United States IRC 409A - Deferred Compensation Requirements
The United States IRC 409A is a law that regulates non-qualified deferred compensation, which is payment that is delayed for a specific reason. The deferred compensation specified is between a “service provider and recipient” and there can be a 20 percent excise tac when specific qualities of the compensation are met. This tax code took effect 1/1/2005 after the passage of the American Jobs Creation Act of 2004. Additionally, this law was in response to the Enron Scandal, where Enron executives used deferred compensation plans to accelerate their payments before the company went bankrupt, this was seen a tax-timing abuse and 409A legislation followed.
More practically, this tax is usually between employers or those who hire independent contractors, this group would be the service recipient. Service providers include executives, regular employees, and independent contractors provide the service. A non-qualified deferred compensation under IRC 409A applies when the service provider has earned compensation in a taxable year that is payable in a later taxable year. Ignoring the exceptions, the deferred compensation for the taxable year becomes includable income for the current year if not included in pervious income. Accrued interest and a 20 percent additional penalty are negative effects of deferring the compensation.
Qualified deferred compensation is compensation approved by the IRS to be allowed to be paid in future tax years without this penalty.
- Any type of payment made within 2 and ½ months of year end are not subject to 409A, known as short term deferrals
- Employer retirement plans
- Some Section 457 plans
- Some Welfare Benefits
- Stock Options (ISOs and ESOs) read more about employee stock options here
Read the full text of 409A here
There has been pushback on the IRS in regard to IRC 409A as from an industry perspective it raises concerns of complexity and unreasonableness. Additionally, many believe that the scope of 409A is too broad.
