Further Guidance on the Application of Section 409A to Nonqualified Deferred Compensation Plans, 74380-74403 [E8-28894]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 236 (Monday, December 8, 2008)]
[Proposed Rules]
[Pages 74380-74403]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-28894]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-148326-05]
RIN 1545-BF50


Further Guidance on the Application of Section 409A to 
Nonqualified Deferred Compensation Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

-----------------------------------------------------------------------

SUMMARY: This document contains proposed regulations on the calculation 
of amounts includible in income under section 409A(a) and the 
additional taxes imposed by such section with respect to service 
providers participating in certain nonqualified deferred compensation 
plans. The regulations would affect such service providers and the 
service recipients for whom the service providers provide services. 
This document also provides a notice of public hearing on these 
proposed regulations.

DATES: Written or electronic comments must be received by March 9, 
2009. Outlines of topics to be discussed at the public hearing 
scheduled for April 2, 2009, must be received by March 9, 2009.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-148326-05), room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC, 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
148326-05), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at https://www.Regulations.gov (IRS REG-148326-05). 
The public hearing will be held in the auditorium, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Stephen Tackney, at (202) 927-9639; concerning submissions of comments, 
the hearing, and/or to be placed on the building access list to attend 
the hearing, Funmi Taylor at (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    Section 409A was added to the Internal Revenue Code (Code) by 
section 885 of the American Jobs Creation Act of 2004, Public Law 108-
357 (118 Stat. 1418). Section 409A generally provides that if certain 
requirements are not met at any time during a taxable year, amounts 
deferred under a nonqualified deferred compensation plan for that year 
and all previous taxable years are currently includible in gross income 
to the extent not subject to a substantial risk of forfeiture and not 
previously included in gross income. Section 409A also includes rules 
applicable to certain trusts or similar arrangements associated with 
nonqualified deferred compensation.
    On December 20, 2004, the IRS issued Notice 2005-1 (2005-2 CB 274), 
setting forth initial guidance on the application of section 409A, and 
providing transition guidance in accordance with the terms of the 
statute. On April 10, 2007, the Treasury Department and the IRS issued 
final regulations under

[[Page 74381]]

section 409A. (72 FR 19234, April 17, 2007). The final regulations are 
applicable for taxable years beginning after December 31, 2008. See 
Notice 2007-86 (2007-46 IRB 990). Notice 2005-1 and the final 
regulations do not address the calculation of the amount includible in 
income under section 409A if a plan fails to meet the requirements of 
section 409A and the calculation of the additional taxes applicable to 
such income. On November 30, 2006, the Treasury Department and the IRS 
issued Notice 2006-100 (2006-51 IRB 1109) providing interim guidance 
for taxable years beginning in 2005 and 2006 on the calculation of the 
amount includible in income if the requirements of section 409A were 
not met, and requesting comments on these issues for use in formulating 
future guidance. On October 23, 2007, the Treasury Department and the 
IRS issued Notice 2007-89 (2007-46 IRB 998) providing similar interim 
guidance for taxable years beginning in 2007. See Sec.  
601.601(d)(2)(ii)(b).
    Commentators submitted a number of comments addressing the topics 
covered by these proposed regulations in response to Notice 2005-1, 
Notice 2006-100, Notice 2007-89, and the regulations, all of which were 
considered by the Treasury Department and the IRS in formulating these 
proposed regulations.

Explanation of Provisions

I. Scope of Proposed Regulations

    These proposed regulations address the calculation of amounts 
includible in income under section 409A(a), and related issues 
including the calculation of the additional taxes applicable to such 
income. Section 409A(a) generally provides that amounts deferred under 
a nonqualified deferred compensation plan in all years are includible 
in income unless certain requirements are met. The requirements under 
section 409A(a) generally relate to the time and form of payment of 
amounts deferred under the plan, including the establishment of the 
time and form of payment through initial deferral elections and 
restrictions on the ability to change the time and form of payment 
through subsequent deferral elections or the acceleration of payment 
schedules. As provided in the regulations previously issued under 
section 409A, a nonqualified deferred compensation plan must comply 
with the requirements of section 409A(a) both in form and in operation.
    Taxpayers may also be required to include amounts in income under 
section 409A(b). Section 409A(b) generally applies to a transfer of 
assets to a trust or similar arrangement, or to a restriction of 
assets, for purposes of paying nonqualified deferred compensation, if 
such trust or assets are located outside the United States, if such 
assets are transferred during a restricted period with respect to a 
single-employer defined benefit plan sponsored by the service 
recipient, or if such assets are restricted to the provision of 
benefits under a nonqualified deferred compensation plan in connection 
with a change in the service recipient's financial health. These 
proposed regulations do not address the application of section 409A(b), 
including the calculation of amounts includible in income if the 
requirements of section 409A(b) are not met. For guidance on the 
calculation of such amounts for taxable years beginning on or before 
January 1, 2007, including the application of the Federal income tax 
withholding requirements, see Notice 2007-89. The Treasury Department 
and the IRS anticipate issuing further interim guidance for later 
taxable years on the calculation of the amount includible in income 
under section 409A(b) and the application of the Federal income tax 
withholding requirements to such an amount.

