A year-end deadline for correcting certain impermissible payment language in employment, severance, or similar agreements is fast approaching.
As background, Code Section 409A - which governs most arrangements providing for future payments of taxable compensation - generally requires that deferred amounts be paid at fixed or identifiable times (e.g., termination of employment or a specified date) and that the covered individual (e.g., employee) not have the right to designate the calendar year in which payment will be made. These rules apply to most severance-pay and similar arrangements that provide for payments in the event of a specified loss of employment (e.g., a termination without cause).
It is common for severance-pay and similar arrangements to condition an employee's right to payment on the employee providing a release of claims. But this can create an issue under Section 409A, depending on how the payment language is written. The IRS takes the position that the payment language must not provide any opportunity for the employee to control or manipulate the calendar year in which payment will be made.
As an example, assume an agreement provides for a right to payment at any time within 90 days after termination of employment, once the employee has delivered a release of claims. If the employee terminates employment on November 1, the employee can effectively choose which calendar year in which to receive payment (the year of termination or the next year) by deciding when to deliver the release. In comparison, if the agreement says payment will be made on the 90th day after termination of employment, regardless of when the release is provided in that 90-day period, then there is no opportunity for manipulation.
The IRS has provided a transitional period to reform document provisions that are out of compliance with this requirement. To qualify for this transitional relief, amendments tightening the payment language must be adopted by December 31, 2012. To ensure there is adequate time, any documents with potential problems on this issue should be reviewed soon.