11/10/2010 02:46 pm ET Updated May 25, 2011

Time Is Running Out on Second Chance to Fix Employee Plans

Colorado businesses that offer any kind of deferred incentives or compensation to their employees need to know that while hell has not frozen over, something almost as unusual has occurred. The IRS is giving you a second chance to be sure your plans qualify with Section 409A of the Internal Revenue Code.

Section 409A was enacted a few years ago to stem perceived abuses in "non-qualified" deferred compensation (a classic example of the Pig Rule in taxes--pigs get fat, hogs get slaughtered). Existing deferred compensation plans were given until 2009 to fix their 409A issues. Well, 409A can get pretty tricky, so early this year the IRS issued Notice 2010-6 to allow noncompliant plans to get into compliance, retroactive to January 1, 2009. You just need to make the fixes by December 31, 2010.

The consequences of not making a fix include the employee being taxed on his or her deferred benefits immediately (potentially years early), an extra 20% income tax assessed on top of that (just because), and applicable state income taxes and interest charges. If you knew you were facing that, you would see your lawyer and fix it, right?

Well, maybe you don't know, because maybe you don't even realize you have a plan that must be 409A compliant. Here's a partial list of the arrangements (regardless if they are a plan that covers a group of employees, or an agreement that covers one person) that may well have a problem. If you have one of these and you haven't seen your lawyer, you should, and soon.

  • Deferred Compensation plans
  • Supplemental Executive Retirement plans
  • Restricted Stock agreements
  • Phantom Equity plans
  • Stock Appreciation Rights
  • Stock Options
  • Bonus plans
  • Separation or Change of Control Agreements
  • Severance Agreements
  • Employment Agreements containing any feature of the above
For those of you that have bothered to read this far even though you don't have an existing deferred compensation plan, and likely don't know what the heck I'm talking about, bless you. Taxes are an important part of any discussion of nonqualified employee incentives--timing (now or later), nature (ordinary or capital) and amount (what's the value of the incentive). The more interesting parts of key employee incentives--identifying owner goals and designing cash and/or equity plans to motivate your employees to get you there--will have to be a topic for another day.