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Tax Management

Compensation Planning JournalTM

Reproduced with permission from Tax ManagementCompensation Planning Journal, Vol. 45, 2, p. 69,02/03/2017. Copyright � 2017 by The Bureau of NationalAffairs, Inc. (800-372-1033) http://www.bna.com

Correcting DocumentFailures of Plans withNonvested DeferredCompensation UnderProposed §409ARegulationsBy Marina Vishnepolskaya*

INTRODUCTION

The Proposed RegulationsEditor’s Note: On January 20, 2017, Presi-dent Trump’s Chief of Staff, Reince Priebus,issued a memo informing department andagency heads that regulations that have beenpublished in the Federal Register but are notyet effective will be postponed 60 days. De-

partment and agency heads were instructedto consider proposing for notice and com-ment a rule to delay the effective date forregulations beyond that 60-day period.

On June 21, 2016, the Treasury Department and theInternal Revenue Service released proposed regula-tions (REG-123854-12)1 (‘‘Proposed Regulations’’)proposing amendments to certain final regulations2

and replacing some previously proposed rulemaking3

with new proposed regulations under §409A of the In-ternal Revenue Code of 1986, as amended(‘‘§409A’’).4 Section 409A imposes restrictions on thetiming and manner of payment of amounts under non-qualified deferred compensation (‘‘NQDC’’) plans.5

These plans, as defined under §409A, provide com-pensation to executives that is awarded in one yearbut is includible in income in a subsequent tax year ofthe employee.6 Immediate inclusion in income, addi-tional tax or interest for violating §409A document or

* Marina Vishnepolskaya is a tax attorney and principal of Ma-rina Vishnepolskaya, Esq., P.C. Marina counsels employers andexecutives on a wide range of executive compensation matters, in-cluding drafting cash and equity-based compensation plans, em-ployment and severance agreements and other compensation ar-rangements, and compliance with related employment and taxlaws. She counsels qualified plan clients on plan administration,design, qualification and reporting requirements and on matterspending with the IRS and the DOL. Marina advises not-for-profitorganizations on all aspects of corporate governance and diversetax matters, such as unrelated business taxable income, grant-making, fundraising, parsonage and applying for and maintainingthe tax exemption, and counsels companies and investors on do-mestic corporate and international tax planning and structuring offinancing arrangements. Ms. Vishnepolskaya is a frequent lecturerand author of numerous articles and a book chapter in these areas,and contributor to bar association reports on various aspects offederal income tax laws. She may be reached by e-mail at [email protected].

1 81 Fed. Reg. 40,569 (June 22, 2016), corrected by 81 Fed.Reg. 51,413 (Aug. 4, 2016).

2 See 72 Fed. Reg. 19,234 (Apr. 17, 2007).3 See Prop. Reg. §1.409A-4, REG-148326-05, 73 Fed. Reg.

74,380 (Dec. 8, 2008). All section references are to the InternalRevenue Code of 1986, as amended, and the regulations thereun-der, unless otherwise specified.

4 See Prop. Reg. §1.409A-4, REG-123854-12, 81 Fed. Reg.40,569 (June 22, 2016) (any referenced Proposed Regulations in-cluding the accompanying preamble cited hereinafter to ‘‘REG-123854-12’’).

5 See §409A(a).6 Reg. §1.409A-1(b)(1). Contemporaneously with the Proposed

Regulations, the IRS issued proposed regulations under, amongother provisions, §457(f) applicable to NQDC under certain ‘‘in-eligible plans’’ sponsored by certain governmental or tax-exemptentities. See §457(f)(1) (general rule for timing of inclusion in in-come upon vesting of the deferred amounts and accruals under anineligible plan); Reg. §1.457-1(e) (2003) (definition of ‘‘eligibleemployer’’); REG-147196-07, 81 Fed. Reg. 40,548 (June 22,2016). Section 409A applies to NQDC plans separately and in ad-dition to §409A. Reg. §1.409A-1(a)(4); Prop. Reg. §1.409A-1(a)(4), REG-123854-12. Generally, these proposed regulationsaddress the definition of an ineligible plan, the definition of a SRFof amounts under an ineligible plan and the rules for inclusion in

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operational requirements do not apply to deferredamounts that are subject to a substantial risk of forfei-ture (‘‘SRF’’) or, in other words, are nonvested for thetax year of the plan participant in which the plan fail-ure occurs.7

The Proposed Regulations amended the anti-abuserule for preventing avoidance of §409A tax or penal-ties with respect to nonvested deferrals.8 NQDC sub-ject to SRF would be deemed as vested and thereforesubject to §409A tax consequences if any of the fol-lowing three prongs applied: (1) the service recipientamends a plan provision concerning the time or formof payment without a reasonable, good faith determi-nation that the change was necessary to correct a§409A(a) failure; (2) facts and circumstances, someof them enumerated, show a pattern or practicewhereby the service recipient effectively drafts andapproves noncompliant plan documents only to make‘‘correcting’’ amendments in future tax years, whichin substance would be impermissible changes to thetime or form of payment of a deferred amount; or (3)the correcting amendment is inconsistent with correc-tion methods (but not certain other unrelated require-ments, such as income inclusion or information re-porting) set forth in applicable IRS guidance.9 Mak-ing correcting amendments in compliance with theproposed anti-abuse rule would require bifurcating theNQDC plan for vested and nonvested amounts, if ap-plicable, and treating the correcting amendment as ap-plying with respect to deferrals that are subject to SRFon the date of the amendment.

Taxpayers may rely on the proposed income inclu-sion regulations, as amended, for purposes of calcu-lating the amount includible in income under§409A(a) until further guidance is issued, to complywith §409A.10 Thus, taxpayers may rely on the pro-posed amendments for purposes of the identificationand treatment of amounts subject to SRF.11 The IRSstated it will not assert positions with respect to anytax periods until final regulations are published that

are contrary to the positions in the Proposed Regula-tions, as amended.12

The NoticePrior to the issuance of the Proposed Regulations,

Notice 2010-6 (hereafter, the ‘‘Notice’’) set forthmethods for correction of NQDC plan document fail-ures for vested amounts under the auspices of a vol-untary correction program (hereafter, used inter-changeably with the Notice, the ‘‘VCP’’).13 The No-tice appeared to exclude NQDC plans with respect tononvested deferred amounts.14 The rationale was,there was no inclusion in income and no impositionof penalties or interest on deferred compensation sub-ject to SRF for the taxable year in which the planfailed to comply with §409A.15

Rather, as a general rule, the plan could be cor-rected to comply with §409A and avoid tax and pen-alties in a subsequent year in which the amountsvested.16 Therefore, the VCP correction methods, in-cluding reporting the correction to the IRS and insome cases including unpaid amounts in income,17

did not apply to nonvested deferrals. Plan sponsors

income of deferrals subject to §457(f). See generally Prop. Reg.§1.457-12, 81 Fed. Reg. at 40,562–40,568; see also id. at 40,550–40,557 (sections of preamble describing proposed rules applicableto ineligible plans). These proposed regulations generally do notprovide any exceptions to the proposed anti-abuse rule for correct-ing ineligible plan document failures. But close scrutiny of theseproposed regulations would be necessary to determine any poten-tial or actual applicability to correcting any ineligible plan docu-ment failures.

7 §409A(d)(4); Reg. §1.409A-1(d)(1).8 Prop. Reg. §1.409A4(a)(1)(ii)(B), REG-123854-12 (June 21,

2016) (new proposed anti-abuse rule); Prop. Reg. §1.409A-4(a)(1)(ii)(B), 73 Fed. Reg. 74,380, 74,393–74,394 (Dec. 8, 2008)(original proposed anti-abuse rule).

9 Prop. Reg. §1.409A-4(a)(1)(ii)(B).10 See Prop. Reg. §1.409A-4(a)(1)(ii)(B).11 See id.

12 See id.; Notice 2008-115, 2008-52 I.R.B. 1367 (interim guid-ance addressing reporting and wage withholding for employersand payers and income inclusion, tax payment and reporting re-quirements for service providers effective for calendar year 2008and subsequent years until further guidance or final regulationsare issued; providing that compliance with the provisions of theproposed regulations with respect to the calculation of the amountincludible in income under §409A(a) and the calculation of theadditional taxes under §409A will be treated as compliance withthe requirements of this notice, provided that the taxpayer com-plies with all the provisions of the proposed regulations).

13 Notice 2010-6, 2010-3 I.R.B. 275.14 See §409A(a)(1)(A)(i); Notice 2010-6.15 See §409A(a)(1)(A)(i).16 Prop. Reg. §1.409A-4(a)(1)(i), 73 Fed. Reg. 74,380, 74,393

(Dec. 8, 2008) (general rule for income inclusion); 73 Fed. Reg.at 74,382 (Dec. 8, 2008) (preamble to the 2008 proposed incomeinclusion regulations stating that, ‘‘if all of a taxpayer’s deferredamounts under a plan are nonvested and the taxpayer makes animpermissible deferral election or accelerates the time of paymentwith respect to some or all of the nonvested deferred amount, thenonvested deferred amount generally would not be includible inincome under section 409A(a) in the year of the impermissiblechange in time and form of payment (although if there werevested amounts deferred under the plan, such amounts would beincludible in income under section 409A(a)). In the subsequenttaxable year in which the service provider becomes vested in thedeferred amount, the plan might comply with section 409A(a) inform and in operation, so that under the general rule no incomeinclusion would be required and no additional taxes would be duefor that year as a result of the late deferral election or accelerationof payment.’’); Notice 2010-6.

17 See Notice 2010-6 §I (overview referencing limited currentinclusion in income where document failure affects the operationof the plan within one year following the date of the correction),§XII (information reporting requirements for correcting document

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could correct the documents internally without disclo-sure to the IRS or inclusion in income by the execu-tive.

