Tax Law Blog

IRS Auditing Deferred Compensation Plans for Section 409A Compliance

The Internal Revenue Service recently announced that it has begun a new audit initiative to test taxpayers’ compliance with Section 409A of the Internal Revenue Code. Section 409A applies complex rules to “deferred compensation,” which generally includes compensation that is payable in a year after the year in which it is earned. This includes benefits provided under traditional nonqualified deferred compensation plans, such as SERPS and phantom stock plans, as well as some bonus and severance benefits and benefits provided under typical employment and consulting agreements.

The IRS Small Business/Self-Employed Division is leading the audit test project. Currently, fewer than 50 relatively large businesses are being tested, each of which was selected from the group of taxpayers that are currently subject to employment tax audits. A factor used in the selection process was the probability that the taxpayer would sponsor a nonqualified deferred compensation plan, which suggests that the IRS will take this factor into account when identifying future audit targets.

The IRS’s initiative is focusing on three primary issues: (1) initial deferral elections, (2) subsequent deferral elections, and (3) distributions, including the six-month delay for specified employees upon separation from service. The IRS is limiting the scope of its examination to the tax years already under examination and to benefits provided to the employers’ top 10 highly compensated individuals.

The IRS expects to complete its initiative within 12 months. The IRS intends to use information regarding the compliance errors that it discovers to inform future Section 409A compliance audits.

Contact Joel with any questions regarding executive compensation and nonqualified deferred compensation plans.

Categories: Compliance