified employees for the 12-month period commencing the following April 1.
  • A service recipient may designate any earlier date following the identification date as the effective date, provided such date may not be later than the first day of the fourth month following the identification date. (Treas. Reg. § 1.409A-1(i)(4))
  • The same effective date must be used with respect to all nonqualified deferred compensation plans, and any change may not be effective for at least 12 months. (Treas. Reg. § 1.409A-1(i)(4))
• Alternative methods and special rules.
  • A service recipient may use an alternative method under which all employees are considered key employees (unlimited inclusion), or no employees are considered key employees (universal exclusion), or a method in which key employees are limited to a class of not more than 200 employees selected in descending order of compensation. (Treas. Reg. § 1.409A-1(i)(5))
  • Any alternative method must be designated in writing, applied consistently, and legally binding before it is effective. (Treas. Reg. § 1.409A-1(i)(5))
  • For purposes of determining key employees, a service recipient generally must include all employees, including nonresident aliens. However, a plan may provide that all nonresident aliens are excluded for purposes of applying the six-month delay, provided the exclusion is applied with respect to all arrangements and any change to include them may not be effective for 12 months. (Treas. Reg. § 1.409A-1(i)(7))
  • Corporate transaction rules apply for spinoffs and mergers. If a new corporation is established in a § 355 spinoff, any employee of the new corporation who was a key employee of the old corporation immediately before the spinoff remains a key employee until the end of the 12-month period beginning on the first day of the fourth month following the old corporation's last identification date preceding the spinoff. (Treas. Reg. § 1.409A-1(i)(6))
• Attribution of ownership.
  • Ownership is determined under the attribution rules of § 318(a), modified so that the 5% threshold in § 318(a)(2)(C) and (3)(C) is substituted for the 50% threshold. (Treas. Reg. § 1.409A-1(i)(1))
  • This means family attribution (spouse, children, parents) applies, as does attribution from partnerships, estates, trusts, and corporations. (IRC § 318(a))
  • EXAMPLE. If a CEO's spouse owns 3% of the employer's stock and the CEO owns 2%, the CEO is treated as owning 5% and qualifies as a key employee under the 5% owner test.
• Consistency requirements across all plans.
  • The same identification date, effective date, and method must apply to all nonqualified deferred compensation plans of the service recipient. (Treas. Reg. § 1.409A-1(i)(8))
  • A designation in one plan is binding on all plans. (Treas. Reg. § 1.409A-1(i)(8))
  • The service recipient must demonstrate that the method of identifying specified employees was applied consistently to all plans and all service providers. (IRS Notice 2007-78, § 5)
  • TRAP. A private company that goes public must identify specified employees before any separation from service occurs. If the company has not previously maintained a specified employee list, all plans providing for separation from service payments must be amended to include the six-month delay provision BEFORE the first employee becomes a specified employee.

Step 9. The Six-Month Delay Mechanic

"In the case of any service provider who is a specified employee as of the date of a separation from service, the requirements of paragraph (a)(1) of this section permitting a payment upon a separation from service are satisfied only if payments may not be made before the date that is six months after the date of separation from service (or, if earlier than the end of the six-month period, the date of death of the specified employee)." (Treas. Reg. § 1.409A-3(i)(2)(i))