II. Effect of a Failure To Comply With Section 409A(a) on Amounts 
Deferred in Subsequent Years

    Commentators asked how section 409A(a) applies if a plan fails to 
comply with section 409A(a) during a taxable year and the service 
provider continues to have amounts deferred under the plan in 
subsequent years during which the plan otherwise complies with section 
409A(a) both in form and in operation. The statutory language may be 
construed to provide that a failure is treated as continuing during 
taxable years beyond the year in which the initial failure occurred, if 
the failure continues to affect amounts deferred under the plan. For 
example, if an amount has been improperly deferred under the plan, the 
statutory language could be construed to provide that the plan fails to 
comply with section 409A(a) during all taxable years during which the 
improperly deferred amounts remain deferred. However, this position 
could cause harsh results and would add administrative complexity. For 
example, a service provider could be required to include in income, and 
pay additional taxes on, amounts deferred over a number of taxable 
years even if the sole failure to comply with section 409A(a) occurred 
many years earlier. In addition, even if there were no failure in the 
current year, to determine a taxpayer's liability for income taxes with 
respect to nonqualified deferred compensation for a particular year, 
the taxpayer and the IRS would need to examine the plan's form and 
operation for every year in which the service provider had an amount 
deferred under the plan to determine if there was a failure to comply 
with section 409A(a) during any of those years.
    For these reasons, the proposed regulations do not adopt this 
interpretation and instead generally would apply the adverse tax 
consequences that result from a failure to comply with section 409A(a) 
only with respect to amounts deferred under a plan in the year in which 
such noncompliance occurs and all previous taxable years, to the extent 
such amounts are not subject to a substantial risk of forfeiture and 
have not previously been included in income. Therefore, under the 
proposed regulations, a failure to meet the requirements of section 
409A(a) during a service provider's taxable year generally would not 
affect the taxation of amounts deferred under the plan for a subsequent 
taxable year during which the plan complies with section 409A(a) in 
form and in operation with respect to all amounts deferred under the 
plan. This would apply even though the amount deferred under the plan 
as of the end of such subsequent taxable year includes amounts deferred 
in earlier years during which the plan failed to comply with section 
409A(a) (including, for example, amounts deferred pursuant to an 
untimely deferral election in the earlier year), as long as there was 
no failure under the plan in a later year. Because there would be no 
continuing or permanent failure with respect to a plan that fails to 
comply with section 409A(a) during an earlier year, each taxable year 
would be analyzed independently to determine if there was a failure. As 
a result, assessment of tax liabilities due to a plan's failure to 
comply with the requirements of section 409A(a) in a closed year would 
be time-barred. But, if a service provider fails to properly include 
amounts in income under section 409A(a) for a taxable year during which 
there was a failure to comply with section 409A(a), and assessment of 
taxes with respect to such year becomes barred by the statute of 
limitations, then the taxpayer's duty of consistency would prevent the 
service provider from claiming a tax benefit in a later year with 
respect to such amount (such as, for example, by claiming any type of 
``basis'' or ``investment in the contract'' in the year the service

[[Page 74382]]

recipient paid such amount to the service provider pursuant to the 
plan's terms).
    Under the general rule in the proposed regulations, if all of a 
taxpayer's deferred amounts under a plan are nonvested and the taxpayer 
makes an impermissible deferral election or accelerates the time of 
payment with respect to some or all of the nonvested deferred amount, 
the nonvested deferred amount generally would not be includible in 
income under section 409A(a) in the year of the impermissible change in 
time and form of payment (although if there were vested amounts 
deferred under the plan, such amounts would be includible in income 
under section 409A(a)). In the subsequent taxable year in which the 
service provider becomes vested in the deferred amount, the plan might 
comply with section 409A(a) in form and in operation, so that under the 
general rule no income inclusion would be required and no additional 
taxes would be due for that year as a result of the late deferral 
election or acceleration of payment. In proposing to adopt this 
interpretation of the statute, the Treasury Department and the IRS do 
not intend to create an opportunity for taxpayers who ignore the 
requirements of section 409A(a) with respect to nonvested amounts to 
avoid the payment of taxes that would otherwise be due as a result of 
such a failure to comply. To ensure that this rule does not become a 
means for taxpayers to disregard the requirements of the statute, the 
proposed regulations would disregard a substantial risk of forfeiture 
for purposes of determining the amount includible in income under 
section 409A\1\ with respect to certain nonvested deferred amounts, if 
the facts and circumstances indicate that the service recipient has a 
pattern or practice of permitting such impermissible changes in the 
time and form of payment with respect to nonvested deferred amounts 
(regardless of whether such changes also apply to vested deferred 
amounts). If such a pattern or practice exists, an amount deferred 
under a plan that is otherwise subject to a substantial risk of 
forfeiture is not treated as subject to a substantial risk of 
forfeiture if an impermissible change in the time and form of payment 
(including an impermissible initial deferral election) applies to the 
amount deferred or if the facts and circumstances indicate that the 
amount deferred would be affected by such pattern or practice.
---------------------------------------------------------------------------

    \1\ Under section 409A(e)(5), the Treasury Department and the 
IRS have the authority to disregard a substantial risk of forfeiture 
where necessary to carry out the purposes of section 409A.
---------------------------------------------------------------------------

III. Calculation of the Amount Deferred Under a Plan for the Taxable 
Year in Which the Plan Fails To Meet the Requirements of Section 
409A(a) and all Preceding Taxable Years

A. In General

    Section 409A(a)(1)(A) generally provides that if at any time during 
a taxable year a nonqualified deferred compensation plan fails to meet 
the requirements of section 409A(a)(2) (payments), section 409A(a)(3) 
(the acceleration of payments), or section 409A(a)(4) (deferral 
elections), or is not operated in accordance with such requirements, 
all compensation deferred under the plan for the taxable year and all 
preceding taxable years is includible in gross income for the taxable 
year to the extent not subject to a substantial risk of forfeiture and 
not previously included in gross income. Accordingly, to calculate the 
amount includible in income upon a failure to meet the requirements of 
section 409A(a), the first step is to determine the total amount 
deferred under the plan for the service provider's taxable year and all 
preceding taxable years. The second step is to calculate the portion of 
the total amount deferred for the taxable year, if any, that is either 
subject to a substantial risk of forfeiture (nonvested) or has been 
included in income in a previous taxable year. The last step is to 
subtract the amount determined in step two from the amount determined 
in step one. The excess of the amount determined in step one over the 
amount determined in step two is the amount includible in income and 
subject to additional income taxes for the year as a result of the 
plan's failure to comply with section 409A(a). Sections III.B through 
III.D of this preamble explain how the proposed regulations would 
address the first step in the process of determining the amount 
includible in income under section 409A, calculating the total amount 
deferred for the taxable year.

