Even as the calendar turns to February, compliance under Section 409A of the tax code and corrections under the new IRS Correction Program still remain on many employers' New Year's resolutions.

Most employers are aware that Section 409A requires all forms of deferred compensation to satisfy certain election rules for salary deferrals, as well as more formality with regard to the time and manner of distribution.

During the period from Jan. 1, 2005 through Dec. 31, 2008, employers were able to rely upon "good faith" compliance with the rules of Section 409A. Commencing as of Jan. 1, 2009, all documents containing any form of deferred compensation must be amended to meet the written plan requirement of Section 409A and to comply with all new rules.

Unfortunately, many employers haven't properly amended all documents requiring attention, such as supplemental executive retirement plans (SERPs), employment agreements, offer letters, severance plans and individual severance agreements.

Failure to satisfy the statutory rules can result in immediate income tax, a 20% excise tax and underpayment of interest penalties for participants. The tax is levied on employees, not employers. Therefore, all employers and employees must continue to work together to achieve compliance.

The IRS issued Notice 2007-100 in 2007, establishing a correction program under Section 409A.This was a highly unusual notice, since the correction program was established even before the Section 409A final regulations became effective.

In December 2008, the IRS issued Notice 2008-113, which revoked the earlier notice and established a more comprehensive corrections program. This notice primarily addresses operational issues regarding failure to comply with employee salary deferral elections and/or the issuance of distributions in violation of Section 409A.

Relief is available if an employer maintains practices and procedures to avoid the occurrence of errors; the tax return of an employee or independent contractor is not under examination for the year of correction; the error is fully corrected; and the employer is not experiencing financial difficulties that could preclude paying benefits when due. Examples of the relief include the following:

Assume an employee who is not an insider (such as a director, officer or 10% shareholder) defers 50% of a bonus payment to be paid after the end of the 2009 calendar year. The election to defer the bonus, if it is a performance-based plan, may be made up until June 30, 2009. Further assume that the bonus is determined to be $100,000 after Dec. 31, 2009 and after review of all financial records. Further assume the employer defers $10,000 instead of $50,000 from the bonus. The IRS rule permits the employee to repay the $40,000 and/or have the $40,000 withheld from subsequent wages earned in 2010 to correct this error. The employee's account also may be adjusted for earnings or losses if done by Dec. 31, 2010.

Assume an employee who is a specified employee (generally in the highest-paid 50 employees for large public companies or highest-paid three employees for small public companies), separates from service and is entitled to a single, lump-sum payment equal to $500,000. In general, this payment cannot be made within six months following a separation from service.Further assume the employer distributes the full $500,000 within 30 days following the separation from employment. The IRS rule permits the employee to repay the amount to correct the error.

The above are just a few illustrations of the manner in which the IRS Notice 2008-113 helps employers to correct operational compliance errors. However, the primary open area is whether or not relief will be provided with regard to documents that have not yet been brought into compliance. For example, assume an executive for a publicly traded company has an employment agreement providing for a single, lump-sum payment equal to three times base salary, plus prorated bonuses, in the event of an involuntary termination without cause, or the executive may terminate employment for "good reason" following a change in control and a loss of responsibility.

The executive has a contractual right to the lump-sum payment. However, if the executive is a "specified employee" (i.e., one of the top-paid corporate officers determined on a worldwide basis), the executive may not receive the distribution within six months following a separation from service. If the employer honors the contract and makes the payment within the six-month period, the executive is subject to the 20% excise tax and other penalties under Section 409A.

The executive could be entitled to receive up to $490,000 in 2008 under an exception to the six-month-delay-in-payment rule. However, since the contract does not permit such distributions to occur, it is doubtful the employer and employee may rely upon the rule, since most provisions under Section 409A must be contained in the controlling document.

The net result is that the executive has a contractual right to a payment, and doubt exists whether or not payment may be made. Furthermore, if the employer corrects the documentation in 2009, without additional relief from the IRS, it is uncertain whether or not such corrective measures will serve to avoid penalties.

Assume an employer maintains a traditional SERP to provide benefits to senior executives following a termination of employment. Most plans prior to Section 409A contain basic distribution rules, such as the payment of benefits in quarterly installments over a 10-year period following a separation from service. Such agreements frequently permitted executives to request a single, lump-sum distribution within the discretion of the employer to pay such benefits, with or without a reduction in the benefits.

For example, if an employee is entitled to $250,000, to honor the request for a single, lump-sum payment, many employers reduced the benefit by 10%, generally referred to as a "haircut." Thus, the executive was entitled to $250,000 paid in accordance with the normal form of distribution, or $225,000 paid in a lump sum. This action often was taken to ensure that an employer was not rubber-stamping lump-sum distribution requests.

Leaving discretion with an employer as to the manner in which to pay a SERP or severance benefit is now a violation of Section 409A. If an employer identifies the issue in 2009, a question remains whether or not corrective actions can be taken.

HR practitioners are strongly encouraging the IRS to expand the correction program to allow the correction of document violations after Dec. 31, 2008, as well as operational issues. Whether or not such relief will be forthcoming remains unanswered. Employers must continue to identify arrangements that required amendment prior to Dec. 31, 2008 and to continue to make good-faith efforts to correct such documents.

Contributing Editor Frank Palmieri is an employee benefits attorney with Palmieri & Eisenberg in Princeton, N.J., and a fellow of the American College of Employee Benefits Counsel.