The Prior Anti-Abuse Rule forNonvested Deferrals

Treasury and the IRS incorporated an anti-abuserule in the 2008 proposed income inclusion regula-tions under §409A.18 The IRS would disregard theSRF of nonvested deferrals if facts and circumstancesdemonstrated that the service recipient made imper-missible changes in the time or form of payment ofnonvested NQDC.19 The amounts also would bedeemed vested if the service recipient was found toengage in a ‘‘pattern or practice’’ of making such im-permissible changes that affected the nonvestedamounts.20

However, the anti-abuse rule was relatively broadand practitioners had significant leeway in determin-ing which failures could be corrected for nonvestedNQDC amounts and the nature of the correctingamendments. The IRS sought to close the loopholesthat may have allowed practitioners liberties inamending noncompliant plans with nonvestedamounts inconsistent with §409A regulations and IRSguidance.21 The general rule was not intended ‘‘to al-low service recipients to change time or form of pay-ment provisions that otherwise meet the requirementsof §409A(a) in a manner that fails to comply with§409A(a).’’22

In particular, the IRS meant to preclude service re-cipients from creating ‘‘errors in nonqualified deferred

compensation plans with respect to nonvestedamounts with the intention of using those errors as apretext for establishing or changing a time or form ofpayment in a manner that fails to comply with section409A(a).’’23 Thus, executives would not avoid inclu-sion in income, penalties or interest on nonvested de-ferred pay that otherwise would have been imposedon vested NQDC absent a correcting IRS submis-sion.24 To achieve this status quo, the IRS set forth therequirements for correcting document failures, whichoriginally were excluded from the Notice with respectto nonvested NQDC, in the §409A proposed regula-tions.25

The Proposed, Expanded Anti-AbuseRule

Editor’s Note: On January 20, 2017, Presi-dent Trump’s Chief of Staff, Reince Priebus,issued a memo informing department andagency heads that regulations that have beenpublished in the Federal Register but are notyet effective will be postponed 60 days. De-partment and agency heads were instructedto consider proposing for notice and com-ment a rule to delay the effective date forregulations beyond that 60-day period.

The Proposed Regulations expanded the anti-abuserule (used interchangeably hereafter, the ‘‘proposedanti-abuse rule’’ or the ‘‘proposed anti-abuse test’’) bytreating nonvested deferred amounts as vested and im-mediately includible in income under §409A(a) if anyof the three conditions described above applied.26 TheIRS did not specify any of the applicable correctionmethods for purposes of the third prong of the pro-posed anti-abuse test.27 The IRS also did not defineprecisely the scope of the VCP requirements that donot apply to nonvested amounts.28

Generally, NQDC plans subject to §409A may beamended to change the definition of a payment eventor the time or form of payment only by complyingwith the requirements set forth in Treasury regula-tions.29 Failure to comply with §409A would result in

failures with respect to vested deferred amounts).18 See generally §409(e)(5) (authorizing legislative regulations

‘‘disregarding a substantial risk of forfeiture in cases where nec-essary to carry out the purposes of’’ §409A); see Prop. Reg.§1.409A-4(a)(1)(ii)(B), 73 Fed. Reg. 74,380, 74,394 (Dec. 8,2008).

19 Id.20 Id.; 73 Fed. Reg. at 74,382 (Dec. 8, 2008) (‘‘In proposing to

adopt this interpretation of the statute, the Treasury Departmentand the IRS do not intend to create an opportunity for taxpayerswho ignore the requirements of section 409A(a) with respect tononvested amounts to avoid the payment of taxes that would oth-erwise be due as a result of such failure to comply. To ensure thatthis rule does not become a means for taxpayers to disregard therequirements of the statute, the proposed regulations would disre-gard a substantial risk of forfeiture for purposes of determiningthe amount includible in income under section 409A with respectto certain nonvested deferred amounts.’’)

21 See Matthew R. Madara, Questions Raised About ProposedNonqualified Deferred Comp Regs, Tax Notes Today (Sept. 19,2016) at *1 (summarizing a discussion at a Practicing Law Insti-tute conference, quoting Treasury benefits tax counsel Robert Neisas saying, inter alia ‘‘that the focus of section 409A is to preventtaxpayers from shifting the year in which they include amounts inincome’’).

22 REG-123854-12 (preamble to 2016 amendments to proposed

income inclusion regulations).23 Id.24 See Notice 2010-6 §XII.25 Prop. Reg. §1.409A-4(a)(1)(ii)(B); Notice 2010-6.26 REG-123854-12.27 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).28 See REG-123854-12.29 See generally §409A(a)(3)–§409A(a)(4)(C); Reg. §1.409A-

2(b); §1.409A-3(j).



immediate tax and penalties on vested amounts.30

However, nonvested amounts are not includible in in-come under §409A.31

The first prong of the proposed anti-abuse rule isdesigned to preclude circumvention of §409A require-ments by making impermissible amendments whilethe deferrals are nonvested.32 Thus, the first prong ofthe proposed anti-abuse rule permits amendments out-side the regulations with respect to nonvestedamounts only if, absent the change, the plan provisionfails to comply with §409A(a) requirements.33

Not just any change is permitted. The third prongof the proposed anti-abuse rule requires plan sponsorsto follow certain correction rules prescribed in theNotice for plans with vested deferrals.34 The applica-tion of these methods may not be selective and varyfrom plan to plan. Instead, substantially similar docu-ment failures in other NQDC plans of the employermust be corrected in substantially the same manner.35

Even these uniformly applied procedures are limited.The second prong of the proposed anti-abuse rule re-quires vesting if the plan sponsor intentionally allowsthe similar failures under one or more plans with non-vested amounts, yielding tax deferral benefits for par-ticipants.36

To correct the document failures for vestedamounts, the Notice may require inclusion in incomeof a portion of the deferred amount under §409A(a).37

But if the plan sponsor engages in a prohibited patternor practice under the proposed anti-abuse rule, somerequirements under the Notice may ensure the newlyvested amounts do not qualify for VCP relief.38 Thus,the proposed anti-abuse rule may subject nonvestedNQDC of an executive to vesting, inclusion in incomeand the additional tax and interest under §409A(a).39

Executive SummaryService recipients (hereafter, interchangeably ‘‘plan

sponsors’’ or employers’’) may discover from time totime that one or more of the provisions in an NQDCplan results in its failure with respect to one or moreservice providers (hereafter, interchangeably ‘‘em-ployees,’’ ‘‘participants’’ or ‘‘executives’’) to complywith §409A(a) rules. At the time the document failure

is discovered, the plan may provide solely for de-ferred amounts that remain subject to SRF or for acombination of amounts, including some nonvested,some vested and paid and others vested but not yetdistributed to the participant or beneficiary. Followingthe issuance of the proposed regulations, sponsors ofNQDC plans and their advisers must know three im-portant concepts to avoid income inclusion, additionaltax and interest on any nonvested amounts under aplan in the event a document failure is found.

First, a service recipient must know which correc-tion methods are mentioned in the generally appli-cable VCP guidance, and therefore must be applied tothe nonvested deferred amounts. Second, the em-ployer must know which timing and other eligibilityrequirements in the VCP guidance are excluded forcorrecting amendments with respect to nonvestedamounts. Third, the plan sponsor must understand theresulting practical application of one or more of thecorrection methods prescribed under the VCP in ordersuccessfully to correct a document failure with respectto NQDC subject to SRF and therefore outside theoriginal authority of the Notice.

This article gleans the applicable correction re-quirements in Notice 2010-6 for plan document fail-ures to comply with the proposed anti-abuse rule withrespect to nonvested cash deferrals. Stock rights andother equity-based NQDC also are subject to these re-quirements but are outside the scope of this article.For each document failure, in Parts I and II, the articlediscusses the applicable general and specific eligibil-ity requirements, respectively, for correcting amend-ments under the proposed anti-abuse rule. In Part III,the article discusses and compares the technical appli-cation of some of the resulting applicable correctionmethods before and after the issuance of the proposedanti-abuse rule, and outlines some practical compli-ance steps.

I. Applicability of General EligibilityRequirements to Nonvested NQDC

The preamble to proposed regulations (hereafter,the ‘‘Preamble’’) explains that a service recipient mustcorrect a document failure with respect to a nonvestedamount using a correction method or methods if anyprescribed for such failure under generally applicableguidance.40 But the proposed anti-abuse rule says,‘‘the requirements under applicable correction guid-ance with respect to eligibility, income inclusion, ad-ditional taxes, premium interest, and information re-

30 §409A(a)(1)(A)(i).31 §409A(a)(1)(A)(i)(II).32 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(1).33 See id.34 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).35 Id.36 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(2).37 See Notice 2010-6 §I.38 See, e.g., Notice 2010-6 §III(B), (D).39 See §409A(a)(1).

40 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3) (prohibiting correctionof a plan with respect to a nonvested amount that ‘‘is not consis-tent’’ with an applicable correction method if one exists set forthin applicable IRS guidance); REG-123854-12 (explanation in thepreamble of the above rule).


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porting by the service recipient or service provider donot apply.’’41 As the Preamble expounds, a service re-cipient is not required to comply with any VCP re-quirement ‘‘that is unrelated to the method for correct-ing the failure, such as general eligibility require-ments, income inclusion, additional taxes, premiuminterest, or information reporting.’’42

It is unclear whether any requirements under theVCP guidance other than the categories specificallyexcluded in the proposed anti-abuse rule43 do not ap-ply to nonvested amounts due to being unrelated tothe correction method.44 Furthermore, there appears aconflict between the language of the proposed anti-abuse rule and the language of the Preamble. The pro-posed anti-abuse rule states that eligibility require-ments do not apply.45

But the Preamble refers only to ‘‘general’’ eligibil-ity requirements as being unrelated to the correctionmethod and therefore not applicable with respect tononvested amounts.46 Thus, the Preamble suggeststhere may be eligibility requirements under the No-tice, which are not general and which are applicablewith respect to nonvested deferrals by being related tothe correction method.47 Such an interpretation wouldbe necessary to encompass all requirements under theNotice that were related to the particular correctionmethod.

Income inclusion, additional taxes, premium inter-est and information reporting requirements relativelyare self-explanatory as being unrelated to the correc-tion method for a nonvested amount.48 But the Pre-amble does not define the scope of the excluded ‘‘eli-gibility requirements.’’49 The Preamble suggests thatthe service recipient may exclude an eligibility re-quirement if it is ‘‘general’’ and ‘‘unrelated to themethod for correcting the failure’’ with respect to non-vested compensation.50

The general eligibility requirements mentioned inthe Preamble appear to be only a subset of the ‘‘eligi-bility requirements’’ referenced in the proposed anti-abuse rule.51 The Preamble seems to refer to thethreshold requirements set forth in section III of theNotice in order to qualify for relief under sections V

through XI of the Notice.52 Otherwise, the IRS hasnot specified which of the numerous requirements un-der the VCP are with respect to eligibility, whether ornot general, and unrelated to the method for correct-ing the failure.53

Excluded General Eligibility RequirementsThis subsection discusses the requirements under

the Notice, which appear to be general eligibility re-quirements not applicable with respect to nonvestedamounts. First, a service recipient or service providermay not be under examination with respect to NQDCon the date of the plan correction for any taxable yearin which the document failure occurred.54 In addition,the document failure may not be due to the amountdeferred being determined by or the time or form ofpayment being affected by the amount deferred underor a provision of a linked NQDC or qualified plan.55

Also, the VCP relief does not apply to a stock right.56

Each of these criteria appears in section III of theNotice, ‘‘Eligibility Requirements and Effect of Cor-rection.’’57 This section sets forth the conditions ‘‘forthe relief provided in §§V through XI’’ of the No-tice.58 Therefore, each of the requirements describedin section III of the Notice applies generally, irrespec-tively of the specific document failure.59 Accordingly,the above three criteria appear to fit within the mean-ing of a general eligibility requirement for purposes ofthe third prong of the proposed anti-abuse rule. More-over, the regulation does not incorporate expresslyany of these requirements.60 Therefore, these criteriamay be deemed not to apply to nonvested NQDC.