B. Total Amount Deferred

1. In General
    In general, under the proposed regulations, the amount deferred 
under a plan\2\ for a taxable year and all preceding taxable years 
would be referred to as the total amount deferred for a taxable year 
and would be determined as of the last day of the taxable year. 
Therefore, for calendar year taxpayers, such as most individuals, the 
relevant calculation date would be December 31. Determining the total 
amount deferred for the taxable year as of the last day of the taxable 
year during which a plan fails to comply with section 409A(a) would 
allow taxpayers to avoid the administrative burden of tracking amounts 
deferred under a plan on a daily basis, because adjustments would not 
be made to reflect notional earnings or losses or other fluctuations in 
the amount payable under the plan as they occur during the taxable 
year, but would be applied only on a net basis as of the last day of 
the taxable year. For example, if a service provider has a calendar 
year taxable year, and if the service provider's account balance under 
a plan is $105,000 as of July 1, but is only $100,000 as of December 31 
of the same year, due solely to deemed investment losses (with no 
payments made under the plan during the year), the total amount 
deferred under the plan for that taxable year would be $100,000.
---------------------------------------------------------------------------

    \2\ For this purpose, the term plan refers to a plan as defined 
under Sec.  1.409A-1(c), including any applicable plan aggregation 
rules.
---------------------------------------------------------------------------

    Similarly, the total amount deferred for a taxable year would not 
necessarily be the greatest total amount deferred for any previous 
year, even if no amount has been paid under the plan. For example, if a 
service provider has a calendar year taxable year, and if the service 
provider's account balance under a plan as of December 31, 2010 is 
$105,000, as of December 31, 2011 is $100,000, and as of December 31, 
2012 is $95,000, and if those decreases are due solely to deemed 
investment losses (and no payments were made under the plan in 2011 or 
2012), then the total amount deferred for 2011 would be $100,000 and 
the total amount deferred for 2012 would be $95,000.
2. Treatment of Payments
    If a service recipient pays an amount deferred under a plan during 
a taxable year, the amount remaining to be paid to (or on behalf of) 
the service provider under the plan as of the last day of the taxable 
year will have been reduced as a result of such payment. To reasonably 
reflect the effect of payments made during a taxable year, the proposed 
regulations provide that the sum of all payments of amounts deferred 
under a plan during a taxable year, including all payments that are 
substitutes for an amount deferred, would be added to the amounts 
deferred outstanding as of the last day of the taxable year (determined 
in accordance with the regulations) to calculate the total amount 
deferred for such taxable year. To lower the administrative burden of 
the

[[Page 74383]]

calculation, the proposed regulations provide that the addition of such 
payments to the total amount deferred for the taxable year would not be 
increased by any interest or other amount to reflect the time value of 
money. The total amount deferred for a taxable year would include all 
payments, regardless of whether the service recipient made some or all 
of the payments in accordance with the requirements of section 409A(a). 
For example, if during a taxable year an employee receives a single sum 
payment of the entire amount deferred under a plan, the employee would 
have a total amount deferred under the plan for the taxable year equal 
to the amount paid.
3. Treatment of Deemed Losses
    Because the total amount deferred would be determined as of the 
last day of the taxable year, losses that occur during a taxable year 
(due to losses on deemed investments, actuarial losses, and other 
similar reductions in the amount payable under a plan) generally would 
be netted with any gains that occur during the same taxable year (due 
to deemed investment or actuarial gains, additional deferrals, or other 
additions to the amount payable under the plan). To that extent, deemed 
investment losses, actuarial losses, or other similar reductions could 
offset deemed investment or actuarial gains, additional deferrals, or 
other increases in the amount deferred under the plan for purposes of 
determining the total amount deferred for the taxable year. This would 
apply regardless of whether a deemed loss occurs before or after the 
date of any specific failure to comply with section 409A(a). For 
example, assume a service provider begins a taxable year with a $10,000 
balance under an account balance plan. During the year, the service 
provider has an additional deferral to the plan of $5,000 and incurs 
net deemed investment losses of $2,000. No payments are made pursuant 
to the plan during the year, the employee has no vested legally binding 
right to further deferrals to the plan, and there are no other changes 
to the account balance. The total amount deferred for the taxable year 
would equal the $13,000 account balance ($10,000 + $5,000-$2,000) as of 
the last day of the taxable year.
4. Treatment of Rights to Deemed Earnings on Amounts Deferred
    Under section 409A(d)(5), income (whether actual or notional) 
attributable to deferred compensation constitutes deferred compensation 
for purposes of section 409A. See Sec.  1.409A-1(b)(2). For example, if 
a service provider must include a deferred amount in income because an 
account balance plan in which the service provider participates fails 
to satisfy the requirements of section 409A(a), notional earnings 
credited with respect to such amount constitute deferred compensation 
and are subject to section 409A. If the plan also fails to comply with 
the requirements of section 409A(a) during a subsequent taxable year, 
the notional earnings must be included in income and are subject to the 
additional taxes under section 409A(a), notwithstanding that the 
``principal'' amount of deferred compensation has already been included 
in income under section 409A(a) for a previous year.
    In this respect, the treatment of earnings on nonqualified deferred 
compensation for purposes of section 409A is significantly different 
from the treatment of such earnings for purposes of section 3121(v)(2) 
(application of Federal Insurance Contributions Act (FICA) tax to 
nonqualified deferred compensation). As a result, notional earnings 
ordinarily are deferred compensation that is subject to section 409A 
even if such earnings would not constitute wages for purposes of the 
FICA tax when paid to the service provider because of the special 
timing rule under section 3121(v)(2) and Sec.  31.3121(v)(2)-1(a)(2). 
Accordingly, the proposed regulations provide that earnings that are 
credited with respect to deferred compensation during a taxable year or 
that were credited in previous taxable years, and earnings with respect 
to deferred compensation that are paid during such taxable year, must 
be included in determining the total amount deferred for the taxable 
year.
5. Total Amount Deferred for a Taxable Year Relates to the Entire 
Taxable Year, Regardless of Date or Period of Failure
    Section 409A(a)(1)(A)(i) states that if at any time during a 
taxable year a nonqualified deferred compensation plan fails to meet 
the requirements of section 409A(a), all compensation deferred under 
the plan for the taxable year and all preceding years shall be 
includible in gross income for the taxable year to the extent not 
subject to a substantial risk of forfeiture (vested) and not previously 
included in gross income. The statutory reference to the deferred 
compensation required to be included in income under section 409A(a) 
does not distinguish between amounts deferred in a taxable year before 
a failure to meet the requirements of section 409A(a), and amounts 
deferred in the same taxable year after such failure. Accordingly, 
under the proposed regulations the total amount deferred under a plan 
for a taxable year would refer to the total amount deferred as of the 
last day of the taxable year, regardless of the date upon which a 
failure occurs. For example, if a plan is amended during a service 
provider's taxable year to add a provision that fails to meet the 
requirements of section 409A(a), the total amount deferred as of the 
last day of the taxable year would be includible in income under 
section 409A(a). This would include all payments under the plan during 
the taxable year, including payments made before the amendment 
(regardless of whether such payments are made in accordance with the 
requirements of section 409A(a)). Similarly, if the plan in operation 
fails to meet the requirements of section 409A(a) during the taxable 
year, the total amount deferred for the taxable year would include all 
payments under the plan during the taxable year, including payments 
made before and after the date the failure occurred.
    The proposed regulations provide that amounts deferred under a plan 
during a taxable year in which a failure occurs must be included in 
income under section 409A(a) even if such deferrals occur after the 
failure and are otherwise made in compliance with section 409A(a). For 
example, salary deferrals for periods during a taxable year after an 
impermissible accelerated payment under the same plan during the same 
taxable year would be required to be included in the total amount 
deferred for the taxable year and included in income under section 
409A(a), regardless of whether the salary deferrals are made in 
accordance with an otherwise compliant deferral election.
6. Treatment of Short-Term Deferrals
    Under Sec.  1.409A-1(b)(4), an arrangement may not provide for 
deferred compensation if the amount is payable, and is paid, during a 
limited period of time following the later of the date the service 
provider obtains a legally binding right to the payment or the date 
such right is no longer subject to a substantial risk of forfeiture 
(generally referred to as the applicable 2\1/2\ month period). Whether 
an amount will be treated as a short-term deferral or as deferred 
compensation may not be determinable as of the last day of the service 
provider's taxable year, because it may depend upon whether the amount 
is paid on or before the end of the applicable 2\1/2\ month period. For 
purposes of calculating the total amount deferred for a taxable year, 
the proposed

