1. Tax Code Section 409A : Some Things You Should Know ABA Section of Labor and Employment Law Employee Benefits Committee Meeting February 19-21, 2009

2. Consequences of Violating §409A Daniel N. Janich Janich Law Group Chicago, IL

3. Consequences of Violating §409A What is includible in income? What are the reporting and withholding requirements? Is There an IRS Correction Program?

4. Proposed §409A Income Inclusion Regulations How to determine amounts includible in income under §409A, the 20% penalty & interest Issued December 8, 2008; may rely upon pending final regulations

5. Proposed §409A Income Inclusion Regulations Important clarifications— – §409A violations examined year-by-year – Violations of time and form of benefit payments of unvested amounts may be corrected before vesting occurs includes relief for plan document errors where no vesting has occurred under plan – Deferrals included in income determined as of last day of employee’s taxable year of violation

6. Proposed §409A Income Inclusion Regulations – Nonvested amounts and previously included income amounts are subtracted from amount includible in income – No double taxation – Amounts included in income due to §409A violation are exempt from income tax when actually paid Includible income never paid due to employer insolvency entitles employee to deduction, BUT No recovery of 20% penalty or interest tax

7. Proposed §409A Income Inclusion Regulations 20% Penalty & Interest Calculations— Penalty applied to total amount includible in income Interest determined by amount includible in income for current year, and Calculated based on hypothetical tax underpayment at IRS underpayment rate plus 1%

8. Reporting & Withholding Obligations IRS Notice 2008-115 Code “Y” Reporting Requirement— – Annual reporting of employee deferrals (Form W- 2 or 1099-MISC) waived pending future guidance Amounts includible in income subject to applicable withholding at supplemental withholding rates 20% penalty and interest tax not subject to withholding

9. Relief for §409A Operational Failures IRS Notice 2008-113 issued December 22, 2008 Provides limited relief for operational failures only Application of these rules hinge on— – Timing: When was violation discovered and corrected? – Amount: What is the deferred amount involved?

10. Relief for §409A Operational Failures Operational Failures Eligible for Correction— – Failure to defer – Early Payments – Excess Deferrals – Below-Market Stock Rights

11. Relief for §409A Operational Failures Failures corrected in same taxable year of failure: No §409A Penalties Failures corrected in taxable year immediately subsequent to taxable year of failure: No §409A Penalties, But Interest Payable on Repayment Amounts – “Insiders” Are Ineligible

12. Relief for §409A Operational Failures Failures corrected by end of second taxable year following taxable year of failure: §409A Penalties Apply To Deferred Amounts Involved, Provided Such Amounts Do Not Exceed §402(g) Limit Failures corrected in later years: ¶409A Penalties Apply to Deferred Amounts Involved, Requires Repayments to Plan Sponsor

13. Relief for §409A Operational Failures Correction Methods— – Failures to Defer & Early Payments: Service Provider repays amounts that should have been deferred – Excess Deferrals: Plan Sponsor must distribute amount of excess deferral – Below-Market Stock Rights: Plan Sponsor must increase exercise price of stock right to equal FMV of stock on grant date; previously exercised stock rights ineligible for correction

14. Relief for §409A Operational Failures Special Transitional Rule for Non-Insiders— – For operational failures occurring before December 31, 2007, 2009 is treated as taxable year “immediately subsequent to year of failure” Relief requires: – Disclosure of operational failure to affected participants (Form W-2 or 1099-MISC) – Implementation of steps to ensure that failure does not reoccur in future – Unavailable if “substantial financial downturn.”