The first of a series of guidance on the application of the new deferred compensation rules enacted as part of the American Jobs Creation Act of 2004 was recently issued by the Treasury Department. As expected, the guidance provides fairly generous transition rules and even grandfathering of certain deferred compensation arrangements to ease the burden of the transition to the restrictions in new Internal Revenue Code Section 409A. Among the highlights of the new guidance (issued as IRS Notice 2005 – 1) are the following:

Deferral of Bonuses. Until further guidance is issued, deferral elections with respect to bonuses that are based on services performed over a period of at least 12 months will be treated as satisfying the performance-based compensation provisions of the new law as long as the election is made at least six months before the end of the performance period, and the payment of the bonus is contingent on the satisfaction of “organizational or individual performance criteria” which are not substantially certain to be met at the time the deferral election is permitted.

Stock Appreciation Rights (SARs). Although the law contains an exception for fair market value nonstatutory stock options, there is no corresponding exception for SARs. However, the guidance provides a limited exception from the rules that will cover most SARs that are issued with respect to, and payable solely in, publicly-traded stock and which do not include any deferral feature other than the deferral of recognition of income upon the exercise of the SAR. Also, until further guidance, payments of stock or cash pursuant to the exercise or cancellation of an SAR are generally excepted from the rules if the SAR is granted pursuant to a program in effect on or before October 3, 2004.
Restricted Stock. Most restricted stock awards will be excepted from the rules. However, the guidance notes that arrangements under which a service provider obtains a legally binding right to receive stock (or other property) in the future may indeed be a deferred compensation arrangement that is subject to the new restrictions.

Grants of Partnership Interests. Until further guidance is issued, taxpayers may treat the issuance of a partnership capital or profits interest (or an option to purchase a partnership interest) that is granted in connection with the performance of services under the same principles that govern the issuance of stock. This means that most compensatory grants of partnership profits interests that do not, under the normal tax rules, result in income at the time of the grant will also not result in a deferral of compensation.

Change in Control Events. A change in the ownership or effective control of a corporation is a permitted payment trigger event under the new law. The guidance defines change in control events along the lines of the definitions found in the “golden parachute” regulations, with some modifications.
Acceleration of Payments. Provision is made for early payment in order to comply with a domestic relations order, to pay employment taxes that become due on deferred compensation, to cash out de minimus amounts on termination of a participant’s interest in a plan, and in other instances.
Effective Date. The Notice gives useful guidance in applying the effective date of new Code Section 409A and also provides rules for determining what amounts of compensation will be considered deferred before 2005 under the new rules.
Transition Rules. The Notice provides generous rules for operating and amending a plan adopted before 2006. In particular, severance plans that cover no key employees, or are collectively bargained, generally need not meet the requirements of the new law during calendar year 2005. Provisions are also made for other types of plans to add new payment elections consistent with the new law, prior to 2006 without violating the new law. Also, plans adopted before 2006 may be amended to allow participants, during all or part of 2005, to terminate participation or cancel a deferral election with regard to amounts deferred without penalty (other than the inclusion in income of the amounts subject to the termination or cancellation).

Other guidance is provided with respect to the information reporting and withholding requirements that are part of the new law.

Additional Information

The Employee Benefits Group at Ogletree Deakins is available to assist you with the implementation of measures to comply with these new rules. Alternatively, you may contact the Ogletree Deakins attorney with whom you normally work or the Client Services Department at 404-881-1300 or via e-mail at

Note: This article was published in the January 4, 2005 issue of the National eAuthority.

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