Church Alliance Core Lawyer Working Group 457(f)/409A Impact of IRS Notice

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1 Church Alliance Core Lawyer Working Group 457(f)/409A Impact of IRS Notice Bruce L. Wolff, Esq. Summer Meeting Philadelphia July 21, Avenue of the Americas New York NY

2 What Does Code Sec. 409A Cover? Non-Qualified Deferred Compensation Broad scope of deferred compensation Covers employment contracts, bonuses, severance, taxable reimbursements Applies to Steeple and Non-Steeple Tax-Exempt Entities 1) Covers employees and independent contractors 2) For non-steeples, 409A applies in addition to 457(f) 2

3 What Does Section 409A Do? Limits Payment Events Restricts Elections Regarding Payment Time and Form Strict Rules Governing Timing of Initial and Subsequent Deferral Elections Failure to Comply in Form or Operation Early taxation, 20% penalty tax, interest charge 3

4 Two Key 409A Exemptions Two Times/Two Year Severance Pay Exemption Requirements Solely on account of involuntary separation Payment not to exceed 2 times lesser of annual rate of pay or Code Sec. 401(a)(17) limit Payments made by end of 2nd tax year following separation 4

5 Short-Term Deferral Exemption Payment made by 2 ½ months following later of employer or employee tax year when amount vests Key point is when 409A vesting date occurs 5

6 Substantial Risk of Forfeiture (SROF) 409A Two Standards Performance of substantial future services, or Condition related to a purpose of the compensation, and Possibility of forfeiture is substantial Involuntary separation without cause and "qualifying good reason" termination are SROFs. 6

7 Important SROF Qualifications Non-compete covenants are not SROFs Addition of forfeiture risk after grant disregarded Extension of forfeiture risk disregarded Elective salary/bonus deferrals can not be subject to SROF, unless amount paid materially greater 7

8 What does Code Sec. 457(f) Cover? Ineligible deferred compensation plans of tax-exempt employers (except steeples) Compensation included in income when vested Vesting controls timing of income inclusion (409A impact is short term deferral exemption) Earnings accruing after vesting not taxed until paid Vesting deferral via "rolling risk of forfeiture" Elective salary deferral made subject to vesting 8

9 IRS NOTICE Issued 7/23/07; no follow-up formal guidance since Expresses IRS intent regarding Code Sec. 457 guidance for bona fide severance pay plan and substantial risk of forfeiture Guidance will be prospective, but current reliance permitted 9

10 Bona Fide Severance Plans Exempt from Code Sec. 457 Notice applies 409A 2 times /2 year rule (including exceptions for window programs, coll. barg. separation plans, reimb/in-kind benefit arrangements) Notable differences from 409A 2 times/2 year rule 409A Annual rate of pay is for calendar year preceding year of employee severance (adjusted for permanent pay increases in severance year); 457(f) Notice is silent Severance from employment (457(f)) v. separation from service (409A) No express coverage for good reason termination or contract non-renewal (409A includes good reason and contract non-renewal as invol. termination) Current ERISA standard for severance pay 2 times pay (no 401(a)(17) limit) and payment within 24 months of termin. date 10

11 SROF under Notice Adopts 409A SROF definition Impact Non-compete covenants no longer SROF "Rolling risk of forfeiture" disregarded Elective salary/bonus deferral not eligible for SROF (unless materially greater amount paid) 11

12 Interaction of 409A and 457(f) Non-Steeples both 409A and 457(f) apply 457(f) vesting event (income inclusion) is payment date for 409A Common SROF definitions 409A short term deferral exemption applies Earnings on delayed payment subject to 409A 12

13 Where Are We Now? 409A final regs. effective 1/1/09 Special transition period ends 12/31/08 409A-compliant plan documents required by 12/31/08 IRS says don't wait for final 457(f) guidance Amend for 409A now 13

14 Some Open 457(f) Issues Remain Involuntary separation should include good reason termination and employer non-renewal of employment contracts Impact of non-exempt severance pay conditioned on release Timing of taxable reimbursement payments 457(f) impact on vested bonus paid during short term deferral period How will performance-based SROF apply to nonprofits 14

15 Stay Tuned Final 457(f) guidance likely issued after 409A regs take effect 457(f) guidance will require plan design changes and amendments (e.g., eliminating salary deferral arrangements and rolling risks of forfeiture), though some transition relief expected Common SROF definitions eliminate 409A via short term deferral, except for delayed earnings payout 15

16 Contact Information Bruce L. Wolff, Esq