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Section 409A
Practical Law Glossary Item 1-506-3280 (Approx. 4 pages)
Glossary
Section 409A
Enacted as part of the American Jobs Creation Act of 2004, P.L. 108-357 (2004), Section 409A of the Internal Revenue Code and the related regulations (Treasury Regulation Sections 1.409A-0 to 1.409A-6) set out a comprehensive set of rules regulating the taxation of nonqualified deferred compensation. Section 409A and its related regulations outline the specific requirements for the timing of deferral elections, and the designation of the time and form of payment of deferred compensation amounts.
Section 409A covers a broad range of arrangements not typically regarded as providing for a deferral of compensation. For example, the following may all be nonqualified deferred compensation subject to Section 409A:
- Bonuses.
- Severance payable under an employment agreement.
- Stock options granted with an exercise price below the fair market value of the underlying shares on the grant date.
The tax penalties for noncompliance with Section 409A are severe and are imposed on the service provider rather than the service recipient. Penalties for violations of Section 409A may include:
- Income inclusion at the time of vesting even if the benefit has not yet been paid.
- A 20% penalty tax on the deferred amounts.
- An increased interest rate on the late payment of the income tax due on the compensation.
For more information on Section 409A, see Practice Note, Section 409A: Deferred Compensation Tax Rules: Overview.