[[Page 74384]]

regulations provide that the right to a payment that, under the terms 
of the arrangement and the facts and circumstances as of the last day 
of the taxable year, may or may not be a short-term deferral, is not 
included in the total amount deferred. In addition, even if such amount 
is not paid by the end of the applicable 2\1/2\ month period so that 
the amount would be deferred compensation, the amount would not be 
includible in the total amount deferred until the service provider's 
taxable year in which the applicable 2\1/2\ month period expired. For 
example, assume that as of December 31, 2010, an employee whose taxable 
year is the calendar year is entitled to an annual bonus that is 
scheduled to be paid on March 15, 2011, and that the bonus would 
qualify as a short-term deferral if paid on or before the end of the 
applicable 2\1/2\ month period, which ends on March 15, 2011. The bonus 
would not be included in the total amount deferred for 2010. This would 
be true regardless of whether the bonus is paid on or before March 15, 
2011. However, the bonus would be includible in the total amount 
deferred for 2011 if the bonus is not paid on or before March 15, 2011.

C. Calculation of Total Amount Deferred--General Principles

1. General Rule
    Generally, the proposed regulations provide that the total amount 
deferred under a plan for a taxable year is the present value as of the 
close of the last day of a service provider's taxable year of all 
amounts payable to the service provider under the plan, plus amounts 
paid to the service provider during the taxable year. For this purpose, 
present value generally would mean the value as of the close of the 
last day of the service provider's relevant taxable year of the amount 
or series of amounts due thereafter, where each such amount is 
multiplied by the probability that the condition or conditions on which 
payment of the amount is contingent would be satisfied (subject to 
special treatment for certain contingencies), discounted according to 
an assumed rate of interest to reflect the time value of money. A 
discount for the probability that the service provider will die before 
commencement of payments under the plan would be permitted to the 
extent that the payments would be forfeited upon the service provider's 
death. The proposed regulations provide that the present value cannot 
be discounted for the probability that payments will not be made (or 
will be reduced) because of the unfunded status of the plan, the risk 
associated with any deemed investment of amounts deferred under the 
plan, the risk that the service recipient or another party will be 
unwilling or unable to pay amounts deferred under the plan when due, 
the possibility of future plan amendments, the possibility of a future 
change in the law, or similar risks or contingencies. The proposed 
regulations further provide that restrictions on payment that will or 
may lapse with the passage of time, such as a temporary risk of 
forfeiture that is not a substantial risk of forfeiture, are not taken 
into account in determining present value. However, any potential 
additional deferrals contingent upon a bona fide requirement that the 
service provider perform services after the taxable year, such as 
potential salary deferrals, service credits or additions due to 
increases in compensation, would not be taken into account in 
determining the total amount deferred for the taxable year.
    For purposes of calculating the present value of the benefit, the 
proposed regulations require the use of reasonable actuarial 
assumptions and methods. Whether assumptions and methods are reasonable 
for this purpose would be determined as of each date the benefit is 
valued for purposes of determining the total amount deferred.
    The proposed regulations also provide certain rules relating to the 
crediting of earnings, generally providing that the schedule for 
crediting earnings will be respected if the earnings are credited at 
least once a year. In general, if the rules with respect to the 
crediting of earnings are met, any additional earnings that would be 
credited after the end of the taxable year only if the service provider 
continued performing services after the end of the year would not be 
includible in the total amount deferred for the year. If the right to 
earnings is based on an unreasonably high interest rate, the proposed 
regulations generally would characterize the unreasonable portion of 
earnings as a current right to additional deferred compensation. In 
addition, if earnings are based on a rate of return that does not 
qualify as a predetermined actual investment or a reasonable interest 
rate, the proposed regulations provide that the general calculation 
rules as applied to formula amounts would apply.
    The proposed regulations provide other general rules that address 
issues such as plan terms under which amounts may be payable when a 
triggering event occurs, rather than on a fixed date, or plan terms 
under which the amount payable is determined in accordance with a 
formula, rather than being set at a fixed amount. In addition, the 
proposed regulations provide specific rules under which the total 
amounts deferred under certain types of nonqualified deferred 
compensation plans would be determined. The rules applicable to 
specific types of plans would apply in conjunction with the general 
rules. As a result, under the proposed regulations, an amount of 
deferred compensation may be includible in income under section 409A(a) 
even if the same amount would not yet be includible in wages under 
section 3121(v)(2).
2. Rules Regarding Alternative Times and Forms of Payment
    To calculate the total amount deferred under a nonqualified 
deferred compensation plan, it is necessary to determine the time and 
form of payment pursuant to which the amount will be paid. Under the 
proposed regulations, if an amount deferred under a plan could be 
payable pursuant to more than one time and form of payment under the 
plan, the amount would be treated as payable in the available time and 
form of payment that has the highest present value. For this purpose, a 
time and form of payment generally would be an available time and form 
of payment to the extent a deferred amount under the plan could be 
payable pursuant to such time and form of payment under the plan's 
terms, provided that if there is a bona fide requirement that the 
service provider continue to perform services after the end of the 
taxable year to be eligible for the time and form of payment, the time 
and form of payment would not be treated as available. If an 
alternative time and form of payment is available only at the service 
recipient's discretion, the time and form of payment would not be 
treated as available unless the service provider has a legally binding 
right under the principles of Sec.  1.409A-1(b)(1) to any additional 
value that would be generated by the service recipient's exercise of 
such discretion. If a service provider has begun receiving payments of 
an amount deferred under a plan and neither the service provider nor 
the service recipient can change the time and form of payment of such 
deferred amount without the other party's approval, then no other time 
and form of payment under the plan would be treated as available if 
such approval requirement has substantive significance.
    In certain instances, a service provider will be eligible for an 
alternative time and form of payment only if the service provider has a 
certain status as of a future date. For example, a time and form of 
payment may be

