Guest Article

(From the September 8, 2009 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS CCA Memo Advises that Salary Advances May Violate IRC § 409A

The IRS informally advised that an employer's salary advance program would violate IRC § 409A because it allowed the salary advances to be offset against the recipient's nonqualified deferred compensation benefit at termination of employment. Chief Counsel Advice Memorandum 200935029 (Released 8/28/2009).

IRC § 409A Prohibits Acceleration of Payment

An employer's "salary advance" program required recipient employees to earn out the advances through future services or otherwise make payment in full at termination of employment. In lieu of payment, the employees were allowed to offset their outstanding salary advances against their deferred compensation benefit at termination of employment. In addressing the program, the IRS Chief Counsel cited potential problems with IRC § 409A.

IRC § 409A generally prohibits the acceleration of the time or schedule of any payment under a deferred compensation plan. An offset against the payment of deferred compensation may constitute a prohibited "acceleration of payment" because it is generally considered to be payment of the deferred compensation. The Preambles to the Treasury Regulations explain:

Therefore, amounts that currently or in the future may be offset against nonqualified deferred compensation are treated as payments of deferred compensation and may violate the anti-acceleration rule under IRC § 409A(a)(3).

Salary Advance Program or NQDC Plan Must Be Modified

Failure to comply with IRC § 409A results in the benefit under the deferred compensation plan being included in the recipient's taxable income retroactive to the year of the deferral, with interest imposed on the past-due taxes at the standard IRS underpayment rate plus 1% and the application of a 20% penalty to the amounts that are included in income.

The Advice Memorandum advised the employer to discontinue the salary advance program or modify the terms of the nonqualified deferred compensation plan so that it complies with IRC § 409A.

The Treasury Regulations do provide a narrow exception by which offsets are allowed if the debt is incurred in the ordinary course of the service relationship, the offset in any taxable year does not exceed $5,000, and the offset is taken at the same time and in the same amount as the debt otherwise would have been due from the employee service provider. Treasury Regulations § 1.409A-3(j)(4)(xiii).

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2009, Deloitte.