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Enron's Binge - Your Hangover

20070923 When the Enron scandal broke, it was hard for a small businessman not to laugh at the $6,000 shower curtains, the offshore accounts, and the extravagant excesses of the period.

Then Congress got involved, and now the laugh is on all of us.

Congress added "Section 409A" to the tax law in response to the use of high-tech deferred compensation arrangements by corporate looters.  These new tax rules on "non-qualified" deferred comp plans were carefully tailored by Congress to apply to... almost everyone.

It has taken the IRS three years and hundreds of pages of regulations to try to make sense of Sec. 409A, so we can only scratch the surface here.

THE TAX PENALTY

If you make a mistake designing or operating a plan covered by Section 409A, two bad things happen:

- The employee covered by the deferred compensation plan pays tax on all amounts that have been deferred for his benefit since he was employed - even if the employee didn't receive the amounts, or even if he never receives them.

- The employee also pays a 20% penalty tax on the deferred amounts included in income


ITS REACH

You don't need to have a Ken Lay-sized retirement plan to be covered by Section 409A.  It's almost easier to list plans that aren't covered by Section 409A. 

Traditional "qualified" retirement plans are not covered by Section 409A.  That means it doesn't affect:

- Section 401(k) Plans;

- Profit-sharing plans;

- Defined benefit retirement plans

- ESOPs

Plans that are affected include almost any other arrangement that defers employee pay more than 2 1/2 months after the year in which it is earned.  This can include "phantom stock" plans, stock option plans, and supplemental or "top hat" plans for executives and owners. 

But the rules don't only cover executives and owners.  The IRS recently had to address how Section 409A affects schoolteachers who have their salary for the school year spread over 12 months to ensure a summer paycheck.

THE DEADLINES

Last week the IRS announced that employers have until the end of 2008 to draft documents for plans covered by Section 409A.  But there is a more pressing deadline.   Employers generally have only until the end of 2007 to decide whether to bring old plans into compliance with the new rules, or to instead terminate them and distribute the funds to employees without the 20% penalty tax.

TALK TO YOUR TAX ADVISOR

The Section 409A rules are complicated, and the penalties for violating them are severe.  If you think you even might have a plan affected by Section 409A, discuss them with your tax advisor.

Links:

Section 409A Final regulations

IRS DELAYS DOCUMENT DATE FOR 409A DEFERRED COMP RULES

Prior Section 409A guidance

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