• The snapshot rule.
  • Status as a specified employee is determined as of the date of the separation from service ONLY. (Treas. Reg. § 1.409A-3(i)(2)(i))
  • A service provider who is NOT a specified employee as of the date of separation will NOT be treated as subject to the delay even if the service provider would have become a specified employee on the next effective date. (Treas. Reg. § 1.409A-3(i)(2)(i))
  • Conversely, a service provider who IS a specified employee as of the date of separation remains subject to the delay even if the service provider would not have been a specified employee after the next effective date. (Treas. Reg. § 1.409A-3(i)(2)(i))
  • EXAMPLE. An executive is a specified employee on April 1, 2025, but would fall off the list on April 1, 2026. If the executive separates on March 15, 2026, the six-month delay applies because the executive was a specified employee as of the separation date, even though the new list effective April 1, 2026, would not include the executive.
• The two permissible implementation methods.
  • The required delay is met if either of the following methods is used. (Treas. Reg. § 1.409A-3(i)(2)(ii))
    1. Accumulation method. Payments to which a specified employee would otherwise be entitled during the first six months following separation are accumulated and paid on the first day of the seventh month following the date of separation from service.
    2. Per-payment delay method. Each payment to which a specified employee is otherwise entitled upon separation from service is delayed by six months.
  • A service recipient may retain discretion to choose which method will be implemented, provided that no direct or indirect election as to the method may be provided to the service provider. (Treas. Reg. § 1.409A-3(i)(2)(ii))
  • EXAMPLE. An executive is entitled to 24 monthly installment payments beginning 30 days after separation. Under the accumulation method, payments 1 through 6 are accumulated and paid as a lump sum on the first day of the seventh month, with payments 7 through 24 resuming on their normal schedule. Under the per-payment delay method, all 24 payments are simply pushed back by six months, running from month 7 through month 30.
• Application to installment payments and plan aggregation.
  • ALL installments that would otherwise be payable during the first six months following separation from service must be delayed. (Treas. Reg. § 1.409A-3(i)(2)(ii))
  • The aggregation rule under Treas. Reg. § 1.409A-1(c)(2) requires that all deferrals of compensation under all nonaccount balance plans of the service recipient covering the same service provider are treated as deferred under a single plan for penalty purposes. (Treas. Reg. § 1.409A-1(c)(2)(i)(C))
  • However, the plan aggregation rules do NOT apply to the written plan requirements. A failure to include the six-month delay provision in one plan does NOT trigger aggregation with other plans that contain the provision. (Treas. Reg. § 1.409A-1(c)(3)(viii))
  • CAUTION. While the written-plan failure is isolated for aggregation purposes, the payment made in violation of § 409A(a)(2)(B)(i) still triggers income inclusion, 20% penalty, and premium interest on the amounts paid from the noncompliant plan.
• Plan provision requirement.
  • The six-month delay rule must be a written provision of any plan providing for a payment upon separation from service to a specified employee. (Treas. Reg. § 1.409A-1(c)(3)(v))
  • The provision must be set forth in writing on or before the date the service provider first becomes a specified employee. (Treas. Reg. § 1.409A-1(c)(3)(v))
  • In general, this means the provision must be in writing on or before the specified employee effective date for the first list of specified employees that includes the service provider. (Treas. Reg. § 1.409A-1(c)(3)(v))
  • A plan does not fail to be established merely because it does not contain the six-month delay rule when the service provider is not a specified employee. (Treas. Reg. § 1.409A-1(c)(3)(v))
  • TRAP. A private company that expects to go public must include the six-month delay provision in all NQDC plans before the IPO. Once the stock is publicly traded, the first identification date will produce a list of specified employees, and any plan without the provision at that point cannot apply the delay to newly specified employees.
• Permitted payments during the six-month period.
  • The following payments are NOT subject to the six-month delay even for specified employees. (Treas. Reg. § 1.409A-3(i)(2)(i))
    1. Payments upon death during the delay period. (IRC § 409A(a)(2)(B)(i))
    2. Payments to the extent necessary to fulfill a domestic relations order. (Treas. Reg. § 1.409A-3(j)(4)(ii))
    3. Payments to the extent necessary for Federal ethics compliance or to avoid violation of conflicts of interest laws. (Treas. Reg. § 1.409A-3(j)(4)(iii))
    4. Payments of employment taxes (FICA, FUTA, income tax withholding) due on the deferred compensation. (Treas. Reg. § 1.409A-3(j)(4)(vi))
• Correction of erroneous early payments.
  • If a specified employee is erroneously paid during the six-month delay period, the service provider will not be treated as having failed to comply with § 409A if the service provider repays the amount on or before the last day of the service provider's taxable year in which the amount was paid. (IRS Notice 2007-100, Section II.C)
  • After repayment, the service provider must have a legally binding right to receive the amount on a new date determined by adding the number of days between the erroneous payment and the repayment to the later of the original payment date or the repayment date. (IRS Notice 2007-100, Section II.C)
  • EXAMPLE. A specified employee separates on May 1, 2028, with a payment due December 1, 2028. The employer erroneously pays on May 1, 2028. The employee repays on July 1, 2028 (61 days later). The new payment date is January 31, 2029 (61 days after December 1, 2028). Provided the employer does not pay before January 31, 2029, the error is corrected without 409A penalty.
  • If the correction is not made within the same taxable year, Notice 2008-113 may provide relief for operational failures corrected in the second taxable year, but income inclusion and the 20% tax may still apply. (IRS Notice 2008-113, Section VII.C)

