The new nonqualified deferred compensation provisions (IRC 409A) are generally effective on January 1, 2005, leaving little time for employers to bring their existing deferred compensation plans into compliance. The new rules impose, on amounts "deferred" on or after January 1, 2005, three key requirements which must be satisfied both in form and operation: (1) distribution restrictions, (2) acceleration restrictions, and (3) election restriction. It is expected that the Treasury Department and the Internal Revenue Service will offer guidance that will give employers a "grace period" in 2005 during which compliance motivated plan changes can be made and which will also address some of the substantive provisions, including primarily the definition of a "nonqualified deferred compensation plan." However, government officials have emphasized that plans must be "operationally" compliant from January 1, 2005, forward. The guidance is expected to allow employers to rely on a reasonable, good-faith interpretation of the statutory provisions in operating their plans during 2005. These employers will be deemed in operational compliance until further guidance is issued. The IRS has indicated the first round of the transitional guidance should be issued on or before December 21, 2004. The next round would follow several months later.

Government officials have vacillated on both the definition of what will be considered a deferred compensation plan and what will constitute a material modification to those plans which could affect its grandfathered status. Below is a brief summary of these issues.

Deferred Compensation Definition
The new statutory rules apply broadly to any agreement or arrangement that provides for the deferral of compensation. This would apply to arrangements between an employer and employee. The initial guidance is expected to address the question of when an arrangement results in the deferral of compensation. Government officials have indicated that they are currently considering using the same "earned and vested" standard for purposes of determining when an arrangement results in the deferral of compensation (i.e. only with respect to deferrals beyond a period in which the individual is otherwise vested in the amounts in question). However, it has also been suggested that an alternative approach could be considered in which the earned and vested standard would be used for the effective date provisions and another standard, such as an accrual-type standard, would be used for determining when an arrangement results in the deferral of compensation.

Material Modification
As discussed previously, this legislation makes dramatic changes to the tax rules for virtually all nonqualified deferred compensation arrangements. The new rules generally apply to any agreement that provides for the deferral of compensation, though amounts deferred before January 1, 2005 are not subject to the new rules unless the deferred compensation plans are "materially modified" on or after October 3, 2004. Congress has defined a "material modification" to be a post-October 2, 2004 benefit, right or feature addition to the plan after that date. It has been proposed that a plan termination occurring before January 1, 2005 would not be considered a "material modification" and therefore, should not be subject to the new rules. Also, a plan terminated after that date, so long as it is not a subterfuge for avoiding the new rules, should not be deemed to violate those rules.

Source: AALU Bulletins 04-133, 04-155, 04-163.