On 5 January 2010, the Treasury Department and the Internal Revenue Service (IRS) issued Notice 2010-6 regarding correcting deferred compensation plan documents that do not meet the requirements of section 409A of the Internal Revenue Code. Significantly, the IRS is effectively waiving most of the substantial tax penalties associated with document failures that are corrected by the end of 2010. It is important for lawyers and human resources and executive compensation professionals to understand the scope of the relief and to begin now to make any necessary corrections.

Notice 2010-6 adopts a structural framework that is similar to that applicable to the correction of operational failures under Notice 2008-113. To qualify for relief under Notice 2010-6, the taxpayer must demonstrate that certain general eligibility conditions have been satisfied, and specific corrective actions, such as plan amendments, must be taken by the deadline specified in the Notice. In addition, both the service recipient (generally, the employer) and the service provider (generally, an employee, director or independent contractor) must comply with specified information and reporting requirements.

The scope of relief available under Notice 2010-6 depends on the nature of the document failure. For many types of failure, timely correction of the plan defect will exempt the service recipient and service provider from the tax penalties of section 409A only if certain events have not occurred before, and do not occur during the year following, the date of correction. If a triggering event occurs within the first year following the date of correction, the service recipient will be required to recognise a portion (typically 50%) of the amount deferred under the plan as income and will be liable for both regular income tax and the supplemental section 409A tax of 20% on the amount.

Pursuant to transition relief, income recognition will not be required – regardless of whether the specified triggering event occurs within one year following the date of correction – as long as:

Most sponsors of non-qualified deferred compensation plans engaged in extensive section 409A compliance efforts before the compliance deadline of 1 January 2009. To the extent that subsequent guidance or experience calls into question whether existing plans comply in all respects with section 409A, the transition relief of Notice 2010-6 offers a valuable window of opportunity for plan sponsors to take a fresh look at their plan documents and make any necessary changes.