Step 10. Anti-Acceleration and Subsequent Deferral Rules

• The general prohibition and its reach.
  • Except as provided in Treas. Reg. § 1.409A-3(j)(4), a nonqualified deferred compensation plan may not permit the acceleration of the time or schedule of any payment or amount scheduled to be paid pursuant to the terms of the plan, and no such accelerated payment may be made whether or not provided for under the terms of such plan. (Treas. Reg. § 1.409A-3(j)(1))
  • This prohibition applies to ALL payments, including those not provided for in the plan terms. An employer cannot make a discretionary early payment without violating § 409A. (Treas. Reg. § 1.409A-3(j)(1))
  • A plan may not provide a service provider discretion with respect to whether a payment will be accelerated, and a service recipient may not provide a service provider a direct or indirect election as to whether the service recipient's discretion to accelerate will be exercised. (Treas. Reg. § 1.409A-3(j)(4)(i))
• Permissible acceleration exceptions.
  • Treas. Reg. § 1.409A-3(j)(4) enumerates the specific exceptions to the anti-acceleration prohibition. The most commonly applicable exceptions include. (Treas. Reg. § 1.409A-3(j)(4))
    1. Domestic relations orders. Payment to an individual other than the service provider to the extent necessary to fulfill a domestic relations order as defined in § 414(p)(1)(B). (Treas. Reg. § 1.409A-3(j)(4)(ii))
    2. Conflicts of interest and ethics laws. Payment to the extent necessary for a Federal officer or employee to comply with an ethics agreement, or to the extent reasonably necessary to avoid violation of Federal, state, local, or bona fide foreign ethics or conflicts of interest law. (Treas. Reg. § 1.409A-3(j)(4)(iii))
    3. Payment of employment taxes. Payment to the extent required under Federal, state, local, or foreign law to satisfy a tax withholding obligation. (Treas. Reg. § 1.409A-3(j)(4)(vi))
    4. Payment of state, local, or foreign taxes. Payment to the extent reasonably necessary to comply with a tax obligation, limited to the lesser of the applicable tax rate or the maximum marginal rate, plus penalties and interest. (Treas. Reg. § 1.409A-3(j)(4)(v))
    5. Limited cashouts. Payment of the present value of all remaining payments if the present value does not exceed the applicable dollar amount under § 402(g)(1)(B) (indexed, $23,000 for 2024). (Treas. Reg. § 1.409A-3(j)(4)(ix)(B))
    6. Termination of 409A plan. Payment upon termination of the plan in connection with a change in control event or due to a dissolution of the service recipient, provided certain conditions are met. (Treas. Reg. § 1.409A-3(j)(4)(ix))
    7. Plan failure distributions. Payment of all deferred amounts if the plan fails to meet § 409A, provided the payment is made in the taxable year the failure is discovered or the following year. (Treas. Reg. § 1.409A-3(j)(4)(x))
    8. Cancellation of deferrals due to unforeseeable emergency. (Treas. Reg. § 1.409A-3(j)(4)(viii))
    9. Offset. Payment to the extent of a bona fide debt owed to the service recipient, limited to the amount of the debt. (Treas. Reg. § 1.409A-3(j)(4)(vii))
    10. Bona fide dispute. Payment to the extent of a bona fide dispute regarding the right to the deferred amount. (Treas. Reg. § 1.409A-3(j)(4)(xi))
• Subsequent deferral election rules.
  • A subsequent deferral election must satisfy three conditions under Treas. Reg. § 1.409A-2(b)(1).
    1. The election may not take effect until at least 12 months after the date on which the election is made. (Treas. Reg. § 1.409A-2(b)(1)(i))
    2. In the case of a payment not due to disability, death, or unforeseeable emergency, the election must delay payment for a period of not less than five years from the date the payment would otherwise have been made. (Treas. Reg. § 1.409A-2(b)(1)(ii))
    3. In the case of a payment due to a permissible payment event, the election must be made not less than 12 months before the date the payment event occurs. (Treas. Reg. § 1.409A-2(b)(1)(iii))
  • TRAP. The 12-month advance rule and the 5-year deferral rule operate independently. An election made 18 months before a fixed date that delays payment only 3 years fails because the 5-year rule is not satisfied. An election made 6 months before separation from service that delays payment 5 years fails because the 12-month advance rule is not satisfied.
  • The payment of a life annuity may be changed to a lump sum if the actuarial present value of the lump sum does not exceed the applicable dollar amount under § 402(g)(1)(B). (Treas. Reg. § 1.409A-2(b)(2)(ii))
  • Installment payments may be changed to a lump sum if the present value of all remaining installments does not exceed the applicable dollar amount. (Treas. Reg. § 1.409A-2(b)(2)(iii))
• Permissible delays beyond the scheduled date.
  • A payment may be delayed to a date after a designated payment date if the delay is due to the service recipient's reasonable anticipation that payment would not be deductible under § 162(m), would violate Federal securities laws or other applicable law, or such other events and conditions as the Commissioner prescribes. (Treas. Reg. § 1.409A-2(b)(7))
  • The service recipient must treat all payments to similarly situated service providers on a reasonably consistent basis. (Treas. Reg. § 1.409A-2(b)(7))
  • The delayed payment date is treated as a fixed payment date for purposes of applying § 409A once the delay reason ceases. (Treas. Reg. § 1.409A-2(b)(7))

