Postponement of 457(f) benefits: the competing rules of 457(f) and 409A

It is maddening to have competing rules for 457(f) plans to postpone the taxable event. The 2016 proposed regs. require a 90 day notice, a minimum 2 year deferral period, and a benefit enhancement greater than 25%. However, because 457(f) plans are also subject to 409A, when applicable, it seems that a postponement election must also meet the 1 year advance notice/ 5 year minimum postponement requirements of 409A. 

If both statues apply, the rule in the 2016 proposd regs is meaningless except for the requirement to add the enhancement. In other words, complying solely with 90 day notice and 2 year postponement results in an automatic 409A violation. This makes no sense, but I have yet to see anyone in this field take the more logical position just to follow the postponement rule in the proposed 457(f) regs and to ignore the 1 year/5 year 409A procedures. 

Has anyone taken the aggressive position to ignore 409A procedures and just follow he 457(f) procedures? This would seem to be good faith, because I haven't seen anything from IRS that definitively requires that both postponement procedures be followed. 

Section 409A applies only if it is a deferred compensation arrangement. A short-term deferral is defined as not being a deferred compensation arrangement. And the short-term deferral rule applies so long as the amount under a 457(f) arrangement is paid within 2½ months following the year of vesting. So a normal 457(f) arrangement in which amounts are paid on vesting isn't a deferred compensation arrangement, and can follow just the 457(f) rules, not the 409A rules. 

The only time you have to worry about the 409A rules in the context of a 457(f) arrangement is if there is deferral beyond the year of vesting. I have seen this most commonly in situations in which the employer wants to provide an annuity payment. What you'd typically do in that situation is to provide that only an amount necessary to pay the 457(f) tax (which is the tax on the present value of the annuity) is paid in the year of vesting. Thereafter, the person receives the annuity payment each year. The annuity is taxable under section 72, meaning that most of each payment is nontaxable (the tax already having been paid in the year of vesting).

In that situation, you have a deferred compensation arrangement. So if, for example, you wanted to delay the start of the annuity payments, you'd have to follow the 409A rules. But if you're just talking about delaying vesting (and still paying out in the year the amount finally vests), you don't need to worry about the 409A rules. 

Carol, Good to hear from you. Sincere thanks, and I like that response. I'm dealing with an employment contract drafted by another firm that decided to push a short term deferral to the end of a 2 year severance arrangement with a non-compete. (no 26% supplement, but that could be added.)  Although a period of enforceable non-competition would maintain STD treatment for the 457(f), it converts it into 409A deferred compensation and possibly the 409A deferral requirements. That unusual situation is what I am dealing with, and I'm inclined still to ignore 409A. (I haven't seen a discussion of this in the Bloomberg 409A handbook and may have missed it.)

I thought I would drill a little further into this question: extending a tax exempt organization's short term deferral. Is 457(f) enough or is 409A required? Carol's answer is correct that 409A won't apply, but there is an important distinction. Does the the extension period cover a period of employment (extending the STD for 409A purposes so that the payment is still an STD)? Or does it cover a period of "refraining from services," such as a post-retirement non-compete that converts the amount into 409A deferred compensation? That second situation, where the goal is to defer a payment with a non-compete, is a common problem. In that event it could be necessary to defer the payment for 5 years and precede the election with a 1 year 409A notice. 

I'm not alone in this thinking. There is a good article in the June 2017 Tax Advisor. See Example 17 which makes this important distinction. Until I read that, I thought 409A would apply only to a second extension, not the first, under the theory that it only becomes "deferred compensation" after the election, and not before. I could still lean that way, but it goes against this article.https://www.thetaxadviser.com/issues/2017/jun/deferred-compensation-proposed-sec-457f-regulations-sec-409a/