IRS Announces New Program to Audit 409A Compliance

R. David Fritz, Jr., CLU

IRS Announces New Program to Audit 409A Compliance

Last month, the Internal Revenue Service announced that a Compliance Initiative Project (CIP) was underway involving a compliance audit for Section 409A plans. The CIP will initially focus on fifty large companies; however, this foreshadows a much broader Section 409A initiative enforcement. The Service issued Information Document Request “IDRs” to about fifty large employers. These initial IDRs will request documents regarding deferred compensation elections and payouts. The IRS informally indicated that these will focus on three issues:

1. Initial deferral elections,
2. Subsequent changes in deferral elections,
3. Timing of payouts.

Code Section 409A imposes a number of restrictions on nonqualified deferred compensation plans. Failure to comply with those rules can have significant adverse tax consequences for affected participants. There are two correction programs that may be used to eliminate those adverse tax consequences. The program for addressing operational compliance issues is not available if the participant’s federal tax return for the year is under examination. The program for addressing document compliance issues is not generally available if the participants or the employer’s tax return is under examination for the year of the failure.

Because the CIP is likely to lead to broader audits regarding compliance with Section 409A and correction programs are typically not available once audits are underway, now is an excellent time to review if your nonqualified deferred compensation plan complies with all of Section 409A rules as well as tax related rules.

Key areas to be reviewed should cover the following issues:

  • Ensure all material terms of the plan are set forth in writing and that none of the plan’s provisions are at odds with the rules of Section 409A
  • Ensure the amounts deferred to the plan are not deducted in the employer’s corporate tax return until those amounts are includable in employee income
  • Ensure deferrals to the plan have been properly reported as FICA and FUTA wages at the appropriate time
  • Ensure distributions are properly reported as income and that applicable income taxes have been withheld from distributions
  • Ensure elections to deferred compensation are timely, and payroll deductions match the deferral elections
  • Ensure changes to payment elections are timely and otherwise comply with the subsequent deferral election rules
  • Ensure distributions are made in the correct amount and at the appropriate time

Do not wait to review your plan and know Executive Benefits Network is available to assist in reviews of existing plans. This is a helpful reminder to do it sooner rather than later.