For purposes of Code section 409A, a deferred compensation plan is any agreement, method or arrangement, in writing or not, that may have the effect of deferring the payment of taxable compensation that a service provider (e.g., an executive) has a legally binding right to receive in one taxable year, to a later year. A legally binding right does not exist if the amount of compensation payable may be unilaterally reduced or eliminated by the service recipient (e.g., the employer) after the performance of services. This includes arrangements between employers and employees, independent contractors and outside directors, and a partner and the partnership, regardless of what the arrangement is called by the parties (e.g., it could be an employment agreement or a split dollar life insurance policy). Such plans are not limited to those under which an executive elects to reduce part of his or her compensation for a taxable year, but include nonelective (employer-paid) plans as well.
Parties should consider any arrangement that pays deferred amounts as being potentially subject to Code section 409A until they determine otherwise. Certain amounts deferred prior to 2005 may be exempt from the section 409A rules.
Nonstatutory stock options may be deferred compensation depending upon the terms and features of the option. Stock appreciation rights (SAR) plans can be structured to be exempt from section 409A. Generally, qualified incentive stock options and options granted through an employee stock purchase plan are not subject to section 409A. Likewise, restricted stock is not subject to section 409A because it is taxed under Code section 83.
Short-term deferrals do not provide for a deferral of compensation that is subject to section 409A, provided that the compensation is paid within 2-1/2 months after the end of the year in which the amount is no longer subject to a substantial risk of forfeiture. This exception is an important one because of its scope.
In general, severance benefits generally are subject to section 409A. However, there is a limited exception for certain separation pay plans following involuntary separation from service or under a window program.
Code section 401(a) qualified plans, Code section 457(b) eligible deferred compensation plans sponsored by governmental or tax-exempt employers, bona fide vacation, sick leave, compensatory time, disability pay and death benefit plans are specifically excluded from Code section 409A. However, section 457(f) ineligible deferred compensation plans sponsored by governmental or tax-exempt employers are covered by Code section 409A.