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409A Nonqualified Deferred Compensation Plans

What is IRC Section 409A?

Section 409A applies to compensation that workers earn in one year, but that is paid in a future year. This is referred to as nonqualified deferred compensation. This is different from deferred compensation in the form of elective deferrals to qualified plans (such as a 401(k) plan) or to a 403(b) or 457(b) plan.

How does coverage under Section 409A affect an employee’s taxes?

If deferred compensation meets the requirements of Section 409A, then there is no effect on the employee’s taxes. The compensation is taxed in the same manner as it would be taxed if it were not covered by Section 409A. If the arrangement does not meet the requirements of Section 409A, the compensation is subject to certain additional taxes, including a 20% additional income tax. Section 409A has no effect on FICA (Social Security and Medicare) tax.

How does Section 409A apply to the 10 and 12-month pay election?

At issue is how the 2004 law change applies to people who have compensation deferred from one year to a future year. Under the new law, when teachers and other employees are compensated on a 12-month pay period in lieu of the 9 or 10-month actual work period, they are deferring part of their income from one year to the next. For instance, a teacher who is paid over a 12-month period, running from August of one year through July of the next year, rather than over the August to May school year, a 10-month period, falls under this law.

Does Section 409A require that an employee be provided an election?

No, Section 409A does not require that an employee be provided any election regarding how the employee is paid. For example, a school district may provide that all teachers will have their pay spread over 12 months, without providing any election to the teachers. In that case, the rules under Section 409A would not apply and no additional taxes would be imposed.

What was the effect of Notice 2008-62 for most public school employees?

Released on July 3, 2008, the Treasury Department and IRS issued Interim Guidance with Notice 2008-62. If the criteria in the Notice is met, it is expected that regulations under Sections 457(f) and 409A would not apply to arrangements of electing 12-months over 10-months of pay.

What if the criteria in Notice 2008-62 are not met?

On August 7, 2007, the IRS established assistance through Frequently Asked Questions on Section 409A and Deferred Compensation which provides guidance on how to establish the deferred election within the provisions of Section 409A.

Resources for IRC Section 409A:

Notice 2008-62, Interim Guidance on 10 vs. 12-month Pay Period

IR-2007-142, August 7, 2007, New Rule Will Not Affect Teacher Salaries in Upcoming School Year

Frequently Asked Questions on Section 409A and Deferred Compensation

Notice 2007-86, Delayed Effective Date of Section 409A Requirements

Section 409A Final Regulations

Presentation Slides on 10 vs. 12-month Pay Period

Page Last Reviewed or Updated: 18-Sep-2013