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Correction Program for Section 409A Document Failures Issued; Changes to Form 5500 for 2009; IRS Clarifies Timing to Claim COBRA Subsidy Credit

Focus On Employee Benefits

Executive Compensation: IRS Issues Correction Program for Section 409A Document Failures

Fred Oliphant, Gary Quintiere, and Adrian Morchower

The IRS has published a section 409A document correction program, generally effective for taxable years beginning on or after January 1, 2009, under which taxpayers may voluntarily correct many types of document failures in order to come into compliance with the document requirements applicable to nonqualified deferred compensation plans under section 409A of the Internal Revenue Code (Code). Notice 2010-6 also clarifies and modifies previously published Notice 2008-113, relating to the correction of operational failures of nonqualified deferred compensation plans, and Notice 2008-115, relating to reporting and wage withholding under section 409A of the Code. As explained more fully below, the new program provides incentives for reviewing plan documents and correcting failures as soon as possible. In particular, employers will want to review their plan documents and take any corrective action this year if they wish to take advantage of certain transition relief incentives.

The document failure correction program applies to a list of specified document errors -- i.e., not all document errors are covered. For example, with one exception, document errors related to linked plans (plans that interact with other qualified plans or nonqualified plans) and stock rights are not covered by the Notice. The specified errors addressed in the Notice include ambiguous and impermissible definitions; impermissible payment events, periods, and schedules; impermissible deferral elections; impermissible reimbursements or in-kind benefit provisions; and failure to include a provision providing for a six-month delay of payment for a "specified employee." In general, for each specified error, there is a prescribed method of correction. So, like the methodology contemplated by Notice 2008-113 with respect to operational errors, taxpayers will need to first identify the applicable category of error -- there may be more than one that applies -- and then apply the prescribed correction method for the particular error. The Treasury Department and the IRS have requested comments regarding document failures not covered by the Notice.

While the Notice is designed to provide relief, the Notice also effectively serves as a vehicle for the IRS to identify provisions it considers impermissible under the section 409A regulations. One such category of impermissible provisions that has already attracted a good deal of attention (and objection) is the one in Section VI.B in which the IRS appears to take the position that if a document provides for payment within a permissible payment period, e.g., 90 days, but also provides that payment will be made within such period only if the service provider executes a release or non-competition agreement, the document needs to be corrected, i.e., by amending the document to provide for payment only on the last day of such period. Employers will want to pay particular attention to this interpretation of the regulations in reviewing their documents. The documentary issue presented by this interpretation would presumably not apply if the payment did not constitute deferred compensation, so that payments qualifying as short-term deferrals that are to be paid no later than the short-term deferral deadline, but only on receipt of a release, would not appear to be affected.

As a general matter, except as provided in certain transition relief provisions in the Notice, document failures will not be eligible for correction with respect to a particular employee or service provider if the erroneous document provision is in fact applied prior to the correction. For example, if a plan impermissibly provides that the service provider's transfer from employment with a parent corporation to employment with a wholly-owned subsidiary corporation of that parent qualifies as a separation from service and as a payment event, then, other than as provided in the transition relief provisions, the plan cannot be corrected once the service provider has transferred from the parent to the subsidiary, regardless of whether the deferred amount is paid to the service provider.

Some document failures, though, may be corrected under the Notice within a reasonable time after such event. Thus, if a plan impermissibly provides for a payment period of more than 90 days following a permissible payment event (such as a separation from service), the plan may be amended within a reasonable time following the event if that payment is, in fact, paid within 90 days following the event and other requirements are satisfied.

Like the approach taken in Notice 2008-113, there are certain general eligibility requirements that must be met in order to qualify for relief under the document correction program. Perhaps most importantly, relief under the document correction program is not available to service providers and service recipients who are under IRS examination. For these purposes, an individual will be treated as under examination if the individual's federal tax return is under exam for a year in which the document failure existed. A non-individual is generally treated as being under exam if the entity has received written notification from the examining agent specifically citing nonqualified deferred compensation as an issue, but for corrections made on or before December 31, 2011, with respect to examinations for periods beginning before 2012, the entity will be treated as under examination only with respect to a specific document failure that has been identified as an issue in the examination.