General Eligibility Requirements that ApplyUnder the Notice, the failures being corrected must

be inadvertent and unintentional.61 As another re-quirement, a service recipient must take commerciallyreasonable steps to identify all other NQDC plans thathave a document failure that is substantially similar tothe document failure initially identified and cor-rected.62 This general requirement applies even if theservice provider at issue does not participate in any of

41 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).42 REG-123854-12.43 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).44 See REG-123854-12.45 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).46 REG-123854-12.47 See id.48 See REG-123854-12.49 Id.50 REG-123854-12.51 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).

52 See Notice 2010-6 §III.53 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).54 Notice 2010-6 §III(C).55 Notice 2010-6 §III(G).56 Id.57 Notice 2010-6 §III.58 Notice 2010-6 §III(A).59 See Notice 2010-6 §III.60 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).61 Notice 2010-6 §III(D).62 Id. §III(B).



these other plans.63 Second, the service recipient mustcorrect the substantially similar failure in all suchplans in a manner consistent with the Notice.64 Bothof these general eligibility requirements are reflectedin the proposed anti-abuse rule applicable to non-vested NQDC.65

Thus, the third prong of proposed the anti-abuserule requires that the failure be ‘‘corrected in substan-tially the same manner as a substantially similar fail-ure affecting a nonvested deferred amount under an-other plan sponsored by the service recipient.’’66

Separately, the second prong of the proposed anti-abuse rule prohibits a service recipient from engagingin a pattern or practice of permitting substantiallysimilar failures to comply with §409A(a) under one ormore NQDC plans while the deferrals are non-vested.67 Furthermore, the second prong prohibits thenonvested amounts from being affected by such pat-tern or practice.68

A fact that ‘‘the service recipient has taken com-mercially reasonable measures to identify and correctthe substantially similar failures promptly upon dis-covery’’ indicates absence of such prohibited patternor practice.69 Other factors indicating absence ofabuse are ‘‘whether the failures appear intentional, arenumerous, or repeat one or more similar past failuresthat were previously identified and corrected.’’70

Thus, inadvertent and unintentional failures are a VCPprerequisite with respect to vested amounts. But withrespect to deferrals subject to SRF, this element is apart of a facts-and-circumstances analysis in the pro-posed anti-abuse test, failure of which could result inimmediate vesting and inclusion in income under§409A(a).

II. Applicability of Specific EligibilityRequirements to Nonvested NQDC

Compliance With Specific Eligibility Requirementsfor Nonvested NQDC

In addition to the general eligibility requirementsdescribed in section III of the Notice, timing and othereligibility requirements apply for correcting specificdocument failures with respect to vested deferrals.71

The Notice refers to these criteria as ‘‘the require-

ments of the particular section in §§V through XI ofthis notice providing the correction method and reliefapplicable to the document failure.’’72 Thus, by con-trast to general eligibility requirements, these factorsappear to be related to the particular correctionmethod and therefore applicable to nonvested defer-rals.73

Moreover, under the Notice, a plan has the burdento demonstrate eligibility for relief and that each ofthe requirements have been met.74 But eligibility forVCP relief is not final and is subject to IRS examina-tion.75 In this manner, the IRS retains broad discretionto interpret further the applicability of the eligibilityrequirements under the VCP. The broad administrativeauthority indicates that the eligibility requirementswith respect to nonvested NQDC likewise may besubject to further interpretation by the IRS.

Reporting requirements do not apply to nonvestedamounts, meaning that a significant amount of timecould elapse before a potential IRS review of the in-ternal correction procedures.76 During this period, sig-nificant tax, penalties and interest could accrue in theevent of a future IRS examination and adverse deter-mination with respect to the nonvested deferrals.77

Such a possibility of significant liability in the futurehighlights the importance for plan sponsors to definethe scope and substance of the eligibility requirementsfor correcting document failures with respect to non-vested NQDC.Timing Requirements: Background

The Notice includes various criteria the meeting ofwhich is based on whether or not a certain event oc-curred78 or on whether or not a service recipient, ser-

63 Id.64 Id.65 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(2)–

§1.409A-4(a)(1)(ii)(B)(3).66 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).67 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(2).68 See id.69 Id.70 Id.71 See Notice 2010-6 §III(A).

72 Id.73 See REG-123854-12. Arguably, a narrow reading of the third

prong of the proposed anti-abuse rule may result in none of therequirements in the Notice being applicable other than the specificlanguage that must be included to correct the document failure.However, under the Proposed Regulations, the correction may notbe inconsistent with an applicable correction method in the guid-ance, if it exists. This narrow reading would result in even the de-scriptions of the specific document failures being deemed as inap-plicable requirements (assuming each condition for eligibility forrelief is a ‘‘requirement’’ for relief). In this case, it would be im-possible to connect the document failure with the applicable cor-rection method in the VCP. The application of such a narrow in-terpretation of a VCP requirement being related to the correctionmethod with respect to nonvested amounts is outside the scope ofthis discussion.

74 Notice 2010-6 §III(A).75 Id.76 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).77 See §409A(a)(1).78 See, e.g., Notice 2010-6 §IV(A)(2) (with respect to a plan

that provides for a payment upon a permissible payment event or


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vice provider or other party took a certain action.79

These criteria collectively may be deemed as ‘‘timingrequirements’’ (hereafter, alternatively ‘‘timing crite-ria’’ or ‘‘timing rules’’) based on the plain meaning ofthe term. The IRS did not say whether such timing re-quirements would apply to nonvested amounts.

The Preamble says that a service recipient ‘‘mayamend a noncompliant plan term in a manner permit-ted under applicable correction guidance even thoughthe failure may not have been eligible for correctionunder that guidance (for example, due to applicabletiming requirements).’’80 Thus, the IRS refers to ‘‘ap-plicable timing requirements’’ as examples of eligibil-ity requirements that do not apply under the proposedanti-abuse rule.81

By inference, then, under the Preamble, an appli-cable timing requirement would be an eligibility re-quirement ‘‘unrelated to the method for correcting thefailure,’’ with which a plan sponsor would not have tocomply with respect to a nonvested deferral.82 Butsome timing requirements may be deemed related tothe applicable correction method.83 Also, it is unclearif all timing requirements are exempt ‘‘applicable tim-ing requirements’’ or whether the IRS requires plansponsors to comply with at least certain timing re-quirements for nonvested deferrals.

Separately, the third prong of the proposed anti-abuse rule exempts expressly ‘‘the requirements underapplicable correction guidance with respect to. . . in-

come inclusion.’’84 The IRS has not explained themeaning of an exempted Notice requirement being‘‘with respect to’’ income inclusion.85 Timing require-ments may be deemed to be with respect to incomeinclusion.

Under such an interpretation of the Proposed Regu-lation, a timing requirement with respect to incomeinclusion would not apply for correcting plan docu-ment failures for nonvested NQDC, irrespectively ofwhether or not it is related to the correction method.Due to these apparent inconsistencies, IRS guidancehas not clarified whether plan sponsors may face cer-tain deadlines under the Notice for correcting docu-ment failures with respect to nonvested NQDC.

The Rule for Applicability of Timing Requirementsfor Nonvested NQDC

The analysis in the narrative and Table 1 belowdemonstrates that each specific timing requirement onLine 1 demarcates a deadline for amending a plan toavoid income inclusion resulting from the documentfailure.86 Therefore, these timing requirements in theNotice may be deemed as requirements with respectto income inclusion exempt from compliance for non-vested amounts.87 Construing the rule in this mannerwould eliminate the conflicting treatment of otherwiseexempt ‘‘applicable timing requirements,’’ which nev-ertheless may be related to the correction method andtherefore seemingly applicable under the Preamble.88

Accordingly, these timing requirements do not ap-pear to apply with respect to nonvested amounts un-der the authority of the proposed anti-abuse rule andthe Preamble.89 Rather, as discussed below, there is ageneral rule for amending plans with respect to non-vested amounts some time prior to vesting,90 subjectto compliance with the other elements of the proposedanti-abuse rule, which involves a facts and circum-stances analysis.91

However, as described on Line 2, not all timing re-quirements described in Table 1 below are with re-spect to income inclusion.92 Therefore, employersmust take these timing requirements into accountwhen making a correcting amendment for nonvested

‘‘as soon as reasonably practicable’’ thereafter or contains similarlanguage, providing that generally there is no §409A(a) violationif payment is made timely in accordance with §409A(a) require-ments). See §409A(a)(2) (stating generally that a plan must desig-nate distributions to be made not earlier than a specified event orat a specified time or pursuant to a fixed schedule set forth in theplan at the date of the deferral of the compensation). A paymentmade as soon as practicable may fail to be made in compliancewith these timing requirements. See id. In this case, the paymentalso is an action taken by the service recipient. See n. 79, below.

79 See, e.g., Notice 2010-6 §IV(B)(2) (with respect to correct-ing an ambiguous definition of a permissible payment event, if theparticular provision has been interpreted by the service recipientor by a court with jurisdiction over the plan, the service recipientis not eligible to use the correction method to amend the plan withrespect to vested amounts under the VCP to comply with§409A(a)). The distinctions discussed in this note and n. 78,above, text are devised by the author for the sake of clarity andare not mentioned expressly in the Proposed Regulations or IRSguidance.

80 REG-123854-12.81 See id.82 See REG-123854-12.83 See, e.g., Notice 2010-6 §IV(B)(1) (relief not available after

ambiguous definition of a permissible payment event was inter-preted by the service recipient or a court of competent jurisdic-tion).

84 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).85 See id.86 See n. 123, below.87 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).88 See REG-123854-12.89 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).90 See n. 103, below.91 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(1)–

§1.409A-4(a)(1)(ii)(B)(3).92 See below, Table 1, line 2 (timing requirement applicable

with respect to correcting document failure for nonvested defer-rals but only to determine applicable correction method).



deferrals. In addition, plan sponsors and practitionersmust be aware of the apparent inapplicability of cer-tain deadlines not contingent on and preceding a pay-ment under the plan (‘‘pre-payment’’ or ‘‘pre-distribution’’ timing requirements) for nonvestedNQDC. The pre-payment timing requirements, as wellas deadlines that coincide with a payment event oreven in some instances follow a payment event, eachare designated accordingly in Table 1.93

Thus, the discussion below illustrates that somecorrection deadlines coincide with a distribution andtherefore align with the general rule for amendingplans with respect to nonvested amounts prior to vest-ing.94 Meanwhile, other timing requirements, whichprecede a payment of deferred compensation, are withrespect to income inclusion and therefore are ex-cluded under the third prong of the proposed anti-abuse rule.