Step 11. Short-Term Deferral and Separation Pay Exceptions

• The short-term deferral exception.
  • A deferral of compensation is not treated as deferred compensation subject to § 409A if the service provider actually or constructively receives the payment on or before the last day of the applicable 2.5-month period. (Treas. Reg. § 1.409A-1(b)(4))
  • The applicable 2.5-month period means the period ending on the later of the 15th day of the third month following the end of the service provider's first taxable year in which the right to the payment is no longer subject to a substantial risk of forfeiture, or the 15th day of the third month following the end of the service recipient's first taxable year in which the right is no longer subject to a substantial risk of forfeiture. (Treas. Reg. § 1.409A-1(b)(4))
  • For calendar-year taxpayers, this generally means March 15 of the year following the year of vesting. (Treas. Reg. § 1.409A-1(b)(4))
  • TRAP. The exception is based on the PLAN'S terms, not on when payment is actually made. A plan that provides for payment "as soon as administratively practicable following vesting" but does not mandate payment by the 2.5-month deadline is subject to § 409A even if payment is in fact made within 2.5 months every year.
• The separation pay exception.
  • A right to payment upon an involuntary separation from service is not treated as deferred compensation if the following conditions are met. (Treas. Reg. § 1.409A-1(b)(9)(ii))
    1. The amount payable does not exceed two times the sum of the service provider's annual compensation for the taxable year preceding the taxable year in which the separation occurs (or, if less, two times the compensation limit under § 401(a)(17) for the year preceding the year of separation). (Treas. Reg. § 1.409A-1(b)(9)(iii)(A))
    2. The amounts are paid by the last day of the second taxable year following the taxable year in which the separation from service occurs. (Treas. Reg. § 1.409A-1(b)(9)(iii)(B))
  • The § 401(a)(17) compensation limit is $345,000 for 2024 and $350,000 for 2025, so the maximum separation pay under this exception is $690,000 for 2024 and $700,000 for 2025. (IRS Notice 2023-75) (IRS Notice 2024-80)
  • The involuntary separation requirement may be satisfied through the good reason safe harbor under Treas. Reg. § 1.409A-1(n)(2)(ii) (see Step 2 above) or through the facts-and-circumstances test under Reg. § 1.409A-1(n)(2)(i). (Treas. Reg. § 1.409A-1(b)(9)(ii))
  • CAUTION. All separation pay plans are aggregated for purposes of the two-times cap. A service provider with two separate severance agreements each providing 1.5 times salary exceeds the cap and the exception does not apply to either plan.
• Other statutory exclusions.
  • Vacation, sick leave, compensatory time, and disability pay are generally excluded from § 409A if paid under customary terms. (Treas. Reg. § 1.409A-1(b)(3))
  • Taxable benefits such as most welfare benefits (medical, dental, life insurance under § 79) are excluded. (Treas. Reg. § 1.409A-1(b)(5))
  • Amounts paid under a bona fide reimbursement arrangement, a bona fide fringe benefit arrangement, or a bona fide death benefit plan are excluded. (Treas. Reg. § 1.409A-1(b)(5))
  • Certain stock rights (nonstatutory stock options and stock appreciation rights with an exercise price not less than fair market value on the date of grant) are excluded. (Treas. Reg. § 1.409A-1(b)(5))
  • Amounts subject to a substantial risk of forfeiture that are paid within the short-term deferral period are excluded. (Treas. Reg. § 1.409A-1(b)(4))

