IRS Issues Initial Guidance and Limited Transition Relief for Nonqualified Deferred Compensation Plans Subject to New Section 457A

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Joseph S. Adams, Andrew C. Liazos, David G. Noren, Stephen Pavlick, William R. Pomierski, David E. Rogers, Thomas Ward McDermott Will & Emery LLP, Chicago, IL, Washington, DC

On January 8, 2009, the IRS released its initial guidance interpreting new §457A, which became effective on January 1, 2009. Section 457A generally provides that amounts deferred under a nonqualified deferred compensation plan sponsored by certain foreign and other “nonqualified” entities is taxable upon vesting. Special transitional rules are provided for deferrals attributable to services provided prior to the start of 2009. While enacted largely in response to the deferred compensation practices of offshore hedge funds, Notice 2009-8 confirms that deferral arrangements maintained by a wide range of foreign corporations and partnerships (foreign or domestic) are potentially subject to the new rules.

Notice 2009-8 addresses several important issues under §457A, including the following:

• What types of arrangements will be considered nonqualified deferred compensation subject to §457A, including exceptions for certain profits interest and compensatory options to acquire partnership capital interests

• How to identify the plan sponsor and whether the sponsor is a “nonqualified entity” subject to §457A - in addition to evaluating applicable income tax treaties and foreign tax systems, complex income sourcing rules (in the case of a foreign corporation), partnership allocation rules (in the case of a domestic or foreign partnership) and U.S. tax deduction rules must be applied in many cases

• What qualifies as a substantial risk of forfeiture for purposes of determining the year of “vesting” and the potential availability of a short-term deferral exception for amounts paid within one year of vesting

• How to determine whether deferred compensation is attributable to pre-2009 services - a special transition rule provides for the taxation of this compensation to be deferred until the later of vesting or the 2017 taxable year (unless included in income before then under another tax provision)

Notice 2009-8 also provides employers limited yet important transition relief, including the following:

A one-time opportunity to elect in writing no later than July 1, 2009, to accelerate the vesting of deferred compensation benefits retroactive to December 31, 2008, in order to avoid immediate income taxes for U.S. employees

The ability to change the time and form of payment with respect to deferred compensation that is attributable to services prior to 2009 without violating §409A or losing grandfathering from §409A at any time prior to December 31, 2011

The Treasury Department and the IRS anticipate issuing additional guidance under §457A and have requested comments regarding Notice 2009-8 and §457A. Until further guidance is issued, taxpayers may rely on this guidance for purposes of §457A. Any further guidance that would expand the coverage of §457A will be prospective.

For more information, in the Tax Management Portfolios, see Brisendine and Drigotas, 385 T.M., Deferred Compensation Arrangements, and in Tax Practice Series, see ¶5710, Nonqualified Deferred Compensation.

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