penalities under 409A

[mbozek]

Receiving payments in violation of 409A will result in taxation at ordinary income tax rate, 20% penalty tax and imputed interest at the fed rate for underpyament of income tax. As I understand it, the 20% penalty is added to the amount of income tax and the imputed interest is compounded as of the date the payment was initially deferred. E.g. if employee is paid 100k in violation of 409A when the underpayment interest rate is 6% and the payment was initially deferred 20 years ago, the tax on 100k will be due at the marginal tax plus a 20k penalty and 19,242 in interest @6% compounded for 20 years (6000 x6% for 20 yrs) . I would like confirmation that the interest would be compounded from the date of the deferral at the underpayment rate in effect in the year the payment is made as opposed to the IRS underpayment rate for each year since deferral occurred.

[Alf]

I don't see it that way at all or else I don't understand the retroactive nature of your example.

Keep it simple and just deal with the future. If 100K is deferred into a noncompliant plan, the exec is taxed on 100K in the year of deferral and socked with a 20% excise tax. Every future year that the funds are deferred, the exec owes interest at the underpayment rate until the account balance is paid. Once the funds are paid, everything is over. Your example starts with a 100K payment, so I got lost.

Now, transition rules are a different matter. IF you have a pre-2005 plan that is not grandfathered and not compliant, my guess is that the exec would be taxed on the 1/1/05 balance during 2005 and the 20% tax would be levied on that in 2005. Deferrals for subsequent years would be subject to interest until the balance is paid.

Of course, this is all a guess and may not make sense to anyone but me!!!

[Guest Harry O]

I don't think the statute is clear on this point.

[mbozek]

IRC 409A(a)(1)(B)(ii) is clear that the interest begins to accrue as of the year the def. comp included in income because of a violation of 409A was first deferred or when vested, if later. The example was base on a statement which appeared on P. 2540 of the BNA Pensions & Benefits reporter (11/16/04) that the interest is deem to run from the date that the deferred amount would have been includible in income if it had not been deferred, not from the date the interest is includible as taxable income.

What is not clear about when the imputed intrest begins to run?

[GBurns]

Isn't the interest includible starting at the same time that the deferred amount becomes taxable income?

Imputed interest can only start when there is taxable income on which to charge it.

[Guest Harry O]

I think it is clear WHEN the interest begins to run; I'm not so sure its clear on how the interest is calculated.

[mbozek]

GB: the purpose of 409A was to raise revenue- thats why Congress imposed the 20% penalty tax and imputed interest on the deferral at the fed. underpayment rate + 1%. The imputed interest runs back to the date the amount was initially deferred treating it as a interest free loan to the employee. The imputed interest is deemed to start when the amount that is taxed under 409A was first deferred to eliminate any tax benefit of the deferral to the employee.

[Everett Moreland]

mbozek:

Several code sections impose interest "at the underpayment rate." Whatever scheme is used under those sections to determine the underpayment rate for a period is likely to apply to 409A. Without having researched it, I would be amazed if the underpayment rate for a period is other than the underpayment rate under Section 6621 for that period; I doubt it's fixed at the underpayment rate in effect at the time of the deferral or at the time of taxation.