The IRS may issue additional guidance clarifyingthat correction deadlines, which precede a paymentand are with respect to income inclusion, do not applyfor nonvested amounts, so long as the other prongs ofthe proposed anti-abuse rule are met. In furtherance ofcompliance with the proposed anti-abuse rule, theanalysis and Table 1 below set forth a roadmap forplan sponsors and their advisers in determining appro-priate timing of correcting amendments with respectto nonvested NQDC.

Types of Timing Requirements Under the Notice

Timing Criteria Requiring Compliance Prior toCorrecting Amendment

The Notice sets forth certain timing requirementsamong the eligibility requirements described in sub-section 1 and certain other timing requirements in thecorrection procedures described in subsection 2 foreach type of document failure.95 Generally, eligibilityfor plan correction is based on the facts and circum-stances prior to the correcting amendment, such as ex-isting plan language.96 These prerequisites for relief,

some of which may include an element of timing,97

identify the factors that must be present with respectto a document failure in order for the correctionmethod to apply. However, if a timing element is pres-ent in the specific eligibility requirement, generally itis an indication that the requirement is with respect toincome inclusion and therefore not applicable for non-vested amounts.Timing Criteria Requiring Compliance AfterCorrecting Amendment

By contrast, some timing requirements in the cor-rection procedures involve subsequent events, such asthe correcting amendment not affecting the operationof the plan within one year following the date of cor-rection.98 Timing requirements that are based onevents after the correcting amendment generallywould trigger inclusion in income, not failure toqualify for correcting relief.99 Nonvested amountsmay not be includible in income under §409A(a).100

Thus, under the VCP, such a post-correction timingrequirement technically would not be relevant or ap-plicable with respect to a nonvested deferral. More-over, a timing requirement dispositive to determiningincome inclusion under the VCP, whether pre- orpost-correction, is ‘‘with respect to income inclusion’’and therefore exempt for nonvested deferrals underthe proposed anti-abuse rule.101 Taking into accountthese distinctions, the discussion below identifies andanalyzes the timing requirements in the Notice andtheir respective applicability to nonvested NQDC.Applicability of Timing Requirements in NoticeSections IV Through IX

The Notice categorizes certain types of documentfailures by the corresponding section, and one or more

93 See discussion below in section III.94 See, e.g., Notice 2010-6 §V(B)(2) (requiring correcting

amendment before an impermissible change in control event oc-curs resulting in an operational failure; aligning to some extentwith the general rule for correcting amendments with respect tononvested amounts, since deferrals would vest upon occurrence ofan event that is a payment event under the pre-correction plan pro-vision, but not if it is a deemed payment event only under §409Aand not under the pre-correction plan provision).

95 See, e.g., Notice 2010-6 §V(A)(1) (eligibility criteria for cor-recting an impermissible definition of separation from service);§V(A)(2) (correction procedures for a plan provision containingan impermissible definition of separation from service).

96 See, e.g., Notice 2010-6 §IV(B)(1) (to qualify for relief, re-quiring definition of a permissible event, such as separation from

service, to be ambiguous but stating the provision must not explic-itly include impermissible payment events or explicitly excludeevents that would be required for the payment event to complywith §409A(a)).

97 See, e.g., Notice 2010-6 §V(A)(2) (to correct impermissibledefinition of separation from service, requiring plan to beamended before an operational failure occurred, meaning eitherno payment was made upon occurrence of a separation from ser-vice within the meaning of the term under §409A regulations or apayment was made upon occurrence of an event that is an imper-missible separation from service under the regulations).

98 See generally Notice 2010-6 §I; see, e.g., Notice 2010-6§V(A)(2), §V(B)(2) (requiring income inclusion if within oneyear of correcting amendment the corrected provision was appliedto avoid a payment or to provide for a payment that would nothave been required under the prior language).

99 Notice 2010-6 §I (general reference to one-year rule); see,e.g., Notice 2010-6 §V(A)(2), §V(B)(2). But, as discussed below,pre-correction timing requirements mostly also are with respect toincome inclusion and therefore not applicable for nonvestedNQDC.

100 See §409A(a)(1)(A)(i).101 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).


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subsections address variations of the overarchingdocument failure. The discussion below analyzes theapplicability of categories of the timing requirementsset forth with respect to each document failure in No-tice sections IV through IX. Individual timing require-ments under the Notice for nonvested amounts arepresented in detail in the accompanying Table 1.

Notice section X is not discussed because it ad-dresses the generally applicable period for correctingamendments following initial adoption of the NQDCplan by a service recipient. Likewise, Notice sectionXI is omitted because it provides transition relief forcompliance with the Notice and thus does not addressany specific document failures.

Correction Before a Payment EventThe Notice requires correcting amendments for

some document failures to be made prior to a paymentor other event upon the occurrence of which the de-ferrals would vest or already would be vested.102 Thediscussion below analyzes whether a deadline for cor-rection that corresponds to a payment or other appli-cable event upon which the amounts would be vestedapplies with respect to nonvested amounts.

Timing Requirement, Which Includes a PaymentDate. On the date a payment is made, compensationno longer would be subject to SRF and thereforewould be outside the reach of §409A.103 A deferredamount also would cease being NQDC subject to§409A following a payment to the executive or ben-eficiary.104 Therefore, following a distribution the de-ferred amounts would be outside the scope of the pro-posed anti-abuse rule applicable to nonvested NQDC.

Thus, correction with respect to NQDC only wouldbe subject to the proposed anti-abuse rule prior to thedate of the earlier of vesting or payment. The Noticeoriginally applied only to vested NQDC, so vestingwithout payment is not an event addressed in the No-tice. Accordingly, document failures with respect tononvested amounts may not be corrected past a dead-line under the Notice that corresponds to a distribu-tion event. Moreover, for income inclusion purposesthe deferred amounts would be deemed vested for thetaxable year of the executive during which the SRF ofthe amounts lapsed.105 Thus, it would be too late un-der the proposed anti-abuse rule to amend the planwith respect to nonvested amounts in the tax year inwhich the deferrals vest. Therefore, any correcting

amendment under the Notice with respect to a non-vested amount would have to be made by the last dayof the taxable year of the employee immediately pre-ceding the taxable year of vesting.106

No Correction Prior to Payment Date if Pattern orPractice of Late Payments (Line 2). There is an ex-ception to the general rule for nonvested deferrals ofcorrecting the failure in the tax year preceding the taxyear in which vesting occurs. This exception appliesto correcting an ambiguous payment period followinga payment event under Notice §IV(A).107 Such a planprovision would permit a distribution outside a short-term deferral period following the payment event, re-sulting in a document failure.108 However, if the ser-vice recipient has a pattern or practice of making im-permissible late payments, the plan and any other planof employer containing similar language would betreated as failing to set a permissible payment date inviolation of §409A(a)(2)(A).109

In that case, an ambiguous payment period wouldbe a document failure that may not be corrected underthe Notice. The making of late payments would not bea pattern or practice of permitting substantially simi-lar failures ‘‘while amounts deferred under the plansare nonvested’’ under the proposed anti-abuse rule.110

However, the employer may use the ambiguous pay-ment period to retain discretion to make the late pay-ment until the date of the payment event set forth inthe plan. At the same time, the employee would beable defer the tax event until the end of the permis-sible payment period.

This arrangement, instead of late payments, couldbe viewed under the proposed anti-abuse rule as aprohibited pattern or practice while the amounts re-main nonvested. In this circumstance, the impermis-sible payment period provision would trigger §409Atax and penalties under the proposed anti-abuse rule.Thus, the ambiguous payment period would neitheravoid document failure status nor be correctible underthe Notice prior to the date of the payment event withrespect to any nonvested deferrals.111

Correction Before an Operational FailureThe occurrence of a payment or other event with

respect to amounts vested upon the occurrence of the

102 See §409A(d)(4) (general definition of substantial risk offorfeiture for purposes of §409A, the lapse of which with respectto deferred amounts also generally is ‘‘vesting’’).

103 See §409A(d)(4) (defining generally a substantial risk offorfeiture).

104 See Reg. §1.409A-1(b)(4).105 See §409A(a)(1)(A)(i); Reg. §1.409A-1(d)(1).

106 See §409A(a)(1)(A)(i).107 Notice 2010-6 §IV(A)(2).108 Reg. §1.409A-1(b)(4)(i), §1.409A-3(b).109 Notice 2010-6 §IV(A)(2).110 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(2). This scenario reflects

the pattern discussed at n. 127, below, where in general, timingrequirements are not applicable for nonvested NQDC but non-compliance with other elements of the proposed anti-abuse rulewould result in vesting and tax sanctions for the deferred amounts.

111 See Reg. §1.409A-1(b)(4)(i).



event may result in the failure of the plan to complywith the operational requirements under §409A(a).112

Vested amounts that are not correctible would have tobe included in income in the tax year of the employeein which the failure occurs.113 Generally, an opera-tional failure would remove the vested NQDC fromthe scope of the Notice and would require the servicerecipient to seek relief under Notice 2008-113.114

The IRS has not defined an operational failure tocomply with §409A. Notice 2008-113 states merelythat it applies to ‘‘certain failures of a nonqualified de-ferred compensation plan to comply with §409A(a) inoperation (an operational failure).’’115 Notice 2008-113 addresses in general only failures to pay deferredcompensation that ‘‘otherwise would have beenpaid’’116 or erroneous payments of compensation thatshould have been deferred until a later date.117

Neither of these situations would apply to non-vested amounts. An executive would have a legallybinding right to nonvested NQDC.118 However, if theNQDC is subject to SRF, the deferrals are not payableor may not be paid or included in income until theSRF lapsed.119

Thus, operational failures described in Notice2008-113 may not occur with respect to nonvestedamounts. Therefore, under the Notice, the occurrenceof an operational failure is not a timing requirementthat would be relevant to nonvested NQDC. Instead, acorrecting amendment must be made with respect toNQDC under the Notice in the tax year preceding thetax year of the executive in which the compensationvests or is paid.120 In turn, upon vesting or payment,there may or may not be an operational failure tocomply with §409A.

Correction Before Certain Events Not Resulting inPayment

The timing requirement under the Notice for somecorrecting amendments may be an event that wouldnot trigger payment of a nonvested deferral. The cor-rection deadline also may not result in an operationalfailure that would remove the amount from the scopeof the Notice.121 Generally, the purpose of timing re-quirements for correcting amendments in the Notice isto signify avoidance of inclusion of a certain amountof vested NQDC in income in connection with thedocument failure.122 Nonvested amounts are not in-cludible in income under §409A. Thus, under the No-tice, there would not be any economic consequencesfor amending a plan with respect to nonvested NQDClater than such pre-distribution deadlines.