[[Page 74385]]

available only if the service provider is married at the time the 
payment commences. The proposed regulations generally provide that for 
purposes of determining whether the service provider will meet the 
eligibility requirements so that an alternative time and form of 
payment is available, the service provider is assumed to continue in 
the service provider's status as of the last day of the taxable year. 
However, if the eligibility requirement is not bona fide and does not 
serve a bona fide business purpose, the eligibility requirement would 
be disregarded and the service provider would be treated as eligible 
for the alternative time and form of payment. For this purpose, an 
eligibility condition based upon the service provider's marital status, 
parental status, or status as a U.S. citizen or lawful permanent 
resident would be presumed to be bona fide and to serve a bona fide 
business purpose.
    If the calculation of the present value of the amount payable to a 
service provider under a plan requires assumptions relating to the 
timing of the payment because the payment date is, or could be, a 
triggering event rather than a specified date, the proposed regulations 
specify certain assumptions that must be applied to make such 
calculation. First, the possibility that a particular payment trigger 
would occur generally would not be taken into account if the right to 
the payment would be subject to a substantial risk of forfeiture if 
that payment trigger were the only specified payment trigger. For 
example, if an amount is payable upon the earlier of the attainment of 
a specified age or an involuntary separation from service (as defined 
in the Sec.  1.409A-1(n)), the present value of the amount payable upon 
involuntary separation from service would not be taken into account if 
the payment would be subject to a substantial risk of forfeiture if 
that were the only payment trigger. However, if multiple triggers with 
respect to the same payment would, applied individually, constitute 
substantial risks of forfeiture, such triggers would not be disregarded 
under this rule unless all such triggers, applied in the aggregate, 
would also constitute a substantial risk of forfeiture. Second, the 
possibility that an unforeseeable emergency, as defined in Sec.  
1.409A-3(i)(3), would occur and result in a payment also would not be 
taken into account for purposes of calculating the amount deferred.
    If an amount is payable upon a service provider's death, it 
generally would not be necessary to make assumptions concerning when 
the service provider would die because any additional value due to the 
amount becoming payable upon the service provider's death generally 
would be treated as an amount payable under a death benefit plan, and 
amounts payable under a death benefit plan are not deferred 
compensation for purposes of section 409A(a). Similarly, such 
assumptions generally would not be necessary for an amount payable upon 
a service provider's disability, because any additional value due to 
the amount becoming payable upon the service provider's disability 
generally would be payable under a disability plan, and amounts payable 
under a disability plan are not deferred compensation for purposes of 
section 409A. See Sec.  1.409A-1(a)(5).
    In other cases where it is necessary to make assumptions concerning 
when a payment trigger would occur to determine the amount deferred 
under a plan, taxpayers generally would be required to assume that the 
payment trigger would occur at the earliest possible time that the 
conditions under which the amount would become payable reasonably could 
occur, based on the facts and circumstances as of the last day of the 
taxable year. However, the proposed regulations provide a special rule 
for amounts payable due to the service provider's separation from 
service, termination of employment, or other event requiring the 
service provider's reduction or cessation of services for the service 
recipient. In such a case, the total amount deferred would be 
calculated as if the service provider had met the required reduction or 
cessation of services as of the close of the last day of the service 
provider's taxable year for which such calculation was being made. 
These rules would apply regardless of whether the payment trigger has 
or has not occurred as of any future date upon which the amount 
deferred for a prior taxable year was being determined.
    The Treasury Department and the IRS recognize that for some service 
providers, the earliest possible time that a payment trigger reasonably 
could occur will not be the most likely time the trigger will occur. 
Similarly, the Treasury Department and the IRS recognize that for many 
service providers, the assumption that the service provider ceases 
providing services as of the end of the taxable year may not be 
realistic. The Treasury Department and the IRS request comments on 
alternative standards that could be utilized for these payment 
triggers.
    An alternative approach might presume a date upon which the service 
provider will separate from service such as, for example, 100 months 
after the last day of the service provider's taxable year for which the 
amount deferred is being calculated. Cf. Sec.  1.280G-1 Q&A 24(c)(4). 
Such a standard, however, would not reflect the value of additional 
deferred compensation that would be paid only if the service provider 
separates from service before the end of the 100-month period, such as 
an early retirement subsidy or a window benefit, unless special rules 
were developed to address such situations. Another issue that arises is 
whether such a standard should apply if the service provider is likely 
to retire during the next 100 months, such as if a service provider has 
attained a certain age, number of years of service, or level of 
financial independence. However, the Treasury Department and the IRS 
are concerned whether an approach involving the application of 
individualized standards to determine the probability that a particular 
service provider will separate from service will be administrable in 
practice.
3. Treatment of Rights to Formula Amounts
    Once the date that a payment will occur has been fixed (either as a 
specified date under the plan's terms or through application of the 
rules in the proposed regulations), it is necessary to quantify the 
amount of the payment to which the service provider will be entitled to 
calculate the total amount deferred under a nonqualified deferred 
compensation plan. However, certain plans may define the amount payable 
by a formula or other method that is based on factors that may vary in 
future years. In general, if, at the end of the service provider's 
taxable year, the amount to be paid in a future year is a formula 
amount, the proposed regulations provide that the amount payable in the 
future year for purposes of calculating the total amount deferred must 
be determined using reasonable assumptions.
    A deferred amount generally would be a formula amount subject to 
the reasonable assumptions standard if calculating the payment amount 
is dependent upon factors that are not determinable after taking into 
consideration all of the assumptions and other calculation rules 
provided in the proposed regulations. For example, a future payment 
equal to one percent of a corporation's net profits over five calendar 
years generally would be a formula amount until the last day of the 
fifth year, because the corporation's net profits over the five 
calendar years could not be determined by applying the assumptions and 
rules set out in the