Step 12. Penalties and Plan Aggregation

• Immediate income inclusion upon failure.
  • If at any time during a taxable year a nonqualified deferred compensation plan fails to meet the requirements of § 409A(a)(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 is includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in income. (IRC § 409A(a)(1)(A)(i))
  • The inclusion applies only with respect to participants for whom the failure relates. (IRC § 409A(a)(1)(A)(ii))
  • Under plan aggregation, all deferrals of compensation under all nonaccount balance plans of the service recipient covering the same service provider are treated as deferred under a single plan. (Treas. Reg. § 1.409A-1(c)(2)(i)(C))
  • TRAP. A single operational failure in a $50,000 change-in-control agreement can trigger immediate inclusion on all vested amounts under all nonaccount balance plans covering the same participant, including a $3 million SERP.
• The 20% additional tax.
  • If compensation is required to be included in gross income under § 409A(a)(1)(A) for a taxable year, the tax imposed is increased by an amount equal to 20% of the compensation required to be included in gross income. (IRC § 409A(a)(1)(B)(i)(II))
  • The 20% tax is an additional income tax, not an excise tax, and is subject to the rules governing assessment, collection, and payment of income tax. (IRC § 409A(a)(1)(B))
• Premium interest tax.
  • The tax imposed is also increased by interest at the underpayment rate under § 6621 plus 1 percentage point. (IRC § 409A(a)(1)(B)(ii))
  • The interest is calculated on the underpayments that would have occurred had the deferred compensation been includible in gross income for the taxable year in which first deferred or, if later, the first taxable year in which such deferred compensation is not subject to a substantial risk of forfeiture. (IRC § 409A(a)(1)(B)(ii))
  • Only the amount actually includible in income under § 409A(a)(1)(A) for the failure year is subject to premium interest. Amounts first deferred in the failure year itself are NOT subject to premium interest. (Prop. Treas. Reg. § 1.409A-4(d)(1), 73 Fed. Reg. 74380 (Dec. 8, 2008))
  • EXAMPLE. A participant has $500,000 includible in income under § 409A for 2028 due to an operational failure. Of that amount, $200,000 was first deferred in 2020 and $300,000 was first deferred in 2021. Premium interest is calculated on the hypothetical underpayment for 2020 (on $200,000) and 2021 (on $300,000), running through the end of 2028. The 2028 amount is not itself subject to premium interest because it was first deferred in the failure year.
• California and state tax penalties.
  • California formerly imposed a 20% state penalty mirroring the federal penalty, resulting in a combined 40% penalty rate. California AB 1173 (2013) reduced the state penalty from 20% to 5%. (California Assembly Bill 1173 (2013))
  • Most states that conform to the IRC on a rolling basis automatically adopt § 409A, but not all states have a separate state-level penalty. Employers must track state conformity posture. (California AB 1173 Bill Analysis)
• IRS correction programs.
  • IRS Notice 2008-113 provides correction methods for certain operational failures. If an operational failure is corrected in accordance with Notice 2008-113 Section IV, no amount is required to be included in income under § 409A as a result of the failure. (IRS Notice 2008-113, 2008-51 I.R.B. 1305, Section IV)
  • Same-year correction (by December 31 of the failure year) is the most favorable and avoids all income inclusion, 20% tax, and premium interest. (IRS Notice 2008-113, Section IV)
  • Second-year correction (by the end of the second taxable year following the failure year) still requires income inclusion and the 20% tax, but premium interest is waived. (IRS Notice 2008-113, Section V)
  • CCA 201518013 established that correcting a failure before vesting in the same taxable year does NOT avoid income inclusion if the compensation later vests during that same taxable year. The taint of the failure attaches at any point during the year. (IRS Chief Counsel Advice 201518013 (May 1, 2015))
  • Notice 2010-6 provides document correction for plans that fail to include the six-month delay provision. Corrections must be made before the payment event occurs. If a specified employee separates within one year after correction, 50% of the deferred amount must be included in income. (IRS Notice 2010-6, 2010-3 I.R.B. 275, Section VIII)

