BNA Pension and Benefits Blog

Reviewing the Scope of Section 409A Transition

Full compliance with Section 409A is scheduled to be required in less than four months, by January 1, 2009. This deadline is the result of the considered and responsive review by personnel from Treasury, the IRS and the legislative branch last year, as 2007 ran its course. At that time, an extension sought by the market from an impending December 31, 2007 deadline was gratefully granted, ostensibly on the basis that compliance by year-end 2007 would be difficult to achieve, would result in inordinate corporate distraction and would produce a less-than-optimal quality of compliance.

It may be time to review the present state of Section 409A transition. Market circumstances have changed (AC/DC, still alive and rockin', might say things are "all screwed up"), and the financial crisis has thrown a wide range of institutions into total disarray. That situation is not one that was present as little as several weeks ago, and was not so much as a glimmer in anyone's eye when the year-end 2008 extended deadline was established.

It is submitted here that these unexpected and changed circumstances may well justify a reconsideration of the current deadline generally - not because the existing deadline did not confer sufficient time, but because things, simply put, have changed. The need to devote significant attention to Section 409A compliance may be inconsistent with the attention that will have to be devoted to the economic crisis. And, notwithstanding the ongoing bail-out efforts, query whether any exacerbation of the current crisis in the coming weeks might make broader relief downright necessary.

It is worthy of note that a client memorandum from Wachtell, Lipton distributed earlier today (September 24) suggests that it may be time for a reexamination of Section 409A transition. As unfortunate as it may seem, reconsideration of the deadline may indeed now be appropriate.

Regardless of whether a general reconsideration of the Section 409A compliance deadline takes place, it seems as though some continued permitted good-faith compliance would be appropriate. (Wachtell's memorandum makes a similar point here, too.) In this regard, several things have become evident:

- As a result of the complexity inherent (as is now apparent) in Section 409A itself, the 409A Regulations have turned out to be extraordinarily complex, giving rise to an innumerable number of difficult and sometimes imponderable issues. It seems as though every crevice of the rules gives rise to issues and analyses that are much more interesting than one would expect or hope.

- Experts seem consistently to disagree on a host of issues. Reasoning balanced on the head of a pin comes out one way for one practitioner and another way for another practitioner. One wonders whether there aren't important issues as to which there isn't even unanimity among Treasury and IRS personnel.

- New issues continue to arise. It seems as though issue after issue, some sending shockwaves through the practitioner community, continues to emerge on points that hadn't even been widely identified in the market as being problematic.

- Indications are that, as to matters covered by the existing 409A Regulations, further official guidance will not soon be forthcoming. The existing voluntary compliance program does not generally extend to documentary compliance, thus making compliance more challenging, and, as a further indication of how difficult the issues are to deal with, it looks as though it is going to take Treasury and the IRS considerable time just to develop a more extensive voluntary compliance program.

- Key new authority on income inclusion, reporting and withholding, once hoped for in the early part of the summer, is still not out, presumably because of substantive complexity generally, as well as, possibly, the interrelationship between Section 409A and other provisions.

Against this backdrop of substantive uncertainty, complete and total compliance by December 31, 2008, however desirable it may be, seems almost unattainable. One possible approach could be that, for 2009, good-faith compliance with Section 409A and the existing final authority thereunder would be considered compliance with Section 409A. It is not suggested here that the effectiveness of the final rules would be suspended; rather, the suggestion is that reasonable interpretations of the rules should be sufficient to forestall punitive tax results. Essentially, it would be recognized that, against a landscape riddled with substantive uncertainty, taxpayers should not be punished for taking fair positions under incredibly challenging rules, merely because some theoretical ultimate interpretation of those rules might turn out to be adverse.

Thus far, regulatory consideration of extended relief apparently is not being actively considered (see, e.g., the lead Washington Item in the September 5, 2008 TMCPJ ); given the responsive and substantial extensions that have been previously conferred, that result is arguably understandable. But market conditions have changed, and the substantive analyses just have not sorted out, and it is suggested here that, for both of these reasons, it may unfortunately be time for the transition question to be reopened.

Interim Amendments for Tax Qualified Plans -- A Mixed Bag

Beginning in the late 1990s, the IRS Employee Plans group spent a great deal of time studying various options for avoiding the enormous workload spikes that arose during the determination letter process in the past and developing the settled upon option -- the staggered remedial amendment period (RAP). As part of this process, IRS EP personnel made a real effort to "partner" with the various stakeholders in the benefits community (ranging from benefits practitioners to prototype sponsors and vendors) to develop a workable, manageable program for all. One of the items that most stakeholders generally opposed during this process was a requirement for annual amendments documenting new law or regulatory changes--which have come to be commonly referred to as "interim" amendments. There was considerable concern about the time/expense that would be required to manage this process in an effective manner (particularly for prototype vendors), as well as the potential confusion and resulting "foot faults" this would likely engender. Instead, it was recommended that these amendments generally be required at the time the plan otherwise had to be submitted for IRS approval. It appeared that IRS officials understood these concerns as discussions concerning interim amendments disappeared from the staggered RAP dialogue--or so we thought. To the surprise of many, the final staggered RAP revenue procedure (originally Rev. Proc. 2005-66; now Rev. Proc. 2007-44) contained specific requirements on interim amendments for all tax qualified plans (including prototypes and the like), the primary motivation being that the plan document must be kept up-to-date throughout the cycle.

In a nutshell, the timing turns on whether the amendment is a "discretionary" one or involves a "disqualifying provision." If it is a discretionary change, the amendment must be adopted by the close of the plan year in which the change is first implemented. On the other hand, if a disqualifying provision is involved, it does not have to be adopted until the later of--

• the due date (including extensions) for filing the employer's tax return for the year in which the applicable RAP began, or
• the last day of the plan year in which the RAP began.

So, how do you tell between a discretionary amendment and one which involves a disqualifying provision? In general, a "disqualifying provision" is one which either--

• results in a failure to comply because of a change in the qualification rules, or
• is integral to a requirement that has been changed (which otherwise would result in a compliance failure).

A discretionary amendment covers everything else. While it is often easy to tell what is a discretionary change versus a disqualifying provision, the lines become blurred when there is new law or regulatory change with optional provisions--and where these fall is not always clear.

The guidance concerning the timing for discretionary amendments has, in some respects, provided some welcome clarity, as we now know that plan sponsors generally have until plan year-end to adopt discretionary changes (for example, a new contribution formula or distribution option). However, I fear that the interim amendment requirements have otherwise given rise to the very problems the benefits community was concerned would happen with interim amendments. To its credit, the IRS has taken some steps to alleviate this. In addition to issuing some clarifying guidance on amendment timing for certain new law changes, it has set up a web page which contains a listing of the 2007 interim amendments (http://www.irs.gov/retirement/article/0,,id=173372,00.html)--although it would be more helpful if an updated list was issued annually much like the agency now does with the list of cumulative changes for each staggered RAP cycle. The IRS has also set up a relatively streamlined and inexpensive application process for certain missed interim amendments under the Employee Plans Compliance Resolution System (Rev. Proc. 2006-27, Appendix F)--which the agency is apparently planning on significantly expanding soon. But are these enough or does the complexity/confusion that the interim amendment requirements have caused outstrip their value? I, for one, am finding that the latter may be true.