[[Page 74386]]

proposed regulations until the end of the fifth calendar year.
    A deferred amount would not be a formula amount at the end of the 
taxable year merely because the information necessary to determine the 
amount is not readily available, if such information exists at the end 
of such taxable year. For example, if a deferred amount is based upon 
the service recipient's profits for its taxable year that coincides 
with the service provider's taxable year, the amount would be 
considered a non-formula amount at the end of the taxable year because 
the information necessary to determine the service recipient's profits 
exists, although such information may not be immediately accessible.
    The right to have a deferred amount credited with reasonable 
earnings that may vary, for example because the earnings are based on 
the value of a deemed investment, would not affect whether the right to 
the underlying deferred amount is a formula amount. In addition, the 
amount of earnings to which the service provider has become entitled at 
the end of a particular taxable year would not be treated as a formula 
amount, regardless of whether such earnings could subsequently be 
reduced by future losses. For example, assume a service provider has a 
$10,000 account under an account balance plan, to be paid out in three 
years subject to earnings based on a mutual fund designed to replicate 
the performance of the S&P 500 index. At the end of Year 1, the account 
balance is $10,500. For Year 1, the service provider would have a total 
amount deferred equal to $10,500, notwithstanding that the amount could 
be reduced by future losses based on losses in the mutual fund.

D. Calculation of Total Amounts Deferred--Specific Types of Plans

1. Account Balance Plans
    Under the proposed regulations, the amount deferred under an 
account balance plan for a taxable year generally equals the aggregate 
balance of all accounts under the plan as of the close of the last day 
of the taxable year, plus any amounts paid from such plan during the 
taxable year, so long as the aggregate account balance is determined 
using not more than a reasonable interest rate or the return on a 
predetermined actual investment. This rule would apply regardless of 
whether the applicable interest rate used to determine the earnings was 
higher or lower than the applicable Federal rate (AFR) under section 
1274(d), provided that the interest rate was no more than a reasonable 
rate of interest. For a description of the proposed rules on how to 
calculate the total amount deferred if the right to earnings is based 
on an unreasonably high interest rate, see section III.C.1 of this 
preamble.
2. Nonaccount Balance Plans
    Under the proposed regulations, the total amount deferred for a 
taxable year under a nonaccount balance plan generally is calculated 
under the general calculation rule. See section III.C of this preamble. 
For example, if a service provider has the right to be paid on a 
specified future date a fixed amount that is not credited with 
earnings, the total amount deferred for a year generally would be the 
present value as of the last day of the service provider's taxable year 
of the amount to which the service provider has a right to be paid in 
the future year (assuming no payments were made under the plan during 
the year). Increases in the present value of the payment in subsequent 
years due to the passage of time would be treated as earnings in the 
years in which such increases occur. For example, a right to a payment 
of $10,000 in Year 3 may have a present value in Year 1 equal to 
$8,900, and a present value in Year 2 equal to $9,434, so that the 
total amount deferred in Year 1 would be $8,900, the total amount 
deferred in Year 2 would be $9,434, and the total amount deferred in 
Year 3 would be $10,000 (assuming no payments were made during any year 
except Year 3). Any potential additional service credits or increases 
in compensation after the end of the taxable year for which the 
calculation is being made would not be taken into account in 
determining the total amount deferred for the taxable year.
3. Stock Rights
    In general, the proposed regulations provide that the total amount 
deferred under an outstanding stock right is the amount of money and 
the fair market value of the property that the service provider would 
receive by exercising the right on the last day of the taxable year, 
reduced by the amount (if any) the service provider must pay to 
exercise the right and any amount the service provider paid for the 
right, which is commonly referred to as the spread. Accordingly, for an 
outstanding stock option, the total amount deferred generally would 
equal the underlying stock's fair market value on the last day of the 
taxable year, less the sum of the exercise price and any amount paid 
for the stock option. For an outstanding stock appreciation right, the 
total amount deferred generally would equal the underlying stock's fair 
market value on the last day of the taxable year, less the sum of the 
exercise price and any amount paid for the stock appreciation right. 
For this purpose, the stock's fair market value would be determined 
applying the principles set forth in Sec.  1.409A-1(b)(5).
    The Treasury Department and the IRS recognize that the spread 
generally is less than the fair market value of the stock right, which 
is used for purposes of determining the amount taxable under other Code 
provisions such as section 83 (if a stock option has a readily 
ascertainable fair market value), section 4999, and section 457(f). 
However, because these types of stock rights typically will fail to 
comply with section 409A(a) in multiple years, a taxpayer who holds 
such a stock right generally will be required to include amounts in 
income under section 409A in more than one taxable year. Therefore, the 
Treasury Department and the IRS believe that it is more appropriate to 
use the spread for purposes of applying section 409A(a) to stock 
rights.
4. Separation Pay Arrangements
    A deferred amount that is payable only upon an involuntary 
separation from service generally will be treated as subject to a 
substantial risk of forfeiture until the service provider involuntarily 
separates from service. Accordingly, under the proposed regulations the 
amount of deferred compensation generally would not be required to be 
calculated until the service provider has involuntarily separated from 
service. In addition, if the amount were payable upon either an 
involuntary separation from service or some other trigger, such as a 
fixed date, the possibility of payment upon an involuntary separation 
from service generally would be ignored for purposes of determining the 
total amount deferred under the arrangement. See section III.C.2 of 
this preamble. Once an involuntary separation from service has 
occurred, the amount deferred under the plan would be determined using 
the rules that would apply to the schedule of payments if the right to 
payment were not contingent upon an involuntary separation from 
service. For example, if the amounts payable are installment payments 
and the remaining installment payments include interest credited at a 
reasonable rate, the total amount deferred under the plan would be 
determined under the rules governing account balance plans. If more 
than one type of deferred compensation arrangement were provided under 
the separation pay agreement, the amount deferred under each 
arrangement would

