409A Taxation of Specified Employees

[Guest ERISAQUEEN]

A specified employee terminated in November, 2006. The plan provides that individuals will receive distributions upon termination; however, a specified employee must delay payment for six months.

Is the distribution amount reportable as income for the specified employee in 2006, when there apparently is no longer a substantial risk of forfeiture, or in 2007 when the amounts are actually/constructively received?

[namealreadyinuse]

By "the plan" you mean the old, non-409A version, correct? The new 409A version will say that the specified employee cannot get a distribution until the 6 month rule is met. There is no actual receipt (or constructive receipt, economic benefit, etc.) until payment.

[Just Me]

I assume from the question that this plan is subject to 409A (otherwise status as a specified employee would be irrelevant). Taxation occurs and is reported when the distribution is paid to the employee, assuming the plan sponsor is not a tax exempt entity, in which case taxation may occur when the substantial risk of forfeiture lapses. By the way, why not have the plan provide for IMMEDIATE distributions - that way it would be exempt from 409A under the short term deferral rule, and specified employees won't be subject to the six month wait.

[QDROphile]

Just Me:

Please explain how deferred compensation becomes transformed and is no longer deferred compensation simply because payment is immediate upon the payment event.

[Guest Harry O]

Q -

I think what Just Me is saying is that if the compensation was subject to a SRF up until the date the specified employee terminated (say, it was a severance plan that only paid upon INVOLUNTARY termination of employment and not upon a "good reason" termination), the plan is not considered deferred compensation for 409A purposes if amounts are paid within 2.5 months of the year the employee terminated. It is not clear from the original post whether this is the case . . .

[Steelerfan]

It might help to remember that (ignoring 457 concerns) the lapse of a valid substantial risk of forfeiture would never be a taxable event under 409A unless there was a 409A failure. So in the original example the taxable event would occur in the year in which the payment was made or became available and of course not when the vesing schedule lapsed (or when the plan would have been able to payout had the person not been a specified individual).

Note that in order to avoid the administrative burden of the special specified individual payout rule, many companies opt to apply the six month rule to everyone.