CUNA Comment Letter
Guidance on Deferred Compensation Under Section 409A
April 4, 2005
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044
|RE:||Guidance Under §409(A) of the Internal Revenue Code Deferred Compensation (Notice 2005-1)|
Dear Sir or Madam,
The Credit Union National Association (CUNA) is pleased to provide comments on the Internal Revenue Services (Services) guidance in Notice 2005-1 regarding new section 409A of the Internal Revenue Code (Code) governing nonqualified deferred compensation plans. Section 409A was added to the IRC by the American Jobs Creation Act of 2004. Section 409A establishes specific requirements that certain deferred compensation plans must meet to receive tax deferral treatment. If at any time during a taxable year a nonqualified deferred compensation plan fails to meet the requirements of Section 409A, all amounts deferred under the plan for the taxable year and all preceding taxable years by any participant with respect to whom the failure relates, are includable in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. The new requirements apply to amounts deferred on or after January 1, 2005, subject to several special effective date rules. By way of background, CUNA is the largest credit union trade association, representing approximately 90% of our nations nearly 9,300 state and federal credit unions.
Summary of Comments
- It would be beneficial for the Service to provide some detailed examples of what is and what is not considered deferred compensation for purposes of Section 409A.
- The anti-acceleration provisions should be changed to state that an unlawful acceleration should only occur when the participant elects to receive their benefit at an earlier starting time or if the participant starts taking installments and then subsequently wants to take the rest in a lump sum.
- Some clarifications should be made to the provisions regarding distribution events, including whether a plan provision allowing distribution to occur upon the earlier of two or more distribution events permitted under Section 409A would be considered as a prohibited acceleration of benefits.
- The Service should clarify whether payment of a lump sum pursuant to a plan that allows a participant and/or beneficiary to request a lump sum payment where the decision is beyond the participants control and is up to the discretion of the plan administrator to accept or reject such request would be considered an acceleration of payments in violation of Section 409A.
- We urge the IRS to clarify that the short-term deferral exception would apply to employer-funded 457(f) plans and make this exception permanent, as it is a reasonable exception and does not jeopardize the laws purpose and intent.
- The final guidance should recognize that it is unduly limiting to require a participant desiring to change only the form of payment to have to defer the commencement of payment for five years; the participant should be able to make the change at least one year in advance without the five year delay.
- Section 409A should not apply to typical severance arrangements. Severance is meant to provide income directly following loss of a job and not deferred compensation.
Discussion of Comments
The new section of the Internal Revenue Code, Section 409A, would modify several requirements for Section 457(f) non-qualified deferred compensation plans that some credit unions have in place for their senior management. This is an important issue to many credit unions and other tax- exempt employers because they use 457(f) plans as a part of a comprehensive benefits package to attract and retain talented executives and officers. While Section 409A appears to have a limited impact on 457(f) plans, credit unions may be more impacted if the short term deferral is not made permanent and federal credit unions (FCUs) may end up being more impacted depending on guidance that the Service is expected to provide regarding the Private Letter Ruling (PLR) issued back in April 2004. In the PLR, the Service stated that a particular FCUs non-qualified deferred compensation plan was not subject to Section 457 of the Code.
While CUNA commends the Services efforts to issue guidance implement the new Section 409A in a prompt fashion, we have several concerns with the guidance which we believe should be addressed in the guidance when it is released in final form. Our concerns are set out below.
Definition of Deferral of Compensation
In Q&A 4(a), Notice 2005-1 states A plan provides for the deferral of compensation only if, under the terms of the plan and the relevant facts and circumstances, the [employee] has a legally binding right during a taxable year to compensation that has not been actually or constructively received and included in gross income, and that, pursuant to the terms of the plan, is payable to (or on behalf of) the [employee] in a later year. It would be beneficial for the Service to provide an example or two of what is/is not considered deferred compensation. For example, if an employer promises to pay $1 million dollars to the employee at age 65, provided the employee does not leave or get terminated for cause prior to that time, would that $1 million be deemed deferred compensation?
Acceleration of Payments
The general rule under Section 409A is that a deferred compensation plan may not permit the acceleration of the time or schedule of any payment under the plan. Any plan that permits a participant to accelerate their retirement date to a date prior to the normal retirement date stated in the plan or to accelerate the date they are to receive benefits will cause the plan to be out of compliance and the executive subject to immediate taxation and penalties unless the accelerated payment falls with certain listed exceptions. A plan may permit acceleration of benefits only under the following 5 situations: domestic relations order, certificate of divestiture, 457(f) payment to pay income taxes due upon a vesting event, de minimis and specified amounts, and payment of employment taxes. We urge the IRS to consider modifying the anti- acceleration provisions to allow participants to elect from among several optional payment forms as long as the benefit commencement date is not changed. As illustration, a participant should be permitted to choose between a single sum distributed on January 1, 2007 and a series of installments beginning on January 1, 2007. CUNA believes that an unlawful acceleration should only occur when the participant elects to receive their benefit at an earlier starting time or if the participants started taking installments and then subsequently wants to take rest in lump sum.