Also, these pre-distribution timing rules may bedeemed requirements with respect to income inclu-sion exempt under the proposed anti-abuse rule fornonvested NQDC.123 For example, a noncompliantplan may provide for a permissible and an impermis-sible payment event. In this case, the plan sponsormust amend the plan with respect to vested NQDCbefore the election to defer the amount until the im-permissible payment event becomes irrevocable.124 Ifthe employer fails to remove the impermissible pay-ment event before this deadline, the service providermay have to pay tax and penalties on 50 percent ofthe deferrals under the one-year rule discussed be-low.125 Thus, amending the plan before the impermis-sible election becomes irrevocable would avoid thepotential income inclusion. Accordingly, this timingrequirement is with respect to income inclusion andnot applicable for nonvested NQDC.126

For these reasons, a plan sponsor would not need tocomply specifically with these pre-payment timing re-quirements for correcting amendments with respect to

112 See generally §409A(a)(1)(A)(i)(II) (referring to a plan that‘‘is not operated in accordance with’’ the requirements under§409A(a)(2), §409A(a)(3) or §409A(a)(4)).

113 §409A(a)(1)(A)(i).114 Notice 2008-113, 2008-51 I.R.B. 1305; see, e.g., Notice

2010-6 §V(A)(2) (correction required before a payment event un-der the plan or a separation from service event under §409A thatwould result in an operational failure).

115 Notice 2008-113 §I.116 See, e.g., Notice 2008-113 §IV(C)(2).117 See, e.g., Notice 2008-113 §IV(A)(2), - (B)(2).118 See Reg. §1.409A-1(b)(1) (plan treated as providing for a

deferral of compensation generally if, under the terms of the planand the relevant facts and circumstances, the service provider hasa legally binding (or, in other words, contractual) right during ataxable year to compensation that, pursuant to the terms of theplan, is or may be payable to or on behalf of the service providerin a later taxable year).

119 See §409A(a)(1)(A)(i) (amounts includible in gross incometo the extent not subject to a substantial risk of forfeiture if, inpart, plan not operated in accordance with §409A(a)).

120 See n. 103, above.

121 See Notice 2010-6 §IX(2) (correction before end of taxableyear of service provider immediately following the tax year inwhich a timely initial deferral election must be made); §VII(D)(2)(correction if the discretion to change the time or form of paymentis not exercised or is exercised and then revoked more than a yearbefore the payment event); §VII(A)(2) (correction before electionto defer an amount with respect to an impermissible paymentevent becomes irrevocable or the impermissible payment eventprovision otherwise applies). Also, as discussed below, with re-spect to nonvested amounts, by definition there may not be an op-erational failure.

122 See, e.g., Notice 2010-6 §V(A)(2) (correcting amendmentbefore operational failure). But see Notice 2010-6 §IV(B)(2) (pur-pose of timing requirement to determine appropriate correctionmethod).

123 See id.124 See Notice 2010-6 §VII(A)(2); text below in Table 1, line

1(j).125 See n. 135, below.126 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).


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nonvested deferrals. Instead, the general rule for cor-recting amendments made in the tax year prior to theyear of vesting would continue to apply.127 However,facts and circumstances surrounding the correctingamendment may form the basis for a violation ofsome other elements of the proposed anti-abuse rule.

Under the Notice, the employer must take commer-cially reasonable steps to identify and correct the sub-stantially similar provisions in other plans of the em-ployer, whether or not an impermissible election hadbeen made under those plans.128 This general eligibil-ity requirement does not apply directly with respect toa nonvested amount. However, the second and thirdprongs of the proposed anti-abuse rule incorporate thegeneral eligibility requirement applicable in these cir-cumstances.129

Under the second prong of the proposed anti-abuserule, the presence of a prohibited pattern or practiceof permitting substantially similar failures under§409A while the amounts are nonvested and which af-fect the deferred amounts would result in vesting ofthe NQDC.130 Intent is a factor in finding a prohibitedpattern or practice under the second prong.131 Also,under the third prong, the service recipient must cor-rect substantially similar failures in substantially thesame manner.132 Failure to meet these requirementsunder the proposed anti-abuse rule would result investing of the deferred amounts and consequent in-come inclusion and additional taxes under §409A(a)if there is no relief under the VCP. Consistently, ifvesting is triggered, timing requirements under theVCP for correction of document failures would be-come applicable to the deferred amounts.

One-Year Rule and Amendment Effective ImmediatelyRequirement

For certain document failures under the Notice, thecorrecting amendment must be effective immedi-

ately.133 This timing requirement commonly is ac-companied by a variation of an income inclusion ruleas follows.134 Generally, inclusion in income is re-quired if, within one year of correction a certain eventoccurs that results in avoiding a payment or requiringa payment that would or would not have been due, re-spectively, under the pre-correction provision.135 Inthat case, a percentage of the total deferred amountsubject to the corrected provision is includible in in-come under §409A.136

A primary purpose of the amendment being effec-tive immediately is to trigger the one-year time periodduring which the event may occur.137 In addition, anamendment may be required to be effective immedi-ately in order to ensure that the correction is made be-fore an operational failure occurs requiring the servicerecipient to seek relief under Notice 2008-113, whichlikewise may require inclusion in income.138 How-ever, nonvested amounts are not includible in incomeunder §409A due to document failures.

Accordingly, the one-year rule does not apply tononvested deferrals.139 Likewise, the requirement foran amendment with respect to nonvested deferrals tobe effective immediately does not apply. Rather, as ageneral rule, nonvested amounts must be corrected bythe end of the tax year immediately preceding the taxyear of the executive, in which the deferrals vest.140

Incorporating the applicability rules derived in thissection for the various categories of timing require-ments, the Table below summarizes the applicabilityof each individual timing requirement to nonvestedamounts.

127 See n. 103, above.128 See Notice 2010-6 §III(B).129 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(2)–

§1.409A-4(a)(1)(ii)(B)(3).130 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(2).131 See id.132 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3).

133 See Notice 2010-6 §V(A)(2), §V(B)(2), §V(C)(2),§VII(A)(2), §VII(C)(2), §VII(D)(2), §VII(F)(2), §VIII(2).

134 See Notice 2010-6 §V(A)(2), §V(B)(2), §V(C)(2),§VII(A)(2), §VII(C)(2), §VII(D)(2), §VII(F)(2), §VIII(2).

135 See, e.g., Notice 2010-6 §V(A)(2).136 See id.137 See, e.g., Notice 2010-6 §V(B)(2).138 See generally Notice 2008-113; Notice 2010-6 §V(B)(2).139 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3) (income inclusion

requirements not applicable to nonvested amounts); n. 100, above.140 See n. 103, above.



Table 1. Timing Requirements for Correcting Plans with Respect to Nonvested NQDC

Line no./§ ofthe Notice

DocumentFailure

Timing Requirement forCorrection

Applicability to CorrectingAmendments With Respect toNonvested Amounts

1.aIV(A)(2)Timing requirement (inother words, the deadlinefor the correcting amend-ment; hereinafter ‘‘timingrequirement’’) followspayment event.

Plan provision providesfor a payment to bemade ‘‘as soon as prac-ticable’’ after a paymentevent, or similar lan-guage.

Correcting payment must bemade before expiration ofpermissible payment period(including exceptions)141 thatfollowed the payment event.

• Correcting amendment may notbe made on or after the date ofpayment because on or after thepayment date the amounts nolonger would be nonvested.

• Correcting amendment is notrequired to avoid §409A(a) taxand penalties if payment is madetimely.

• General Rule applies to removeimpermissible payment period.

1.bIV(B)(2)Timing requirement fol-lows vesting and/or a pay-ment event.

Ambiguous Definitionor No Definition of aPermissible PaymentEvent

Before the end of the taxableyear of the service providerduring which the operationalfailure (payment or failure topay which does not complywith §409A) is corrected un-der Notice 2008-113.

• Correcting amendment may notbe made on or after the date ofpayment because on or after thepayment date the amounts nolonger would be nonvested.

• In this case, the payment or afailure to pay is treated as anoperational failure eligible forrelief under Notice 2008-113, butsuch failure would not be rel-evant to a nonvested amount.Thus, the deadline for making acorrecting amendment before theend of the taxable year in whichthe operational failure is cor-rected is not applicable to non-vested amounts.

• A correcting amendment may bemade after the date a plan failsto make a payment required tobe paid to comply with §409A,if a vesting or payment event didnot occur. For example, a pay-ment was not made because theambiguous payment event defini-tion was interpreted not to re-quire a payment or there was analternative payment event underthe plan.

• General Rule applies for correct-ing an ambiguous payment eventdefinition.

141 See, e.g., §1.409A-3(d); §1.409A-3(b) (90-day period or certain number of years after payment events permissible time frames fordistributions).


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DocumentFailure



1.cV(A)(2)Timing requirement coin-cides with payment event.

Impermissible Defini-tion of Separation fromService

Before occurrence of paymentevent that is not a separationfrom service under §409A.

• Correcting amendment must bemade before a payment eventupon the occurrence of whichthe amounts would be vested.

• Likewise, document failure mustbe corrected prior to the occur-rence of a payment event, whichwould constitute an operationalfailure. See Line 1(b) above.

• General Rule applies for correct-ing impermissible definition ofseparation from service.

1.dV(A)(2)Timing requirement pre-cedes a payment under theplan.

Impermissible Defini-tion of Separation fromService

Before occurrence of an eventthat is a §409A separationfrom service but is not a pay-ment event under the pre-correction provision.

• Deferrals may remain nonvestedafter a §409A separation fromservice occurs that is not a pay-ment event under the plan ifthere is an alternative paymentevent that has not occurred yet.Thus, correcting amendment maybe made after a separation fromservice under §409A that is not apayment event under the pre-correction plan.

• But other prongs of the proposedanti-abuse rule may cause vest-ing, inclusion in income and ad-ditional tax in the event of non-compliance.

• General Rule applies for correct-ing an impermissible definitionof a separation from service.

1.eV(B)(2)Timing requirement coin-cides with a paymentevent.

Impermissible Defini-tion of a Change inControl Event

Before a payment event thatis not a change in controlevent under §409A142 occurs.

• Amounts would be vested upona payment event under the planthat is not a change in controlevent under §409A.

• Therefore, such vested amountsno longer would be subject tothe proposed anti-abuse rule,provided there is no subsequent,alternative payment event.

• Also, the payment event mayconstitute an operational failurenot subject to relief under theNotice.

• Accordingly, a correcting amend-ment under the Notice must bemade before such paymentevent.

• General Rule applies for correct-ing the impermissible change incontrol event definition.

142 See Reg. §1.409A-3(a)(5).




DocumentFailure



1.fV(C)(2)Timing requirement coin-cides with a paymentevent.

