Companies should review their existing severance arrangements, change in control arrangements, employment agreements and other nonqualified deferred compensation arrangements to determine if a correction is required under Section 409A of the Internal Revenue Code.
In 2010, the Internal Revenue Service (IRS) issued Notice 2010-6 which provided a correction program for certain document failures under Section 409A. While this was welcome guidance for practitioners, the IRS unfortunately took an unexpected position regarding the interaction between the payment of severance pay (and other nonqualified deferred compensation) and the executive's related execution of a release of claims. The IRS' position is that commencement of the payment of severance pay (and other nonqualified deferred compensation) cannot be conditioned upon the executive's return of a release. As a result, a common provision in many arrangements which provides that the executive's severance pay will commence within a period following the executive's termination date (e.g., 60 days), but not before the executive has executed a release of claims, would result in a document failure under Section 409A.
Unfortunately, this guidance was provided following most companies' review and revision of their existing arrangements for final regulations under Section 409A. As a result, arrangements which already were amended for Section 409A may need to be reviewed again to ensure this language is corrected. The IRS provided an extended transition period for companies to correct their arrangements, which is set to expire on December 31, 2012. As a result, companies should act quickly to inventory their existing arrangements and ensure that the relevant provisions are amended or to determine that such arrangements meet an exception from Section 409A. Additionally, companies that terminated employees this year or are contemplating terminating an employee should reach out to counsel to ensure that all corrective measures are taken to avoid an unintended Section 409A violation.