Additional conditions of eligibility include the following: The taxpayer must take commercially reasonable steps to identify and correct all other nonqualified deferred compensation plans that have a similar document failure. Relief is not available to correct intentional document failures or failures related to participation in a listed transaction under Treas. Reg. § 1.6011-4(b)(2).

In connection with certain document corrections made under Notice 2010-6, the service provider may also be required, in certain circumstances, to include in current income a portion of the amount deferred (generally 50 percent) and to pay the applicable federal taxes, including the additional 20 percent tax, but not the premium interest tax, which are imposed under section 409A(a)(1)(B)(i) of the Code. In such case, the employer is required to report the includible amount on Form W-2, Box 1 and Box 12 using Code Z. Generally, though, these income inclusion requirements are not imposed unless an operational event which would implicate or trigger the defective provision that was corrected occurs within one year of the correction.

Other relief is available when plan corrections are made prior to certain deadlines. For example, if an erroneous plan document provision is corrected no later than the later of the end of the calendar year in which, or the 15th day of the third calendar month following the date, the legally binding right to deferred compensation arose under that plan (and all other plans treated as the same plan), and the payments made (or failures to make payments) attributable to the document failure are treated as operational failures and timely corrected under Notice 2008-113, the income inclusion and penalty tax requirements are not applied. Similar relief is available under a transition rule if a plan document failure is corrected on or before December 31, 2010, in which case the plan is treated as having been corrected on January 1, 2009. The latter rule will effectively allow document corrections under the Notice to be made in 2010 without income inclusion (other than any inclusion required under Notice 2008-113). Certain plan errors in connection with a linked plan or a fixed schedule of payments will not cause a failure of the plan if corrections are made on or before December 31, 2011, and operational failures are timely corrected under Notice 2008-113.

Notice 2010-6 imposes several information and reporting requirements regarding section 409A document failures, including document failures corrected under the transition relief. A service recipient must attach to its original federal income tax return for its taxable year in which it corrects a failure, a statement setting out the information required under the Notice and must provide certain information to affected service providers. The service provider must attach a copy of the statement that was provided by the service recipient to the service provider's income tax return for the applicable year or years. Note that the service provider notice requirement may entail notifying all employees affected by the corrected provision.

As discussed above, Notice 2010-6 provides additional or special relief for prompt corrections of document failures. Therefore, employers should consider initiating a review of their nonqualified deferred compensation plans in order to identify and correct noncompliant plans as soon as possible.


Qualified Plans: Mandatory E-Filing and Other Changes to the 2009 Form 5500

Elizabeth Drake and Garrett Fenton

A number of changes have been made recently to the process for filing Form 5500 (Annual Return/Report of Employee Benefit Plan), as well as to the content of the form and related schedules. To ensure compliance with applicable law, therefore, employer-plan sponsors and plan administrators should familiarize themselves with the new requirements that are effective this year.

Mandatory Electronic Filing

Pursuant to final Department of Labor ("DOL") regulations issued in 2007, all plans required to file a Form 5500 must do so electronically, via the DOL's new EFAST2 system, beginning in 2010 (i.e., for 2009 and subsequent plan year filings). Nearly all filings submitted through EFAST2 will be posted on the DOL's website for public viewing within 90 days of submission. The Form 5500 may be electronically prepared and/or filed by using either (1) an approved third-party software program (see a list of such approved programs), which most plans will use, or (2) the DOL's IFILE system, available directly through the EFAST2 website.

To comply with the new e-filing rules, any employer/plan administrator required to sign a Form 5500 must obtain a PIN by registering with the EFAST2 system as a "Filing Signer." There are other categories for which a person can register as well, depending upon his or her involvement in the submission process and the e-filing method that will be used. For example, anyone who will initiate and prepare a filing using IFILE (not third-party software) must register as a "Filing Author," and anyone who will electronically submit a signed filing (through IFILE or third-party software) must register as a "Transmitter." Registration is now available through the DOL's dedicated website,

Employers/plan administrators can still have third parties prepare and submit Form 5500 filings on their behalf, as long as they view and electronically sign the completed filings (using their EFAST2 assigned PIN) before submission. However, third parties cannot register with EFAST2 on behalf of Filing Signers. Moreover, the DOL expressly prohibits all EFAST2 registrants from sharing their PINs with others. The DOL apparently believes that this will help ensure that Filing Signers will actually view and sign their Forms 5500 before submission.