[[Page 74387]]

be determined using the rules applicable to that type of arrangement. 
The total amount deferred for the taxable year would be the sum of all 
of the amounts deferred under the various arrangements constituting the 
plan.
5. Reimbursement Arrangements
    The proposed regulations provide a method of calculating the amount 
deferred under a reimbursement arrangement, including an arrangement 
where the benefit is provided as an in-kind benefit from the service 
recipient or the service recipient will pay directly the third-party 
provider of the goods or services to the service provider. For example, 
the amount deferred under an arrangement providing a specified number 
of hours of financial planning services after a service provider's 
separation from service would be determined using the rules applicable 
to reimbursement arrangements, regardless of whether the service 
recipient reimburses the service provider for the service provider's 
expenses in purchasing such services, provides the financial planning 
services directly to the service provider, or pays a third-party 
financial planner to provide such services. The rules for reimbursement 
arrangements would apply to all such types of arrangements, including 
arrangements that would not be disaggregated from a nonaccount balance 
plan under Sec.  1.409A-1(c)(2)(i)(E) because the amounts subject to 
reimbursement exceed the applicable limits.
    The proposed calculation rules provide that if a service provider 
has a right to reimbursements but only up to a specified maximum 
amount, it is presumed that the taxpayer will incur the maximum amount 
of expenses eligible for reimbursement, at the earliest possible time 
such expenses may be incurred and payable at the earliest possible time 
the amount may be reimbursed under the plan's terms. The service 
provider could rebut the presumption if the service provider 
demonstrates by clear and convincing evidence that it is unreasonable 
to assume that the service provider would expend (or would have 
expended) the maximum amount of expenses eligible for reimbursement. 
For example, if a service provider is entitled to the reimbursement of 
country club dues the service provider incurs in the next taxable year, 
not to exceed $30,000, if the service provider can demonstrate that the 
most expensive country club within reasonable geographic proximity of 
the service provider's residence and work location will cost $20,000 
per year, and that the service provider's level of compensation and 
financial resources make it unreasonable to assume that the service 
provider would travel periodically to the locales of other, more 
expensive country clubs, the service provider can calculate the amount 
deferred based upon the $20,000 being eligible for reimbursement. The 
presumption of maximum utilization of expenses eligible for 
reimbursement generally would not apply if the expenses subject to 
reimbursement are medical expenses.
    If a right to reimbursement is not subject to a maximum amount, the 
taxpayer would be treated as having deferred a formula amount, provided 
that the taxpayer would be required to calculate the amount based on 
the maximum amount that reasonably could be expended and reimbursed. 
The amount would be considered a nonformula amount as soon as the 
taxpayer incurs the expense that is subject to reimbursement, in an 
amount equal to the reimbursement to which the taxpayer is entitled. 
For example, a right to the reimbursement of half of the expenses the 
service provider incurs to purchase a boat without any limitation with 
respect to the cost would be treated as a deferral of a formula amount, 
until such time as the service provider purchases the boat.
6. Split-Dollar Life Insurance Arrangements
    The amount deferred under a split-dollar life insurance arrangement 
would be determined based upon the amount that would be required to be 
included in income in a future year under the applicable split-dollar 
life insurance rules. Determination of the amount includible in income 
would depend upon the Federal tax regime and guidance applicable to 
such arrangement. If the split-dollar life insurance arrangement is not 
subject to Sec.  1.61-22 or Sec.  1.7872-15 due to application of the 
effective date provisions under Sec.  1.61-22(j), the amount payable 
would be determined by reference to Notice 2002-8 (2002-1 CB 398) and 
any other applicable guidance. If the split-dollar life insurance 
arrangement is subject to Sec.  1.61-22 or Sec.  1.7872-15, the amount 
payable would be determined by reference to such regulations, based 
upon the type of arrangement. For this purpose, the amount includible 
in income generally would be determined by applying the split-dollar 
life insurance rules to the arrangement in conjunction with the general 
rules providing assumptions on payment dates of deferred amounts. 
However, in the case of an arrangement subject to Sec.  1.7872-15, to 
the extent the rules regarding time and form of payment and other 
payment assumptions under these proposed regulations conflict with the 
provisions of Sec.  1.7872-15, the provisions of Sec.  1.7872-15 would 
apply instead of the conflicting rules under these proposed 
regulations. As provided in Notice 2007-34 (2007-17 IRB 996), the 
portion of the benefit provided under the split-dollar life insurance 
arrangement consisting of the cost of current life insurance protection 
is not treated as deferred compensation for this purpose. See Sec.  
601.601(d)(2)(ii)(b).
7. Foreign Arrangements
    Although certain foreign arrangements are a separate category under 
the plan aggregation rules (Sec.  1.409A-1(c)(2)(i)(G)), the amounts 
deferred under such arrangements would be determined using the same 
rules that would apply if the arrangements were not foreign 
arrangements. For example, the total amount deferred by a United States 
citizen participating in a salary deferral arrangement in France that 
meets the requirements of Sec.  1.409A-1(c)(2)(i)(G), but that 
otherwise would constitute an elective account balance plan under Sec.  
1.409A-1(c)(2)(i)(A), would be determined using the rules applicable to 
account balance plans.
8. Other Plans
    The calculation of the total amount deferred under a plan that does 
not fall into any of the enunciated categories (and accordingly is 
treated as a separate plan under Sec.  1.409A-1(c)(2)(i)(I)), would be 
determined by applying the general calculation rules.

E. Calculation of Amounts Includible in Income

    This section III.E of the preamble addresses the second step in 
determining the amount includible in income under section 409A for a 
taxable year--the determination of the portion of the total amount 
deferred for a taxable year that was either subject to a substantial 
risk of forfeiture or had previously been included in income. That 
portion of the total amount deferred for the taxable year would not be 
includible in income under section 409A.
1. Determination of the Portion of the Total Amount Deferred for a 
Taxable Year That Is Subject to a Substantial Risk of Forfeiture
    In general, the proposed regulations provide that the portion of 
the total amount deferred for a taxable year that is subject to a 
substantial risk of

