IRS provides guidance on Section 409A treatment for pre-2009 Section 457A deferrals

Tax Hot TopicsThe IRS recently issued Notice 2017-75 to provide guidance regarding nonqualified deferred compensation plan distributions that are accelerated to pay income taxes on amounts includible in income in 2017 under Sections 457A 801(d)(2) of the Tax Extenders and Alternative Minimum Tax Relief Act (TEAMTRA) of 2008.

In 2008, the TEAMTRA added Section 457A, which provides that any deferred compensation from a nonqualified deferred compensation plan of a nonqualified entity is includible in the gross income of the employee (or other service provider) when the compensation vests. A nonqualified entity includes a foreign corporation unless substantially all of its income is either effectively connected to the United States or subject to a comprehensive foreign income tax. Nonqualified entities also include certain partnerships with foreign ownership or ownership by a tax-exempt organization.  

Section 457A generally applies to nonqualified deferred compensation attributable to services performed after Dec. 31, 2008. Nonqualified deferred compensation that escapes Section 457A treatment solely because the amounts are attributable to services performed before Jan. 1, 2009, is subject to Section 801(d)(2) of TEAMTRA, which states that the deferred amounts must be included in gross income in the last tax year beginning before 2018 or the tax year of vesting, whichever occurs later. As a result, many participants in plans subject to Section 801(d)(2) of TEAMTRA will include their deferred compensation in 2017 gross income, resulting in an income tax withholding obligation for the employer. Plan participants may need cash to meet the withholding obligation, so Notice 2017-75 addresses this need.  

In addition to Section 801(d)(2) of TEAMTRA, these plans are generally subject to Section 409A. Section 409A generally prohibits the acceleration of distributions under a nonqualified deferred compensation plan, with certain exceptions. This means a participant in a plan subject to Section 801(d)(2) of TEAMTRA cannot receive an early distribution from the plan in order to pay withholding taxes without violating Section 409A.  

Notice 2017-75 allows the acceleration of nonqualified deferred compensation plan distributions to meet federal, state, local and foreign income tax withholding requirements on amounts includible in income under Section 801(d)(2) of TEAMTRA, without violating Section 409A. Furthermore, a change to a plan to allow this type of accelerated payment will not be treated as a material modification for purposes of the Section 409A grandfathering rules.

The relief from Section 409A penalties is provided only to the extent the accelerated distribution does not exceed the amount of federal, state, local and foreign income tax that would have been withheld by an employer if there had been a payment of wages equal to the amount includible in gross income pursuant to Section 801(d)(2) of TEAMTRA.

Eddie Adkins
Partner, Washington National Tax Office
T +1 202 521 1565

Jeffrey Martin
Partner, Washington National Tax Office
T +1 202 521 1526

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