Upfront: Are You in Compliance With New Deferred Compensation Rules?

CFOs need to take a close look at their organization's compensation plans.

CFOs need to take a close look at their organization's compensation plans -- and their own rewards package. The American Jobs Creation Act of 2004 added a new section to the Internal Revenue Code, Section 409A, which imposes strict controls on nonqualified deferred compensation arrangements. The legislation is far-reaching, and employers should take immediate action to ensure compliance, according to a report by law firm Mintz Levin Cohn Ferris Glovsky and Popeo PC.

The most immediate effect of the new law is that it prohibits public companies from distributing nonqualified deferred compensation amounts to their key executives until six months after the date an executive terminates employment, explains Peter J. Marathas, partner with Mintz Levin in Boston. Compensation received in violation of the new Section 409A rules will have to be included in the recipient's income and will be subject to interest and a 20 percent penalty tax.

"The traditional nonqualified deferred compensation arrangement is extremely prevalent in large public companies," notes Marathas. "They are referred to as 'SERPs' [supplemental executive retirement plans], 'top hat plans' and 'deferred compensation arrangements.' At bigger companies, some arrangements defer multiples of millions of dollars for key employees. These are clearly covered by the act." In addition, the new legislation "broadens the traditional concept of nonqualified deferred compensation and expands it to any promise to pay some amount in the future," Marathas notes. Severance arrangements, certain stock option grants, stock appreciation rights and long-term incentive plans may be affected, he reports.

"CFOs should immediately review all of their compensation programs -- including employment agreements and option arrangements -- to determine whether they are subject to the act and, if so, what needs to be done to make them compliant," advises Marathas. "In general, companies have until the end of 2005 to amend nonconforming arrangements."