Ready to start a business? Let me introduce Section 409A.
By: BJ Lawson
I’ve written before about the ridiculous and self-destructive tax code that punishes creativity and productivity. Perhaps the best evidence of our present insanity is the Internal Revenue Code’s Section 409a, which was added by Section 885 of the American Jobs Creation Act of 2004. Not ready to read all 650 pages? Here’s the summary:
To amend the Internal Revenue Code of 1986 to remove impediments in such Code and make our manufacturing, service, and high-technology businesses and workers more competitive and productive both at home and abroad.
Of course, by now you’re wondering if this legislation is actually intended to create jobs:
Like a captivating novel, the 650-page American Jobs Creation tax act headed toward President Bush’s desk will make you want to laugh, cry and scream… Will it create new jobs? “Jobs for tax professionals, yes,” says Scharin.
So today, four years later, I received a helpful reminder from my friends at Hutchison Law Group reminding their clients that the deadline for Section 409a compliance is coming up at year’s end. To quote their dispatch:
The deadline for full compliance with Section 409A of the Internal Revenue Code relating to the deferral of compensation for employees and other service providers is December 31, 2008. We do not believe that the IRS will extend this compliance deadline. Therefore, it is crucial for those companies who have delayed reviewing their compensation-related arrangements to do so promptly in order to meet the deadline.
Why is the deadline important?
- Employee satisfaction. Employees are subject to a 20% excise tax for failure to comply with Section 409A. Since Section 409A, among other things, governs issues regarding severance and bonuses, key executives and salespersons are especially likely to be affected.
- The Company also loses. A company that fails to comply with Section 409A will have to correct or supplement its withholdings, which may involve the payment of penalties and interest. The company may also be unable to make certain representations regarding Section 409A compliance in its financing or acquisition documents, thereby potentially losing or otherwise adversely affecting a deal. Such representations are now routinely required in these types of transactions.
What does my company need to do now?
1. Inventory and review current documents for compliance with Section 409A, including:
- Employment agreements and offer letters
- Severance agreements
- Post-employment fringe benefits
- Change of control agreements
- Advisory Board arrangements
- Consulting agreements
- Bonus and other cash incentive arrangements
- Commission plans and arrangements
- Equity plans, stock options and stock appreciation rights
- Phantom stock agreements
- Restricted stock unit plans
- Salary deferral arrangements
- Deferred compensation plans
- Supplemental retirement plans (“SERPs”)
- Tax gross-up and indemnification arrangements
Certain types of plans are generally exempt from Section 409A, including:
- Qualified retirement plans, such as 401(k) plans and pension plans
- Most group health plans
- Bona fide sick leave and vacation plans
- Disability plans
- Death benefit plans, such as group life insurance plans
- Certain medical expense reimbursement plans
- Incentive stock options meeting the requirements of Code Section 422
- Most direct grants of restricted stock
2. Consider unwritten arrangements. Review all unwritten arrangements regarding compensation to ensure compliance with Section 409A. (This means, for example, founder arrangements, back of the envelope arrangements and unwritten sales commission plans.) Employers must reduce all unwritten arrangements that are subject to Section 409A to writing by December 31, 2008.
3. Devise a plan to bring non-compliant compensation-related arrangements into compliance by December 31, 2008. In many instances, this will involve drafting or amending agreements which may require Board approval. Employee consent may also be required. It is important to start this process now so that all available amendments or revisions can be made in a timely manner.
4. Devise a plan for internal controls and compliance. After all current arrangements are brought into compliance with Section 409A, it will be important to make sure that all future arrangements are compliant from the start. Therefore, processes and procedures will need to be adopted to ensure that compensation-related arrangements are reviewed for compliance prior to being used or adopted, and that any modifications or amendments to these types of arrangements are reviewed in advance for potential Section 409A consequences.
What does the above have to do with creating value for your customers, and your community?
It’s no secret that our economy is in trouble. How can we improve our current predicament?
American companies need freedom to serve their customers instead of increasingly byzantine tax codes crafted by lobbyists and special interests. Our nation’s attorneys and accountants need to help their clients on offense, instead of squandering resources defending against a government that doesn’t know when to stop.
Now are you ready to start a business? Or would you prefer to just look for a job, preferably with the government?
The price of complying with the current system is a barrier that prevents many from even trying to start or grow a business.
June 26th, 2008 at 10:15 pm
I can’t even fathom what this bill is actually about, much less how it creates jobs. As someone who aspires to be an entrepreneur, the thought of grappling with things like this simply frightens me. BJ, we’re counting on you to vote against every inane piece of garbage like this once you’re in Washington.
June 27th, 2008 at 7:05 am
This is another reason why we should abolish the IRS, and as Ron says, replace it with nothing.
June 27th, 2008 at 2:18 pm
I’m so sick of big government! Especially in the marketplace. As is, business owners already have to spend way too much time working just to meet tax regulations. It literally is so overwhelming that it stunts entrepreneurship. Does anyone know how in the world did the 16th ammendment pass?? I can’t figure it out…
June 29th, 2008 at 12:35 pm
These cumulating little shots at liberty are exactly why the US empire is going down the drain. While the establishment is busy taking 75% of what we earn and produce (after all taxes across the board, including sales tax), and spending it invading other countries, spreading the welfare benefits, and destroying out freedom - we only continue to get poorer and less competitive. The day is coming very soon where we’ll finally fall behind the rest of the world in terms of economic growth and it will be in the best interest of our children to encourage them to find a better place to live. We’ve embraced Socialism and it is destroying the American Dream, as it were.
June 29th, 2008 at 6:32 pm
“Does anyone know how in the world did the 16th ammendment pass?”
The 16th Amendment was sold to the American public as a “soak the rich” plan. Be very suspicious anytime a politician promises you that he’ll get wealthy people to “pay their fair share”. They’ll inflate us into those upper brackets every time.
-jcr