[[Page 74388]]

forfeiture (nonvested) is determined as of the last day of the service 
provider's taxable year. Accordingly, all amounts that vest during the 
taxable year in which a failure occurs would be treated as vested for 
purposes of section 409A(a), regardless of whether the vesting event 
occurs before or after the failure to meet the requirements of section 
409A(a). For example, if a plan fails to comply with section 409A(a) 
due to an operational failure on July 1 of a taxable year, and the 
substantial risk of forfeiture applicable to an amount deferred under 
the plan lapses as of October 1 of the same taxable year, that amount 
would be treated as a vested amount for purposes of determining the 
amount includible in income for the taxable year.
2. Determination of the Portion of the Total Amount Deferred for a 
Taxable Year That Has Been Previously Included in Income
    For a deferred amount to be treated as previously included in 
income, the proposed regulations would require that the service 
provider actually and properly have included the amount in income in 
accordance with a provision of the Internal Revenue Code. This would 
include amounts reflected on an original or amended return filed before 
expiration of the applicable statute of limitations on assessment and 
amounts included in income as part of an audit or closing agreement 
process. In addition, a deferred amount would be treated as an amount 
previously included in income only until the amount is paid. 
Accordingly, if a deferred amount is paid in the same taxable year in 
which an amount is included in income under section 409A, or all or a 
portion of an amount previously included in income is allocable to a 
payment made under the plan (see section VI.A of this preamble), in 
subsequent taxable years that amount would not be treated as an amount 
previously included in income. For example, if an employee includes 
$100,000 in income under section 409A(a), and $10,000 of the amount 
includible in income consists of a payment under the plan during the 
taxable year, only $90,000 would remain to be treated as a deferred 
amount previously included in income. Similarly, if in the next year 
the employee receives a payment, to the extent any or all of that 
$90,000 amount previously included in income is allocated to that 
payment so that all or a portion of the payment is not includible in 
gross income, the amount allocated would no longer be treated as an 
amount previously included in income.

F. Treatment of Failures Continuing During More Than One Taxable Year

    A plan term that fails to meet the requirements of section 409A(a) 
may be retained in the plan over multiple taxable years. In addition, 
operational failures may occur in multiple years. This section III.F of 
the preamble discusses how section 409A(a) applies in such cases.
    Each of the service provider's taxable years would be analyzed 
independently to determine if amounts were includible in income under 
section 409A(a). See section II of this preamble. Thus, for any taxable 
year during which a failure occurs, all amounts deferred under the plan 
would be includible in income unless the amount has previously been 
included in income or is subject to a substantial risk of forfeiture. 
Generally, this means that a service provider who includes in income 
under section 409A(a) all amounts deferred under a plan for a taxable 
year would not be relieved of the requirement to include amounts in 
income for an earlier taxable year in which a failure also occurred. It 
would undermine the statutory purpose to allow a service provider to 
include an amount in income under section 409A(a) (or otherwise) on a 
current basis with respect to a failure that occurred in a prior 
taxable year and thereby eliminate the taxes owed for the earlier year, 
especially if intervening payments of deferred amounts have reduced the 
total amount deferred as of the end of such current year. In addition, 
this rule generally would prohibit a service provider from selecting 
from among several previous taxable years the most favorable year in 
which to include income. However, if an amount was actually and 
properly included in income under section 409A(a) in a previous year, 
the amount would be treated as an amount previously in income for 
purposes of all subsequent years. Accordingly, this rule would never 
make the same amount includible in income twice under section 409A(a).
    For example, assume an employee participates in a nonqualified 
deferred compensation plan and defers $10,000 each year, credited 
annually with interest at 5 percent (assumed to be reasonable for 
purposes of this example), and receives no payments under the plan. The 
employee's total amount deferred would be $10,500 for Year 1, $21,525 
for Year 2, and $33,101 for Year 3. If the nonqualified deferred 
compensation plan fails to meet the requirements of section 409A(a) in 
each year, the employee would be required to include $10,500 in income 
under section 409A(a) for Year 1, $11,025 in income for Year 2, and 
$11,576 in income for Year 3. If the employee includes $33,101 in 
income under section 409A(a) for Year 3, the employee would not have 
properly reported income for Year 1 and Year 2. However, an amount 
included in income for Year 3 would be treated as previously included 
in income for purposes of any further failures in subsequent years. In 
addition, if the employee subsequently properly includes amounts in 
income for Year 1 and Year 2 on amended returns, the employee could 
claim a refund of the tax paid on the excess amounts included in income 
for Year 3. Similar consequences apply to the employer. If the employer 
fails to report and withhold on amounts includible in income under 
section 409A(a) in Year 1 and Year 2, the employer could not avoid 
liability for the failure to withhold in Year 1 and Year 2 by reporting 
the full amount and withholding in Year 3.
    Because each taxable year would be analyzed independently, the IRS 
could elect to audit and assess with respect to a single taxable year, 
and require inclusion of all amounts deferred under the plan through 
that taxable year (even if failures also occurred in prior taxable 
years). Under those circumstances, the taxpayer could simply include 
amounts in income under section 409A(a) for that taxable year. However, 
before expiration of the applicable statute of limitations, the 
taxpayer could amend returns for previous taxable years and include in 
income amounts required to be included under section 409A(a), lowering 
the amount includible in income under section 409A(a) for the audited 
taxable year because, for purposes of that taxable year, those amounts 
would have been included in income in previous years. For example, an 
audit of Year 3 in the example above could result in an adjustment 
requiring $33,101 to be included in income under section 409A(a). 
However, before expiration of the applicable statute of limitations, 
the employee could amend the employee's Year 1 and Year 2 Federal tax 
returns to include $10,500 in income under section 409A(a) for Year 1, 
and $11,025 in income under section 409A(a) for Year 2, and accordingly 
include only $11,576 in income under section 409A(a) for Year 3. 
However, the employee would be required to pay the additional section 
409A(a) taxes for Year 1 and Year 2, including the premium interest 
tax. In addition, if amounts deferred under the plan had been paid in 
Year 1 or Year 2, the employee would be required to include

[[Page 74389]]

those additional amounts in income under section 409A(a) for the year 
paid (meaning, if the payment had been included in income for the year 
in which it was paid, the employee would be required to amend the 
previously filed tax returns to pay the additional section 409A(a) 
taxes on such income).

IV. Application of Additional 20 Percent Tax

    Section 409A(a)(1)(B)(i)(II) provides that if compensation is 
required to be included in gross income under section 409A(a)(1)(A) for 
a taxable year, the income tax imposed is increased by an amount equal 
to 20 percent of the compensation that is required to be included in 
gross income. This amount is an additional income tax, subject to the 
rules governing the assessment, collection, and payment of income tax, 
and is not an excise tax.

V. Application of Premium Interest Tax

A. In General

    Section 409A(a)(1)(B)(i)(I) provides that if compensation is 
required to be included in gross income under section 409A(a)(1)(A) for 
a taxabl