The deferred compensation rules create high hurdles around the conditions for deferral and the timing of compensation, but the COVID-19 pandemic could fall into a special category of unforeseen events.
“For employees who want to stop their deferrals to a plan, there may be an opportunity to do it, but it’s going to be heavily fact-intensive and needs to be discussed with experts on section 409A to make sure it doesn’t mess up the plan and result in immediate tax and the 20 percent additional tax,” Michael Collins of Gibson, Dunn & Crutcher LLP said April 2 during a webinar hosted by the American Law Institute.
Section 409A provides the rules on nonqualified deferred compensation and restricts when that compensation can be received. If those rules are violated, the deferred compensation can be included in income and subject to the additional 20 percent penalty.
“There’s a very limited ability to get money early out of these plans or to modify deferral elections for 2020 once the year has started,” Collins said.
Unforeseeable Emergency
Collins said the only way to change deferral elections is if the employee has an unforeseeable emergency. Section 409A defines an unforeseeable emergency as “a severe financial hardship to the participant resulting from an illness or accident of the participant, the participant’s spouse, or a dependent (as defined in section 152(a)) of the participant, loss of the participant’s property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant.”
This latter, catchall portion of the definition is what could potentially be used in response to the coronavirus, Collins said.
Jason A. Rothman of Ogletree, Deakins, Nash, Smoak & Stewart PC agreed that the unforeseeable emergency provision presents an opportunity.
“Unforeseeable emergency will allow an individual to turn off their deferral election in a nonqualified plan,” Rothman said during a March 25 webinar hosted by his firm. He added that this means reducing the deferral election to zero and leaving it that way for the rest of the year.
“There’s also an opportunity for a distribution due to an unforeseeable emergency, but there are a lot of hoops that an individual’s going to have to go through to show that they have an unforeseeable emergency,” Rothman said.
In terms of cost-cutting strategies for employers, Collins said employers may be able to reduce or eliminate employer contributions to nonqualified deferred compensation plans depending on the plan terms. “That reduction or elimination won’t be subject to section 409A,” he said.
An IRS official said in October 2019 that previously proposed guidance on section 409A will probably be reproposed. Earlier this year, the Government Accountability Office issued a report that criticized the IRS’s enforcement of section 409A.