In Notice 2010-80, the Internal Revenue Service (“IRS”) provided a remedial period until December 31, 2012, to correct nonqualified plans or agreements subject to Section 409A of the Internal Revenue Code (“Section 409A”) that pay compensation at separation from service, but base the timing of the payment on when a release of claims is submitted. It is the view of the IRS that there is a violation of Section 409A when the timing of such a payment is contingent on when the employee submits the release of claims because the employee could control the payment date by selecting the date on which the release of claims is submitted. For example, assume that under an employment agreement the employee is eligible for thirty-six monthly payments of base salary if the employee is involuntarily terminated without cause, but payment is contingent on the employee timely executing and delivering a release of claims to the employer. Also, assume that the employee has 60 days to consider whether to sign and deliver the release of claims and that the severance pay would commence within 30 days after the employee’s execution of the release of claims. Because in the example above the employee might be able to control the taxable year in which the severance pay would commence by selecting the date on which he or she executes the release of claims, the IRS would deem this employment agreement to have a plan document failure under Section 409A.
Agreements or Plans that Can Be Corrected under Notice 2010-80
In order to take advantage of the remedial period under Notice 2010-80 (“Notice”):
- the agreement must be subject to Section 409A;
- the agreement or plan must provide for a payment upon separation from service;
- the timing of the payment must be contingent on delivery of an executed release of claims or similar document; and
- the agreement or plan must have been in effect by December 31, 2010.
For applicable agreements or plans, there are two permissible correction methods under the Notice.
Agreements or Plans with a Set Payment Period
If the agreement or plan contains a permissible payment period after separation from service (such as within 60 days), but the date on which payment is actually made can be affected by when the employee signs the release of claims, then the plan or agreement can be amended by stating either that:
- payment will be made on the last day of the specified payment period; or
- if in any event the payment period crosses over two taxable years, then payment will commence in the second taxable year.
Agreements or Plans without a Set Payment Period
If the agreement or plan does not contain a permissible payment period, then the plan or agreement can be amended by stating either that:
- payment may be made on a specified date either 60 or 90 days after separation from service; or
- payment may be made within a period of no more than 90 days, but that if in any event the payment period crosses over two taxable years then payment will commence in the second taxable year.
Corrections under the Proposed Income Inclusion Rules
If the agreement or plan providing for payment upon separation from service was not effective by December 31, 2010, and does not provide a permissible payment period as required under the Notice, then it may still be possible to correct the contingent payment period under the IRS’s proposed income inclusion regulations. Under those regulations, if the right to the payment is still subject to a substantial risk of forfeiture (i.e., the employee must continue working to vest in the payment), then an improper payment period under an agreement or plan may still be corrected up to the year prior to the year in which the right to the payment vests. For severance pay that is made upon an involuntary separation from service, the right to the payment usually vests when the employee terminates employment. Because the date on which an employee may terminate employment is not always known, it is best not to wait to correct under this method; the proposed income inclusion regulations cannot be used to correct a plan or agreement in the year the employ terminates or otherwise vests in the right to separation pay that is subject to Section 409A.