Substantive Changes to Form 5500

In addition to the new e-filing requirements, changes have been made to the 2009 Form 5500 and related schedules. The most significant changes are to Schedule C (Service Provider Information), regarding compensation paid to service providers. For example, plans can no longer limit their Schedule C compensation disclosures to the "top 40" highest-paid service providers, and may need to provide information about "indirect compensation" for service providers who received $5,000 or more from the plan. In addition, the Schedule SSA (Annual Registration Statement for Deferred Vested Participants) will no longer be filed with the Form 5500. Instead, filers required to submit information on participants who separated from service with deferred vested benefits must file a separate annual registration statement with the IRS. Although the IRS has indicated that the registration statement will be in the form of a stand-alone Form SSA, the relevant 2009 form and instructions have not yet been released.


Health and Welfare: IRS Clarifies Timing to Claim COBRA Subsidy Credit

Michael Lloyd, Susan Relland, and Garrett Fenton

On January 20, 2010, the IRS issued clarifying guidance (Q&A RD-6) regarding the appropriate period in which employers must claim the federal 65% COBRA subsidy on their quarterly payroll tax returns. New Q&A RD-6 interprets the previously-issued Q&A FP-15, and specifically addresses a scenario in which an employer receives an assistance eligible individual's 35% COBRA premium payment in 2010 for coverage provided in 2009.

The American Recovery and Reinvestment Act of 2008, as amended by the Department of Defense Appropriations Act for Fiscal Year 2010, requires certain employers (and insurers of insured health plans) to accept a reduced 35% COBRA premium payment as payment-in-full from certain individuals who became eligible for COBRA because of an involuntary termination of employment occurring between September 1, 2008, and February 28, 2010. Please see our December 22 Employee Benefits Alert. The employer may claim the remaining 65% premium amount as a payroll tax credit on its Form 941, Employer's Quarterly Federal Tax Return.

Q&A FP-15 indicates that an employer may claim the COBRA subsidy credit on a Form 941 filed for either the quarter in which the "subsidy is provided," or a later quarter in the same calendar year. Questions have arisen regarding whether an employer must claim the credit for the coverage year rather than the year in which the employer receives the 35% premium. For example, consider a situation in which an employer receives an assistance eligible individual's 35% COBRA premium in January 2010, for coverage provided in December 2009. There has been some confusion regarding whether the 65% COBRA subsidy should be claimed on a Form 941 for fourth quarter of 2009 or the first quarter of 2010.

New Q&A RD-6 indicates that FP-15 requires an employer to claim the 65% COBRA subsidy credit on the Form 941 filed for the quarter (or a later quarter in the same calendar year) in which the reduced 35% premium payment is received. Note that FP-15 and RD-6 do require employers that reduce their payroll tax deposits for the 65% COBRA subsidy in a given quarter to claim the credit for that particular quarter. Thus, for the example described above, the employer would need to claim the credit on the Form 941 filed for the first quarter of 2010 (or a subsequent quarter, if applicable). The credit expressly could not be claimed for the fourth quarter of 2009 (when the related coverage was provided). As a result, it appears that the appropriate interpretation is that the COBRA subsidy arises at the time an individual's premium is received, not when the related coverage is provided.

We have also learned of situations involving the use of pre-year end cutoff dates by payroll service providers for administrative reasons (e.g., limiting COBRA premiums received after December 15). This can be problematic for employers and result in the filing of incorrect returns, which, in the absence of further IRS guidance, may necessitate an amended filing (Form 941-X). We suggest that all employers who utilize payroll service providers confirm the effect of any administrative cutoff procedures and take corrective action, if necessary.

For additional information, please contact any of the following attorneys in our ERISA/Employee Benefits practice:

Fred Oliphant,, 202-626-5834

Gary Quintiere,, 202-626-1491

Elizabeth Drake*

Michael Lloyd*

*Former Miller & Chevalier attorney

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

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