Terminating a 409A Plan

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Under 409A plan, terminating a nonqualified plan is an exceptional event that generally prohibits any discretionary acceleration of the participant-elect time and form of payment. To terminate a NQDC plan, the 409A conditions should be satisfied and the administrative consequences should be addressed.

For termination of the NQDC plan, there are some regulations that must be met. To make it more understandable for you, you can dive into our post to find out what regulations should be satisfied for termination of NQDC and more information about termination of a 409A plan. Here you go!

Regulations for Termination a 409A Plan

The IRS, Section 409A requires deferred compensation to be paid under written agreements that specify both the time when the form of payment and payments commence. The Section 409A actually prohibits earlier payment under an anti-acceleration rule.

One of the few exceptions to an acceleration of benefits under an NQDC plan is actually full and discretionary termination of that NQDC plan that require all of the following:

  1. Termination and liquidation of the NQDC plan should not happen, because of a downturn in the employer’s financial health
  2. All related NQDC plans or other similar nonqualified NQDC plans should be terminated
  3. No payout under the NQDC plan can happen within 12 months of board action to terminate the NQDC plan irrevocably
  4. All payments should be made within 24 months of the NQDC plan termination by the board
  5. The employer does not need to adopt a new similar type of NQDC plan within 36 months from the date the employer first took the board action needed to terminate the NQDC plan irrevocably

Treasury regulation that is issued under Code 409A seems to carve out narrow exceptions under which plans will be terminated and liquidated, including:

  • Termination in connection with the company’s dissolution or reorganization under federal bankruptcy laws
  • Termination in connection with a change in control like what is available under 409A regulations
  • Discretionary terminations under specified conditions which attempt to reduce the conflict of interest between the executives and the employer who participate in the plan.

Well, this exception is predicated on the first requirement, which is that there will not be a downturn in the employer’s financial health. According to thetaxadviser.com, the important element of the financial health requirement actually involves a meaningful change in the employee’s ability to pay the unsecured deferred compensation benefits.

However, it’s so clear in the regulations and from the preamble to the regulation, the relevant time to examine the employer’s financial health is not only when the formal action is taken to terminate the NQDC plan, but also the benefits should be paid out one to two years later.

Another issue also involves the second element of this termination exception. They are  the requirement to terminate the relevant NQDC plan and all others of a like class. Well, the regulations clearly show that all such NQDC plans should be terminated and deactivated sooner than three years later.

Termination of employment should ideally take into account the impact of termination payments on the employer’s other employee benefit plans, and how the lump sum payment can be received by shareholders when reported on the employer’s annual proxy.

For the NQDC’s termination that is related, trusts and employer owned life insurance probably have additional financial consequences which should be considered well in advance of the final plan liquidation date.

Change in Control Terminations

In the event of a ‘change in control event’ as defined in the final regulation under 409A, the employer probably needs to terminate a nonqualified deferred compensation plan. Well, the conditions for plan termination and liquidation may include:

  • The employer that is mainly liable for the payment of plan benefits once the transaction needs to adopt an irrevocable resolution to terminate the plan during a period. It can begin 30 days prior to closing and ends 12 months after closing. Depending on how the transaction is structured, the seller or buyer may be primarily liable. With the subsidiary as the entity primarily liable, the sale of a subsidiary usually works to transfer the subsidiary’s liability to the buyer. The sale of assets could result in retention of primary liabilities by the sellers, in this case the seller would be the party that is authorized to terminate the plan.
  • The plan should be liquidated within 12 months once the irrevocable resolution is adopted.
  • The termination and liquidation will apply only to the portion of the plan which benefits participants that are affected by the change in control.
  • All of the non-qualified plans of a similar type where the affected employees participate should be terminated as well.

How to Terminate a 409A Plan?

Under Section 409A, a nonqualified deferred compensation plan means a pay arrangement that is created by employers to give their employee further performance incentives through monetary or other rewards at a later time.

In this case, the employee does not need to pay taxes on the deferred compensation until they receive the payment. However, there’s the right where the participants could terminate a nonqualified deferred compensation.

Here are the steps to terminate a NQDC:

  • First, you can call the plan administrator and ask whether there are any provisions defined in the plan’s adoption agreement which allow for employer termination. Make sure to request a copy of the provisions.
  • After that, you can read the provisions to see if your company will be permitted to terminate a NQDC. The IRS-allowed provisions include a corporate termination, the employer terminates for a more favourable incentive plan or corporation change of control. The employers will not be allowed to terminate a deferred compensation plan based exclusively on financial loss of the company.
  • In this step, you can also hire a labor attorney to review the provisions of termination and confirm that you are entitled to terminate the plan.
  • You can also call the deferred compensation plan administrator back and request termination paperwork. Here, you may need to fill out the paperwork and submit it. The administrator will then send notification to the IRS.
  • Last, you can pay all accrued deferred compensation, based on the plan guidelines and payment allotments. Ask payroll to complete the required W-2 forms to inform the IRS of the additional income to employees.

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