Deferred Compensation Agreements Need Attention by Year-End

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Title:
Deferred Compensation Agreements Need Attention by Year-End
Date:
December 1, 2005
Publication:
From December 2005 Riker Danzig Tax and Trusts & Estates UPDATE.
Area(s) of Practice:
Tax Law

As discussed in our December 2004 and March 2005 UPDATES (which are available on www.riker.com), in 2004, Congress enacted Section 409A of the Internal Revenue Code, creating strict requirements for many deferred compensation plans and imposing significant tax penalties on plan participants. While the IRS previously issued preliminary guidance on how to comply with the new law in January 2005, in late September 2005, the IRS issued long-awaited Proposed Regulations under Section 409A. This article alerts you to items under the Regulations that you may need to act on in 2005 and provides some additional insight under the Regulations.

Although the Regulations extend the deadline to December 31, 2006, for bringing deferred compensation plans and stock option arrangements into compliance, plan participants must take the following actions by December 31, 2005 (and if plan modification is required to permit such action, the plan amendments must be in place as of December 31, 2005):

  1. Terminate your participation in a deferred compensation plan. If you no longer wish to participate in a deferred compensation plan, you must terminate your participation in 2005.

     

  2. Cancel a deferral election under a plan. You may cancel all amounts previously deferred under a plan and receive those amounts as taxable income in 2005 (without penalties or interest).

     

  3. Cash out for below-market stock options. Stock options that have an exercise price equal to the stock's fair market value on the date of grant generally are not subject to 409A. If, however, you have stock options that were granted with an exercise price below the stock's fair market value on the date of grant, your company may re-issue the option with a strike price equal to the stock's fair market value on the date of grant of the original option, without penalty to you, by December 31, 2006. The company may compensate you for the difference in value between the old strike price and the new, higher strike price. While there are several permissible ways to provide that compensation, if you want to receive a cash payment as compensation, you must receive that payment by December 31, 2005.