Impermissible Defini-tion of Disability

Before a payment event oc-curs that is not a disabilityunder §409A.

• Amounts would be vested uponthe occurrence of the impermis-sible payment event (whichwould be an operational failure)and therefore not subject to theproposed anti-abuse rule.

• Therefore, correcting amendmentmust be made before the pay-ment event, assuming there is nosubsequent, alternative paymentevent under the pre-correctionplan.

• General Rule applies for correct-ing the impermissible definitionof disability.

1.gVI(A)(2)Timing requirement coin-cides with a paymentevent.

Payment Period Follow-ing a Payment EventLonger Than 90 Daysand Not Within theSame Taxable Year143

Before the occurrence of thepermissible payment event.

• Amounts would be vested uponthe occurrence of the permissiblepayment event.

• Therefore, correcting amendmentmust be made before the pay-ment event.

• General Rule applies for correct-ing the impermissible paymentperiod.

1.hVI(A)(2)Timing requirement fol-lows a payment event.

Payment Period Follow-ing a Payment EventLonger Than 90 Daysand Not Within theSame Taxable Year

Within a reasonable time fol-lowing the permissible pay-ment event.

• Amounts would be vested fol-lowing the permissible paymentevent.

• Therefore, correcting amendmentmay not be made following thepermissible payment event.

1.iVI(B)(2)Timing requirement coin-cides with a paymentevent.

Payment Period Follow-ing a Payment EventDependent on Discre-tionary Action of Ser-vice Provider, Such asExecuting a Release ofClaims

Before the occurrence of thepermissible payment event.

• Amounts would be vested uponthe occurrence of the permissiblepayment event.

• Therefore, correcting amendmentmust be made before the permis-sible payment event. (Also, fail-ure to pay timely would be anoperational failure outside thescope of the Notice.)

• General Rule applies for remov-ing the impermissible discretion.

143 See Reg. §1.409A-3(b).


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DocumentFailure



1.jVII(A)(2)Timing requirement pre-cedes a payment eventunder the plan.

Plan Providing for aPermissible and an Im-permissible PaymentEvent

Before a deferral election bythe service provider with re-spect to an impermissible pay-ment event or before the im-permissible payment eventprovision otherwise becomesapplicable to the deferrals ofthe service provider.

• The election of an impermissiblepayment event or the impermis-sible payment event provisionotherwise applying does not re-sult in vesting, payment or anoperational failure. An impermis-sible deferral election is a docu-ment failure.144

• Therefore, the correcting amend-ment may be made to removethe impermissible payment eventeven after the election has beenmade irrevocably145 or the im-permissible payment event provi-sion otherwise applies to the de-ferrals of the service provider,but before the amounts vested.

• But other prongs of the proposedanti-abuse rule may cause vest-ing, inclusion in income and ad-ditional tax in the event of non-compliance.146

• In addition, the General Ruleapplies for correcting an imper-missible payment event.

1.kVII(A)(2)Timing requirement coin-cides with a paymentevent.

Plan Providing for aPermissible and an Im-permissible PaymentEvent

Before the date any of theimpermissible payment eventsoccur.

• An impermissible payment eventwould result in an operationalfailure for which the Notice doesnot provide relief.

• Also, the amounts would bevested upon the occurrence of animpermissible payment event.

• Therefore, correcting amendmentunder the Notice must be madebefore the impermissible pay-ment event.

• General Rule applies for correct-ing an impermissible paymentevent.

1.lVII(B)(2)Timing requirement coin-cides with a paymentevent.

Plan Providing for Onlyan Impermissible Pay-ment Event

Before the impermissible pay-ment event occurs.

• See Line 1.k above (GeneralRule applies).

144 See §409A(a)(4)(B).145 See Reg. §1.409A-2(a)(1) (addressing an election becoming irrevocable as resulting in a contractual commitment to defer the com-

pensation); §1.409A-2(a)(2) (discretion being exercised by service recipient with respect to service provider election to defer indicatingthe election being revocable).

146 See Notice 2010-6 §III(B), §VII(A)(2).




DocumentFailure



1.mVII(C)(2)Timing requirement coin-cides with a paymentevent.

Impermissible Alterna-tive Payment Schedule

Before a separation from ser-vice or other applicable pay-ment event occurs.

• The amounts would be vestedupon the occurrence of a pay-ment event.

• Therefore, correcting amendmentunder the Notice must be madebefore the payment event.

• General rule applies for correct-ing the impermissible toggle.

1.nVII(D)(2)Timing requirement pre-cedes a payment eventunder the plan.

Impermissible Discre-tion with Respect to aPayment Schedule Fol-lowing a PermissiblePayment Event (Includ-ing Subsequent DeferralElections)

• Before service recipient orservice provider exercisediscretion to change thetime or form of payment;or,

• If the discretion is revokedmore than one year beforethe payment event occurs.

• There is no document failure,and therefore, no correctingamendment is required if thediscretion is not exercised or isrevoked more than one yearprior to the payment event if theplan provision includes a defaulttime or form of payment, discre-tion to change the time or formof payment is not exercised, andthere is no discretion under theplan to change the time or formof payment after the paymentevent occurred.

• If the discretion is revoked oneyear or less before the paymentevent, a document failure wouldoccur. But the document failurewould not result in vesting orpayment of nonvested amounts,and would not be an operationalfailure outside the scope of theNotice.

• Thus, correcting amendment maybe made if the discretion tochange the time or form of pay-ment was exercised and revokeda year or less before the paymentevent.



1.oVII(D)(2)Timing requirement coin-cides with a paymentevent.

Impermissible Discre-tion with Respect to aPayment Schedule Fol-lowing a PermissiblePayment Event (Includ-ing Subsequent DeferralElections)

Before payment event occurs. • Amounts would be vested uponthe occurrence of the paymentevent.




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DocumentFailure



1.pVII(E)(2)Timing requirement pre-cedes a payment eventunder the plan.

Impermissible ServiceRecipient Discretion toAccelerate PaymentEvent

Before earlier of:

• Service recipient irrevocablyexercises discretion to ac-celerate a payment; or,

• A payment is made pursuantto service recipient discre-tion.

• Irrevocable exercise of servicerecipient discretion to acceleratea payment under the plan is adocument failure. Irrevocableexercise of discretion does notresult in vesting, payment or anoperational failure outside thescope of the Notice.

• Thus, correcting amendment toremove impermissible discretionto accelerate a payment or tomake the acceleration permis-sible may be made after the irre-vocable exercises of discretion toaccelerate a payment.


• Amounts would be vested uponthe occurrence of the impermis-sibly accelerated payment eventand such payment event wouldconstitute an operational failureoutside the scope of the Notice.


1.qVII(F)(2)Timing requirement coin-cides with a paymentevent.

Impermissible Reim-bursement or In-KindBenefit Provisions

Before an event occurs thatwould result in eligibility ofservice provider for benefits.

• Under Example 16 in Notice§VII(G), an event that wouldresult in eligibility of serviceprovider to receive the benefitswould be a payment event.147

• Correcting amendment under theNotice must be made before apayment or a vesting event.

• General Rule applies for correct-ing the impermissible plan provi-sions.

• If the event resulting in eligibil-ity is a vesting event, then thedeferrals may not remain non-vested after the eligibility eventoccurs and therefore, a correct-ing amendment with respect tononvested deferrals must precedethe event resulting in eligibilityfor benefits and General Ruleapplies for correcting the imper-missible plan provisions.

147 Notice 2010-6 §VII(G), Ex. 16.




DocumentFailure



1.rVIII(2)Timing requirement coin-cides with a paymentevent.

Failure to Include Six-Month Delay of Pay-ment for Specified Em-ployee

Before separation from ser-vice or if earlier death ofspecified employee.

• Amounts would be vested uponthe occurrence of a paymentevent such as separation fromservice.


• General Rule applies for correct-ing the failure to include the six-month delay.

1.sIX(2)Timing requirement pre-cedes a payment eventunder the plan.

Impermissible InitialElection to Defer Com-pensation (Not Electionas to Time or Form ofPayment Eligible forCorrection UnderVII(D))

Before the end of the taxableyear of the service providerimmediately following thetaxable year during which theinitial deferral election musthave been made.

• If amounts do not vest before theend of the taxable year of theservice provider immediatelyfollowing the tax year duringwhich a timely initial deferralelection was due, the correctingamendment may be after the ex-piration of that period.


• General Rule applies for correct-ing the impermissible initialelection to defer.

2. IV(B)(2)Timing requirement is notwith respect to incomeinclusion.

Permissible PaymentEvent with No Defini-tion or AmbiguousDefinition

• Before service recipient in-terprets the ambiguous pro-vision setting forth the pay-ment event so as to giverise to a pattern or practiceof interpreting the term in away that does not complywith §409A; or,

• Before a court of competentjurisdiction interprets suchcontractual provision,

• Either in the plan or in anyother plan of service recipi-ent with substantially simi-lar language.

• Before interpretation that createsa pattern or practice: Notice§IV(B)(2) would apply but sim-ply to determine the applicablecorrection method.

• The second prong of the anti-abuse rule prohibiting a patternor practice of permitting substan-tially similar failures with re-spect to nonvested amounts,which affect the nonvestedamounts may apply and wouldresult in vesting.

• Before interpretation by a court:would apply but simply for thepurpose of determining appli-cable correction method (if pay-ment event definition is not am-biguous, Notice §V may providerelief).

III. Practical Application of Correction Methodsin Notice to Nonvested NQDC

Under the proposed anti-abuse rule, the applicablecorrection methods in the Notice govern how plansponsors may correct document failures with respectto nonvested amounts. Generally, the Notice providesrelief for document failures concerning definitions ortiming of payment events or changes to time or formof payment. As an exception, document errors, which

may result in failure to comply with §409A(a) due tothe definition of a substantial risk of forfeiture wouldbe outside the scope of the Notice. The reason is thatthe Notice originally applied only to vested NQDC.

The discussion below compares the manner inwhich some common document failures could be cor-rected with respect to nonvested amounts before andafter issuance of the proposed anti-abuse rule. Theprior anti-abuse rule did not specify the restrictions


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contained in the Notice on correction methods fordocument failures. Thus, employers were not obli-gated expressly under IRS guidance to employ a par-ticular correction method subject to these restrictions.

But correction methods outside the Notice alsowere not sanctioned expressly with respect to non-vested deferrals. Thus, the discussion below refers tocorrection procedures that were not verified for com-pliance with §409A as attempts by the service recipi-ent to correct a particular document failure.

The discussion in section II of the article demon-strated the significance of the facts and circumstancessurrounding the timing of correction of a documentfailure, especially where a pre-distribution timing re-quirement does not apply. Applying a prescribed cor-rection method for nonvested NQDC likewise in-volves an analysis of the facts and circumstances at-tendant to the plan document failure in order tocomply with the proposed anti-abuse rule.