Under Code Section 409A(a)(2)(A), distributions under a plan are limited to the following events: specific date/time or pursuant to a fixed schedule stated in the plan; separation from service; death; disability; change of control; and unforeseen financial emergency. CUNA requests that the Service clarify whether a plan provision allowing distribution to occur upon the earlier of two or more distribution events permitted under Section 409A(a)(2)(A) would be considered as prohibited acceleration of benefits under Section 409A(a)(3).
In addition, it would be helpful if the service would clarify the extent to which exact timing is required to meet the specified time or fixed schedule requirement. Is it sufficient that only the year of payment is specified or must exact dates be set down? Can timing within a year be discretionary?
Lump Sum Payments
Some plans allow a participant and/or a beneficiary to petition the plan administrator to receive a lump sum payment rather than installments. The plan administration has the discretion to accept or reject the participants or beneficiarys request. If accepted, it would clearly be taxed in the current taxable year. However, it is still unclear as to whether, given that the administrators decision is beyond the participants control, the receipt of the payment would this constitute an acceleration of payments. If would be useful if the Service would address this situation in the final guidance.
Short-Term Deferral Exception
Q&A 4(c) provides that a deferral of compensation does not occur if, absent an election to otherwise defer the payment to a later period, at all times the terms of the plan require payment by, and an amount is actually or constructively received by the participant by, the later of (i) the date that is 2½ months from the end of the participants first taxable year in which the amount is no longer subject to a substantial risk of forfeiture or (ii) the date that is 2½ months from the end of the employers first taxable year in which the amount is no longer subject to a substantial risk of forfeiture. The Notice states that this exception is effective until additional guidance is issued by the Service. We urge the IRS to clarify that this provision would apply to employer-funded 457(f) plans and make this exception permanent, as it exempts most Section 457(f) plans from coverage under Section 409A. This is because most Section 457(f) plan distributions occur immediately upon or shortly after the time the participant vests. As indicated by the legislative history of the American Jobs Creation Act, it was Congress intent to exempt short-term deferrals from Section 409A: It is intended that the [Act] does not apply to annual bonuses or other annual compensation amounts paid within 2-1/2 months after the close of the taxable year in which the relevant services required for payment have been performed. (Joint Explanatory Statement of the Committee of Conference Accompanying H.R. 4520 (October 7, 2004)).
Under 409A(a)(2)(A), distributions under a plan are limited to the following events: specific time or date stated in the plan; separation from service; death; disability; change of control; or unforeseen financial emergency. We encourage the Service to clarify in the circumstance where there is a delay in payment of occurrence of a distribution event beyond the short-term deferral period whether that delay will be deemed an additional deferral to which the requirements of 409A(a)(2)(A) apply.
Changes in Timing and Form of Distributions
CUNA requests that a modification be made in the guidance provisions dealing with a delay in a payment or a change in the form of payment after the initial deferral decision. In particular, Section 409A(a)(4)(C)(ii) requires that the first payment with respect to which such election is made be deferred for a period of not less than 5 years from the date such payment would otherwise have been made . We ask the Service to modify the provision to indicate that an election to merely change the form of payment (such as from a lump sum payment to installment payments) subsequent to the participants initial decision, if made at least one year in advance, does not require the participant to defer the commencement of payment for five years.
Notice 2005-1 indicates in Q&A 19(d) that severance plans which are amended on or before December 31, 2005 to conform to the provisions of Section 49A are exempt from the requirements of §409A during the calendar year 2005 with respect to such severance pay benefits as long as the plan is either (i) a collectively bargained plan or (ii) covers no service providers who are key employees . The Notice specifically asks for comments on whether 409A should exclude any specific types of severance plans or arrangements. CUNA strongly feels that this limited exception should be expanded. Section 409A should not apply to typical severance arrangements. Severance pay is designed to provide a temporary source of income to employees who are involuntarily terminated. This directly contradicts the purpose of severance pay.
Thank you for the opportunity to comment. If you have any questions about this letter, please contact me at (202) 638-5777.
Senior Regulatory Counsel
Credit Union National Association