December 31, 2012 Deadline Looms Under Tax Code for Fixing Severance Agreements with Releases

 

Employers have until the end of the year to take advantage of relief from penalties under section 409A of the Internal Revenue Code for agreements that require employees to sign releases before severance benefits are paid. Section 409A was enacted in 2004 to regulate deferred compensation.  Internal Revenue Service ("IRS") regulations made clear that it would affect not only traditional deferred compensation arrangements, but also arrangements previously not thought of as deferred compensation. Severance and change-in-control benefits are often subject to the section 409A requirements. Employees pay most of the price for mistakes that result in violations of section 409A, including a 20 percent tax penalty.

The IRS surprised many in early 2010 when it announced that agreements that require the employee to sign a release of claims (or non-competition or non-solicitation agreement) before severance or change-in-control payments start may run afoul of section 409A because they give the employee some control over when payments will start, sometimes allowing the employee to choose which year payments will be made. Industry push-back persuaded the IRS to provide transition relief, the last of which will end on December 31, 2012. This relief allows employers to modify agreements to deal with such release requirements to specify when payments will be made and what happens if a release is not signed on time. The transition relief allows correction of agreements with these problems – even if payments have already started – something not otherwise available. In addition, the employer is not forced to notify the employee of the documentary violation of section 409A and the employee does not have to attach a notice to the employee’s personal income tax return about the violation. After December 31, 2012, this relief will no longer be available.

If you are interested in a more detailed discussion of this relief and the required changes to employee releases, check out Stoel Rives' recent Client Alert on the subject.

 

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