Definition of a Payment Event

Ambiguous Definition of Certain PermissiblePayment Events

Prior Timing of Correction. Previously, there wasno applicable timing requirement in IRS guidanceother than the former anti-abuse rule for correcting anambiguous definition of a payment event. Thus, anemployer could attempt to amend an ambiguous term,such as the definition of a separation from service, af-ter having applied the term in violation of §409A toother distributions from the plan or similarly draftedplans.148

Timing of Correction Under the Proposed Anti-Abuse Rule. By contrast, under the Notice, a patternor practice of interpreting the definition of a paymentevent in violation of §409A precludes the service re-cipient from using the correction method for an am-biguous payment event definition.149 Moreover, underthe Notice the service recipient may not have used theambiguous term intentionally in the plan or in anyother plan with substantially similar language.150

Prior Correction Method. Prior to the issuance ofthe proposed anti-abuse rule, a service recipient couldattempt to add or delete a payment event to conformthe definition of the payment to §409A requirements.The service recipient could argue the change was jus-tified based on the relevant facts and circumstances151

that gave rise to the drafting ambiguity. Likewise, the

service provider could say that, based on the relevantfacts and circumstances, the addition or deletion of apayment event would resolve an inconsistency of thedefinition with other provisions in the plan. For in-stance, those provisions might indicate that the partiesintended the additional payment event to apply or anexisting payment event under the plan to be inappli-cable.

Correction Method Under the Proposed Anti-AbuseRule. Under the Notice, the employer simply couldadd a qualifier that the definition is intended to be in-terpreted as necessary to comply with §409A.152 Al-ternatively, the employer could set forth a new defini-tion of the payment event under the plan.153 But theemployer may not expand or narrow the definition toexclude an existing payment event or include a newpayment event not previously set forth in the plan.154

In addition, to be eligible for relief, the plan sponsormay not have intentionally used an ambiguous termfor a payment event.155 Finally, the plan sponsor or acourt of competent jurisdiction may not have inter-preted previously the ambiguous definition with re-spect to the plan participant or the NQDC plans ofother employees.156

The Notice says explicitly that only those alterna-tive payment event designations that were ‘‘timelymade and explicitly provided’’ in the plan would betaken into account.157 Therefore, by contrast to previ-ous potential correction methods, relevant facts andcircumstances without adequate plan language may beinsufficient to support an added or deleted paymentevent in the plan definition. However, the Notice doesnot appear to preclude the payment event under thecorrected provision from varying from but being inthe same category of a distribution event under§409A(a)(2)(A) as the pre-correction paymentevent.158

For example, a poorly drafted plan may have setforth an unintentionally ambiguous definition of aseparation from service. The plan sponsor and partici-pant may seek to amend the definition to comply with§409A159 by specifying a different separation fromservice event upon which a distribution would occur.In this situation, the ‘‘addition or deletion’’ prohibi-tion under the Notice should not apply to precludesuch a correcting amendment, as opposed to anamendment that, for example, would replace a separa-

148 See Notice 2010-6 §IV(B)(1).149 Id.150 Notice 2010-6 §IV(B)(2).151 See Reg. §1.409A-1(b)(1) (existence of deferral determined

based upon plan language and the relevant facts and circum-stances).

152 Id.153 Id.154 Notice 2010-6 §IV(B)(2).155 Id.156 Notice 2010-6 §IV(B)(1).157 Notice 2010-6 §IV(B)(2).158 §409A(a)(2)(A).159 See §409A(a)(2)(A)(i).



tion of service with a specified date of distribution asa payment event.160 The reason is that, under the firstprong of the proposed anti-abuse rule, an amendmentoutside the §409A regulations may be made so longas it is necessary to bring the plan into §409A compli-ance.161

The first prong of the proposed anti-abuse rule doesnot state expressly that only certain types of amend-ments are permitted in particular circumstances.162

Thus, the first prong does not expressly prohibit anamendment that creates a different type of a distribu-tion event, so long as change would make the pay-ment event permissible under §409A. On the otherhand, changing the type of a payment event may beviewed as making an amendment that is not ‘‘neces-sary to bring the plan into compliance’’ with§409A.163 Moreover, if the parties amended the planin this manner with respect to only some participants,the change may violate the second and third prongs ofthe proposed anti-abuse rule.164

In sum, it is unclear under the Proposed Regula-tions how the correction method for an ambiguous orundefined permissible payment event under the No-tice would apply for nonvested NQDC. But underboth the Notice and the proposed anti-abuse rule, factsand circumstances play a key role in applying the pre-scribed correction method for noncompliant defini-tions of payment events with respect to nonvested de-ferrals. Therefore, plan sponsors and executivesshould be cautious in tailoring the correcting amend-ment as closely as possible to the pre-correction planlanguage. In furtherance of this objective, it wouldseem advisable to specify a payment event under theamended provision that is of the same type under§409A as the pre-correction distribution event.

Possible Safe Harbor for Amending AmbiguousDefinitions of Certain Payment Events. Such a fact-intensive application of the proposed anti-abuse ruleto correcting ambiguous or undefined permissiblepayment events may force the parties to renegotiatecompensation arrangements, potentially increasing thecost of NQDC awards. As an economic burden passedto the shareholders, these restrictions may not be ap-propriate for compensation before the executive actu-ally has earned the award. In these instances, there isno guaranteed payment of compensation and thereforeless potential for abuse.

To ease these apparent compliance burdens with re-spect to nonvested deferrals, the IRS may issue addi-

tional guidance establishing a safe harbor for this typeof a correcting amendment. The rule may clarify thatan amended payment event that is in the same cat-egory under §409A as the ambiguously defined pay-ment event in the pre-correction plan would complywith the proposed anti-abuse rule.

The safe harbor also may clarify that, in this case,the parties would not need to establish the original in-tent with respect to such amended, similar paymentevent. Likewise, the safe harbor may clarify that theamended, similar payment event was not required tohave been referenced under pre-correction terms ofthe ambiguously drafted plan document. Such an ex-ception would eliminate additional compliance costsin situations preceding vesting of the compensation,where the plan language is ambiguous and the plansponsor has not yet interpreted the ambiguous provi-sion with respect to the employee or other partici-pants.

Some Practical Steps for Employers in CorrectingPayment Event Definitions. Until any conclusive guid-ance in this regard is issued, it would be significantfor employers correcting an ambiguous or undefinedpayment event internally to memorialize the scriven-er’s or other type of good faith error, once discovered.For this purpose, plan sponsors may find helpful to re-tain on file any draft copies of the plan document andrelated correspondence or other writing. Plan sponsorsalso must ensure that any internal correcting amend-ments of payment event definitions are uniform acrossall NQDC contracts with the same executive or otheremployees, which contain substantially similar lan-guage.

In addition, employers must confirm that prior tocorrecting the document failure, the service recipienthad not interpreted the similarly ambiguous or unde-fined payment provision with respect to NQDC of thesame employee under another plan or of other em-ployees in a manner that would be inconsistent withthe contemplated correcting amendment. Employersalso would find it important to correct any discovereddocument failures across all noncompliant plans assoon as reasonably possible. These steps would assistin demonstrating lack of intent of the plan sponsor toavoid §409A in amending the distribution provisionand compliance with other requirements for suchamendments under the Notice and the proposed anti-abuse rule.

Patently Impermissible Definition of PermissiblePayment Events

Prior Timing of Correction. Before the proposedanti-abuse rule, impermissible definitions of certainotherwise permissible payment events including aseparation from service, a change in control or a dis-ability had to be amended prior to vesting of the

160 See §409A(a)(2)(A)(iv).161 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(1).162 See id.163 See REG-123854-12.164 Prop. Reg. §1.409A-4(a)(1)(ii)(B)(1)–

§1.409A-4(a)(1)(ii)(B)(2).


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amounts to avoid having to comply with VCP require-ments.

Timing of Correction Under the Proposed Anti-Abuse Rule. If the payment event definition were notdeemed ambiguous or absent from the plan documentunder the Notice, impermissible definitions of a sepa-ration from service, a change in control or a disabilityeach would have to be corrected prior to the earlier ofvesting or payment under the proposed anti-abuserule.165

Prior Correction Method. Similarly to ambiguousor unstated definitions of a separation from service, anemployer could take into account relevant facts andcircumstances to determine a permissible definition ofa separation from service consistent with the intent ofthe parties. Likewise, with respect to correcting animpermissible definition of a change in control, theparties were not restrained expressly from specifyinga payment event under the amended plan based on therelevant facts and circumstances of the agreement.Similarly, if a definition of a disability did not con-form to §409A(a)(2)(A)(ii) requirements, the servicerecipient could amend the definition to comply with§409A.

Correction Method Under the Proposed Anti-AbuseRule. The employer and executive have some leewayin deleting a disability as a payment event or amend-ing it to comply with §409A under the proposed anti-abuse rule before a payment event occurs.166 By com-parison, the proposed anti-abuse rule imposed morerestrictions on permissible correcting amendments fora definition of a separation from service or a changein control.167 Similarly to an ambiguous definition ofa separation from service, an employer may notamend the definition under the plan to add or delete apayment event.168

Likewise, to amend the definition of a change incontrol169 to comply with §409A(a)(2)(A)(v), a ser-vice recipient may not cause an event that was not apayment event under the original terms of the plan tobecome a payment event under the plan.170 Thus,similarly to correcting ambiguous definitions of other-wise permissible payment events, the employer andexecutive may not rely solely on relevant facts andcircumstances to establish a compliant definition ofthe payment event consistent with their original in-tent.

For an impermissible as opposed to ambiguous orunstated definition, the employer does not have todemonstrate under the Notice that the deficient planprovision was unintentional. Also, a plan sponsor doesnot have to show that an impermissible separationfrom service definition was not interpreted on prioroccasions in a Section 409A noncompliant manner,but such a rule inherently would not be relevant to afacially impermissible provision. Thus, if the NQDCplan provides for a clearly impermissible as opposedto an ambiguous or omitted definition of a separationfrom service, the Notice does not require a showingof intent.

But, as stated above, intent of parties with respectto the plan document failure is a factor in determiningcompliance with the second prong of the proposedanti-abuse rule.171 Thus, practical steps other thanprior interpretation of the noncompliant plan term out-lined above would be useful for correcting impermis-sible definitions of a separation from service or achange in control.

Possible Safe Harbor for Amending ImpermissibleDefinitions of Payment Events. To ease the adminis-trative and economic burden on plan sponsors andparticipants, the IRS similarly may clarify in a safeharbor the application of the addition or deletion therule for correcting an impermissible definition of apermissible payment event.