Step 13. FICA, Employment Tax, and Documentation Obligations

• FICA special timing rule operates independently.
  • Amounts deferred under nonqualified deferred compensation plans are FICA wages at the later of (a) when services are performed or (b) when there is no substantial risk of forfeiture. (IRC § 3121(v)(2)(A))
  • The nonduplication rule under § 3121(v)(2)(B) prevents double FICA taxation on distributions. Once an amount is taken into account for FICA purposes, subsequent earnings on that amount are not subject to FICA if they do not exceed a predetermined investment rate or reasonable interest rate. (IRC § 3121(v)(2)(B))
  • The six-month delay for income tax purposes does NOT affect FICA timing. FICA taxes are typically due at vesting or deferral, which may be years before the income tax inclusion date for specified employees. (IRS Audit Technique Guide, Publication 5528)
  • CAUTION. Do not withhold only income tax during the six-month delay. If FICA was not previously paid on the deferred amount, it remains due. Verify FICA status for each deferred amount before making any payment.
• Income tax withholding on § 409A inclusions.
  • § 3401(a) provides that the term "wages" includes any amount includible in gross income of an employee under § 409A, treated as paid in the year of inclusion even if no actual cash payment occurs. (IRC § 3401(a))
  • This means an employee who has deferred compensation included in income due to a § 409A failure is subject to income tax withholding on the included amount, even if no cash is actually distributed.
• Form W-2 and Form 1099 reporting.
  • Form W-2 Box 12 Code Z is used to report § 409A income inclusions for employees. (IRS Notice 2005-1, 2005-1 C.B. 274, Section IV.F)
  • Form W-2 Box 12 Code Y for annual deferrals is currently suspended pending further guidance. (IRS Notice 2005-1, Section IV.F)
  • For non-employees, § 409A income is reported in Box 15b of Form 1099-MISC. (IRS Notice 2005-1, Section IV.F)
  • TRAP. Failure to report § 409A income inclusions on Form W-2 or Form 1099 can result in employer penalties under § 6721 and § 6722, separate from the employee-level 409A penalties.
• Plan documentation requirements.
  • § 409A(a)(1)(C) requires that the plan be in writing. (IRC § 409A(a)(1)(C))
  • Treas. Reg. § 1.409A-1(c)(3) requires that material terms of the plan be set forth in writing and maintained in a manner sufficient to demonstrate compliance.
  • The six-month delay provision must be in writing on or before the date a service provider first becomes a specified employee. (Treas. Reg. § 1.409A-1(c)(3)(v))
  • The identification date, effective date, and method for identifying specified employees must be designated in writing and legally binding on the service recipient and all affected service providers. (Treas. Reg. § 1.409A-1(i)(3)) (Treas. Reg. § 1.409A-1(i)(8))
  • Blanket savings clauses ("this plan is intended to comply with § 409A") are disregarded and do not satisfy the written plan requirement. (Treas. Reg. § 1.409A-1(c)(3))
• Operational records and consistency.
  • The service recipient must maintain records demonstrating the method by which specified employees were identified and that the method was applied consistently to all plans and all service providers. (IRS Notice 2007-78, § 5)
  • The service recipient must document the compensation definition used, the identification date, the effective date, and any alternative method elected. (Treas. Reg. § 1.409A-1(i)(2)-(8))
  • TRAP. If the service recipient uses a non-default compensation definition or alternative identification method, the records must demonstrate that the election was legally binding before it became effective and was applied consistently across all arrangements.
• Form 8925.
  • After exhaustive review, no connection between Form 8925 and § 409A was found in primary authority. Form 8925 appears unrelated to § 409A compliance.