3557 / What are Section 409A’s effective dates, compliance deadlines and grandfathering rules?

The requirements of Section 409A generally apply to amounts deferred (or prior unvested amounts) after December 31, 2004. The requirements also apply to amounts deferred prior to January 1, 2005, if the plan under which the deferral is made is “materially modified” after October 3, 2004. There is an exception for material modifications made pursuant to IRS guidance. The IRS deferred the date to comply in both form and operation with the final regulations under Section 409A until December 31, 2008, and actual compliance began as of January 1, 2009.¹ Prior to January 1, 2009, plans were required to operate in “good faith” compliance with Section 409A documentary and operational requirements.²

The proposed 409A technical clarification regulations that change the final 409A regulations can be relied upon until the clarifications are made final.³ The 457/409A integration regulations apply to compensation deferred under a plan for calendar years after the date the rules are published as final. However, they could be relied on immediately.⁴ Unfortunately, there is no grandfathering or transition language for plans impacted by any the changes, especially as to ineligible 457(f) plans, for the long period between the final regulations and the 2016 release date of proposed regulations for such plans.

It should be noted that, under IRS Notice 2010-6, addressing documentation errors, sponsors were given until not later than December 31, 2010, to make corrections to documents not made compliant by December 31, 2008, and to have these corrections deemed retroactively in compliance as of the January 1, 2009 actual compliance deadline under Section 409A (see prior discussion on correction of documentation and operational plan errors in Q 3553). This deadline has passed and generally has not been extended except for certain specific corrections outlined in Notice 2010-80 that expired after December 31, 2012.

Finally, plans with certain assets in offshore rabbi trusts were given only until December 31, 2007 to disconnect or terminate the trust so as to comply with the 409A(b) funding requirements. Notice 2008-33 provided temporary guidance on complying with these requirements. Currently, no regulations on Section 409A(b) have been released, so further guidance as to the structuring of assets in such rabbi trusts is not yet available. A plan is “materially modified” if a new benefit or right is added or if a benefit or right existing as of October 3, 2004 is materially enhanced and such addition or enhancement affects amounts earned and vested before January 1, 2005. The reduction of an existing benefit is not a material modification.⁵ Adding a participant right to a grandfathered plan that it did not possess, even though it was technically permissible under Section 409A, will be considered to be a material modification (for example, an “unforeseeable emergency” distribution right).

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Planning Point: Employers should use great care in making any modifications to existing pre-409A deferred compensation arrangements until they are paid out to avoid the application of IRC Section 409A. According to the final regulations, a “material modification” that causes loss of grandfathering may be considered to be a formal plan amendment and may occur simply by virtue of an employer’s exercise of administrative discretion in the plan participant’s favor. Any amendment effected by form or practice that adds a beneficial right to a plan, even if it was allowed prior to the enactment of Section 409A and remained permissible after enactment (for example, a financial hardship provision), can cause loss of grandfather protection.

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1.   Notice 2007-86, 2007- 46 IRB 990; Notice 2006-79, 2006-43 IRB 763.