In May, the IRS announced that it had launched an audit initiative (the Initiative) to gauge compliance with the rules for nonqualified deferred compensation arrangements under Internal Revenue Code (Code) Section 409A. Yesterday, we participated in a national conference with the IRS where IRS agents provided their unofficial opinions regarding the focus and applicability of the Initiative as well as other relevant matters under Code Section 409A.
The IRS has audited arrangements subject to Code Section 409A in the past, but the announced Initiative is the first systematic IRS compliance review under Code Section 409A. The IRS has described the Initiative as of “limited scope.”
Employers selected for audit under the Initiative have or will receive Information Document Requests (IDRs). In the IDRs, the IRS requests documents relevant to the issues under audit. The IRS confirmed for us that fewer than 50 employers have been selected to receive IDRs under the Initiative, and they have been chosen from a population of employers that have already been selected for employment tax audits.
The IRS also confirmed that they are not targeting just one type of employer, such as large employers, but intend to audit a cross section of employers. The IRS uses a model IDR, but it is modified depending on the specifics of the employer (for example, the IDRs may vary slightly between public and private companies).
The Initiative is designed to test compliance in three particular areas: (i) initial deferral elections; (ii) subsequent deferral elections; and (iii) plan distributions, including, if applicable, the six month delay for “specified employees.” During the conference, the IRS also provided the following additional information:
- To relieve the burden on employers selected for audit, the Initiative will focus on the 10 most highly paid participants.The IRS has no plan to release the model IDRs, but it does not discourage employers that receive IDRs from circulating them.
- The primary purpose of the Initiative is to gauge the level of employer compliance with Code Section 409A and to gain insight into the challenges employers are having with compliance.
- The IRS will continue to look at Code Section 409A compliance on a case-by-case basis where it appears warranted, but there is currently no plan to expand the Initiative.
- The IRS expects the Initiative to be completed by the middle of 2015. At that time the IRS will decide how best to use that information and whether the results of the Initiative will be shared with the public.
Other Code Section 409A Matters
In addition to their comments regarding the Initiative, IRS agents shared insight into other Code Section 409A matters. Among those, the IRS agents provided the following unofficial information:
- The IRS currently offers two self-correction programs for Code Section 409A violations—one for operational errors and one for document errors. The IRS stated it has no plans to offer a program under which employers can apply to receive IRS assurance that their errors were properly corrected.
- The IRS is open to expanding the types of errors that can be corrected under the self-correction programs. The Initiative will help the IRS identify where additional corrections may be warranted.
- The IRS is working to issue technical corrections under Code Section 409A and to finalize the regulations regarding income inclusion under Code Section 409A. One IRS agent said this additional guidance is expected to come out “soon.”
- When asked how an employer can correct violations under Code Section 409A that do not fall under one of the two current self-correction programs, the IRS said these violations cannot be corrected. The correction programs are designed to be limited in scope and violations outside the programs should result in tax penalties.
In light of the IRS’s current focus on Code Section 409A audits, employers should consider self-auditing their nonqualified deferred compensation arrangements for operational and plan document compliance. This is especially important given the IRS’s refusal to allow corrections outside the two-year correction window under the Code Section 409A self-correction programs. Even where an error cannot be corrected under the self-correction programs, an employer who identifies an error early can minimize the damage done by the error by, for example, limiting the accumulation of late tax penalties. Finally, it is important to remember that the self-correction programs are not available once an IRS audit begins.
If you have any questions regarding Code Section 409A compliance or the Initiative, please contact your Kutak Rock LLP attorney or a member of our Employee Benefits Practice Group.