Thus, so long as the amended payment event is inthe same category as the prior distribution event andcomplies with the definition of such category of dis-tribution condition under §409A, the amendmentwould not violate the proposed anti-abuse rule. Butthe plan sponsor might do so only so long as there is(1) no pattern or practice of permitting substantiallysimilar failures while the amounts are subject to SRF,and (2) the plan sponsor reasonably identifies and cor-rects all substantially similar plan failures. Similarlyto a possible clarification of the rule for amending am-biguous definitions, such a clarification may be incor-porated in the proposed anti-abuse rule. This addi-tional language would help to better balance the re-spective interests of regulatory enforcement andprivate stakeholders in correcting ambiguous, omittedor impermissible definitions of permissible distribu-tion events

Time or Form of Payment

Impermissible ToggleAn impermissible toggle results generally when a

plan provides for multiple times or forms of paymentupon the occurrence of a permissible payment

165 See Notice 2010-6 §V.166 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3); Notice 2010-6

§V(C)(2).167 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(3); Notice 2010-6

§V(A)(2), §V(B)(2).168 Notice 2010-6 §V(A)(2).169 See §409A(a)(2)(A)(v).170 Notice 2010-6 §V(B)(2).

171 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(2).



event.172 Prior to the proposed anti-abuse rule, a plansponsor could attempt to amend the plan to removethe erroneous alternative form of payment prior tovesting or payment. The employer could argue thatthe form of payment was included in the plan errone-ously and was not intended by the parties, as demon-strated by relevant facts and circumstances or in con-junction with other plan provisions.

Under the Notice, the service recipient may correctcertain impermissible toggles prior to vesting or pay-ment by removing an alternative time or form of pay-ment.173 However, the Notice sets forth restrictionsregarding the time or form of payment, which the plansponsor may remove by a correcting amendment.First, the remaining payment date or schedule must bethe time or form of payment resulting in or potentiallyresulting in the latest final payment date.

Second, if two payment dates or schedules resultactually or potentially in the same final payment date,the remaining date or schedule must be that which iscommencing or potentially commencing at the lastpossible date. Third, if both times or forms of pay-ment commence actually or potentially at the sametime, the plan sponsor must select the payment dateor schedule that generally would be anticipated to re-sult in the deferred amount being paid at later dates.

As discussed above, unlike vested compensation,remuneration subject to SRF is not guaranteed pay.Thus, by contrast to vested deferrals, the thresholdquestion for a distribution of nonvested amounts isnot when it would take place, but rather, whether thedistribution would occur. Therefore, these timing re-strictions may not be appropriate for deferred pay thatwould not be distributed necessarily to the executive.

This is especially true since, the VCP requirementsfor correcting toggles address only the prohibition onacceleration of payments.174 Applying these Noticerequirements technically may be inconsistent with thesubsequent deferral election rules.175 In seeking anappropriate balance between administrative enforce-ment objectives and limiting excessive shareholdercosts, the suggestion may be to exempt toggle correc-tions for nonvested amounts from these technical No-tice requirements.

Instead, the IRS may issue guidance permittingplan sponsors alternatively to amend payment formsor schedules for nonvested amounts based on atten-dant facts and circumstances used to establish the

original intent of the plan sponsor and executive withrespect to the time or form of payment. The require-ment under the first prong of the proposed anti-abuserule would ensure that only amendments necessary toeliminate the toggle are made.176 Consistently, deter-mining compliance with the first prong of the pro-posed anti-abuse test is based on facts and circum-stances. A facts and circumstances approach, evi-denced by supporting documentation, may be a moreappropriate correction method in some instances withrespect to nonvested deferrals in the view of comply-ing with Section 409A requirements for the time orform of payment of NQDC.

Discretion to Determine Payment Schedule AfterPayment Event

Prior to the proposed anti-abuse rule, a discretion toselect a time or form of payment after the paymentevent occurred without a default payment date orschedule would have violated subsequent deferralelection or acceleration of payment requirements un-der §409A.177 A plan sponsor could attempt to deletethe impermissible discretion and include a defaulttime or form of payment while amounts were non-vested. The service recipient could argue the amend-ment reflected the original intent of the parties and therelevant facts and circumstances as to the time orform of distributions after a payment event, withoutlimitation on the amended time or form of payment.

Under the Notice, the same three-point methodol-ogy applies to delete the discretion to select a time orform of distributions after the payment event oc-curred, if the plan does not provide a default paymentdate or schedule.178 However, in this case, the three-point rule may be appropriate for correcting amend-ments for nonvested amounts. The reason is that,since the service recipient failed to state a default timeor form of payment, there is a greater possibility thatthe parties may have intended a deferred payment ar-rangement that would have resulted in circumventionof §409A restrictions on timing or form of payment.Accordingly, where the plan does not set forth a de-fault time or form of payment, removal of impermis-

172 See Reg. §1.409A-3(c).173 See Notice 2010-6 §VII(C)(2) (setting forth specific rules

for toggles with respect to payment events arising by reason otherthan a separation from service being voluntary or involuntary).

174 See §409A(a)(3).175 See §409A(a)(4)(C).

176 See Prop. Reg. §1.409A-4(a)(1)(ii)(B)(1).177 See Reg. §1.409A-2(b)(1) (general requirements for subse-

quent deferral elections); §1.409A-2(b)(5) (coordination of certaintiming requirements applicable to changing the schedule of pay-ments under a plan with the prohibition on acceleration of pay-ments); §1.409A-3(j)(1) (general rule for prohibition on accelera-tion of time or schedule of payments); §1.409A-3(j)(2) (applica-tion of prohibition on acceleration of payments to addition,deletion or substitution of a permissible payment event under theplan, requirement to comply with subsequent deferral electionrules with respect to permissible addition of a payment event thatwould result in a payment being made at an earlier time).

178 Notice 2010-6 §VII(D)(2).


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sible discretion of service recipient to make such a de-termination after distributions commence may be sub-ject to the Notice restrictions.

Discretion of a Service Recipient to Accelerate aPayment

Prior to the proposed anti-abuse rule, a service re-cipient could amend a plan provision setting forth animpermissible discretion to accelerate a payment.179

Similarly to the above plan document failure, an em-ployer might have amended an existing plan by pro-viding a new payment date or schedule that wouldhave resulted in a prohibited acceleration of pay-ments.180 In each case, the employer could attempt tocorrect the document failure by removing the discre-tion or the amended payment schedule at any time be-fore the payment event with respect to nonvested de-ferrals.

Under the Notice, an impermissible discretion toaccelerate a payment may be removed with respect tovested amounts prior to the earlier of the date the dis-cretion is exercised and becomes irrevocable or theaccelerated payment date.181 However, with respect tononvested amounts, irrevocable exercise of discretionby the service recipient to pay amounts on an earlierdate does not result in vesting or payment of the de-ferrals.

Therefore, the service recipient may make the cor-recting amendment following the irrevocable exerciseof discretion to accelerate but before the acceleratedpayment event. Under the Notice, the employer maycorrect the document failure by removing the prohib-ited discretion to accelerate a payment. Alternatively,the plan sponsor may conform the payment provisionto comply with §409A requirements for permissibleacceleration of a payment.182 Accordingly, the pro-posed anti-abuse rule does not impose additional re-strictions on correcting an impermissible discretion ofa service recipient to accelerate a payment with re-spect to nonvested NQDC compared to the prior anti-abuse rule.

CONCLUSIONBy virtue of the proposed, three-prong anti-abuse

rule under the proposed §409A income inclusionregulations, the IRS eliminated numerous timing and

other eligibility requirements for correcting plans withrespect to nonvested amounts that would have appliedto vested NQDC. However, the proposed anti-abusetest calls for a facts and circumstances analysis as areplacement for the eliminated eligibility require-ments and to ensure proper application of the pre-scribed correction methods. Without further clarifica-tion, this test imposes an undue administrative burdenon plan sponsors and executives, the cost of which ul-timately is borne by the shareholders.

The remaining criteria with respect to nonvestedNQDC under the Notice represent a divergent ap-proach to the applicable correction methods. On theone hand, this new framework is less defined with re-spect to nonvested deferrals. On the other hand, basedon the language in the Notice applicable to VCP sub-missions, the IRS has broad authority to reject the in-terpretation of a taxpayer of the applicable correctionrequirements for nonvested NQDC.

Thus, without further clarification, plan sponsorswould have to tailor some correcting amendments fora payment event definition closely to original planterms. Such revisions potentially may come at the ex-pense of accurately reflecting the original intent of theparties in negotiating the terms of the deferred com-pensation arrangement. Also, employers prospectivelymay have to retain draft plan documents or other writ-ing evidencing the lack of intent to circumvent §409Arequirements.

Internal reviews of numerous NQDC plans of theemployer may be required if a plan document failureis detected. A service recipient would have to amendpromptly any noncompliant plans for the various planparticipants under the weight of these restrictions. Theplan sponsor may have to make conforming amend-ments to the NQDC plan provisions even if the factsand circumstances of each individual arrangementmay not warrant conforming plan language. These areonly some of the issues that could arise in complyingwith the proposed anti-abuse rule and applicable No-tice requirements, as currently written.

The costs of these additional administrative bur-dens on the plan sponsors and executives ultimatelywould affect adversely shareholder interests. To ad-dress these concerns, it would be advisable for theIRS to promulgate additional guidance or include ad-ditional language in the income inclusion regulationsidentifying or clarifying as discussed in this article thespecific Notice requirements for correcting documentfailures with respect to nonvested deferrals. Specifi-cally, the IRS could say in the anti-abuse rule that tim-ing requirements do not apply for nonvested amountsbecause they are with respect to income inclusion.Such a rule would be warranted based on the analysisof the timing requirements in this article and little po-tential for abuse given the uncertainty that nonvestedamounts eventually would be paid.

179 See Reg. §1.409A-3(j) (general prohibition on permitting toaccelerate payments under plan terms or on actually acceleratingpayments irrespective of the plan language). But see Prop. Reg.§1.409A-3(j)(2).

180 See Reg. §1.409A-3(j)(4) (permitting discretion of servicerecipient to accelerate payment under a plan only under limitedconditions). But see Prop. Reg. §1.409A-3(j)(4).

181 Notice 2010-6 §VII(E)(2).182 See Reg. §1.409A-3(j)(4).



Likewise, in determining the applicable correctionmethods, the IRS may include safe harbors discussedin the article that would ease the administrative andeconomic burden on plan sponsors, executives andshareholders in correcting ambiguous or impermis-sible definitions of payment events. Similarly, the IRSmay incorporate in the proposed anti-abuse rule a

facts and circumstances based safe harbor for correct-ing impermissible alternative payment forms orschedules. This guidance or rulemaking would pro-vide more certainty and thereby enable plan sponsorsand participants to avoid potential pitfalls in comply-ing with the new correction regime for nonvestedNQDC.


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