Code Section 409A(a)(2)(A) prescribes six times or events when deferred compensation may be paid: separation from service, the disability of the participant, the death of the participant, a specified time or fixed schedule specified under the plan, a change in control of the employer, or an unforeseeable emergency. In explaining and developing these permissible payment rules, the Treasury Regulations contain two special rules that allow some wiggle room (perhaps more than one might think) to an employer in establishing the payment dates or in actually making a payment. These provisions reflect the recognition on the part of the drafters that it may not be possible or practicable to make a payment precisely on the intended date and minor delays in payment will not materially affect the income taxation of the payments. We often find ourselves referring to these special rules and offer this brief synopsis and a few observations to those who tangle with deferred compensation on a regular basis.
For our limited purposes, and taking some editorial liberty, we will say that the Section 409A Regulations divide the six permissible payment events into two categories: payments that are essentially triggered by events (death, disability, separation from service, change in control, and unforeseeable emergency) and payments to be made or begin on a specific date set at the time the deferral is made (or deemed to have been made). With respect to event-driven payments, Treasury Regulations section 1.409A-3(b) sensibly allows a plan to provide for the actual payment to be made within a designated period after the event occurs so long as the period is objectively determinable and nondiscretionary at the time the event occurs and so long as one of two alternative additional conditions are met. The first alternative is to have the designated period begin and end within one taxable year of the service provider. So, for example, a plan could specify that payment of deferred compensation to a participant will be made any time between January 1 and December 31 of the year immediately following a separation from service.
The second alternative is to specify a designated period that is not more than 90 days after the event, so long as the service provider does not have a right to choose the taxable year of payment. Under this alternative, which is frequently used, the plan could state that payment shall be made within 60 days following separation from service. Since one of the requirements is that the employee not have the right to choose the taxable year of payment, it would not be a bad idea to draft right into the plan (or election form) a statement confirming that the actual payment date will be as determined by the employer. The absence of such a statement, however, should not be problematic since it would be difficult for the IRS to assert that an employee has a right to select the taxable year of payment if no such right can be found in any document. (Note that special timing issues and concerns apply when the payment of deferred compensation, for example after a separation from service, is to occur only after the execution of a release. Those issues are significant and are beyond the scope of this post.)
A somewhat different, and arguably more forgiving, rule applies with respect to a payment to be made on a specified payment date or under a fixed schedule. In that case, Treasury Regulations section 1.409A-3(d) provides that payment will be considered to have been on the date specified in the plan so long as it made either on the date or on a later date within the same taxable year. So if a plan calls for a deferred bonus payment to be made on April 30 of each year (or a given year), a payment of the bonus on December 31 of that year will be considered timely. The regulation also incorporates a variant of the “short-term deferral” exception, which comes in handy in the case of payment dates that occur late in the year. Specifically, the regulation states that a payment will be considered timely if it is made by the 15th day of the third month following the specified payment date so long as the service provider is not permitted (directly or indirectly) to designate the taxable year of payment. Therefore, a deferred bonus that is scheduled to be paid on December 1, 2012 will still be timely if paid on March 15, 2013, so long as the payment date has been chosen by the employer in its sole discretion.
Finally, Treasury Regulations section 1.409A-3(d) also allows a limited opportunity to accelerate the timing of the payment. Specifically, the regulation states that payment will be considered to have been made on the date specified in the plan even if it is made up to 30 days before the designated payment date so long as the service provider is not permitted (directly or indirectly) to designate the taxable year of payment. In that case, a payment scheduled to be made on January 15, 2013 could be paid as early as December 15, 2012, so long as the timing has been selected by the employer free from an employees instructions. (The IRS will not be heard to complain if someone ends up paying taxes sooner than expected.) Under these rules, then, a payment that is set to be made on January 1, 2013 can be paid as early as December 1, 2012 or as late as December 31, 2013 without running afoul of Section 409A.
When working with these rules note that the “event-driven” timing rules require the designated payment period (e.g., within 60 days following separation from service) to be specified in the plan, while the somewhat more open ended rules that provide wiggle room for payments made after a specified payment date can be applied in operation. We find these rules in particular to be very helpful in addressing issues brought to us by clients who suffer from Section 409A anxiety and fear that any tardy payment could be fatal. How those clients love it when we tell them that they should be okay as long as the payment is made by the end of the year.