Current developments in employee benefits and pensions (Part I): this two-part article provides an overview of current developments in employee benefits, including executive compensation, welfare benefits, and qualified plans. Part I focuses primarily on executive compensation and welfare benefits.

EXECUTIVE SUMMARY

* Final regulations trader Sec. 409A were released that will become effective as of January 1, 2008. In the interim, taxpayers must operate in "good faith compliance" with the statute, Notice 2005-1, and the six other Sec. 409A notices released by the Service.

* The Service provided guidance on the reporting and wage withholding requirements applicable to nonqualified deferred compensation arrangements for 2005 and 2006 and granted reporting relief for deferrals made in 2006 but not includible in income under Sec. 409A.

* The IRS updated the definition of covered employee under Sec.162(m)(3) to reflect the changes made by the SEC to the list of officers covered by the Exchange Act disclosure requirements.

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This two-part article covers significant developments in late 2006 and 2007 in employee benefits, including executive compensation, welfare benefits, and qualified plans. Part I, below, focuses on new guidance regarding executive compensation and welfare benefits. Part II, in the December 2007 issue, will focus on updates and changes to the rules for qualified retirement plans.

Executive Compensation

Sec. 409A Guidance

One of the most important pieces of executive compensation guidance released this year involved Sec. 409A, originally enacted as part of the American Jobs Creation Act of 2004 (AJCA). (1)

Final regs.: The IRS released final regulations under Sec. 409A on April 10, 2007 (TD 9321); they will become effective as of January 1, 2008. In the interim, taxpayers must operate in "good faith compliance" with the statute, Notice 2005-1, and the six other Sec. 409A notices released by the Service. (2) (See suggestions for complying with the regulations in the box at the end of this article.) Compliance with either the proposed or final regulations is not required but constitutes good-faith compliance. There are several important differences between the existing guidance and final regulations:

* The definition of "service recipient stock" has been expanded, giving service recipients additional flexibility to determine the stock on which they grant equity rights.

* Extending the exercise period of equity rights will not be treated as the addition of an impermissible deferral feature, as long as the extended expiration date does not go beyond the earlier of 10 years from the date of grant or the end of the original maximum term of the option. As before, there are no restrictions on the extension of underwater equity rights.

* The regulations clarify when a reimbursement arrangement or an arrangement for in-kind benefits does not provide for a deferral of compensation (and thus is not subject to Sec. 409A), and how such arrangements that do defer compensation can comply with Sec. 409A payment timing roles.

* The regulations revise rules on what constitutes a payment, a change in payment, or permissible delays in payment. The changes provide additional flexibility and reduce the likelihood that an unanticipated or inadvertent delay will result in income inclusion and additional tax under Sec. 409A.

* The short-term deferral exception to Sec. 409A coverage exempts compensation paid no later than 2 1/2 months after the end of the year in which the service provider's rights become vested. The final regulations clarify that this exception applies only to arrangements that do not provide for payment outside the short-term deferral period under any circumstances. The preamble notes that if a short-term deferral plan is in writing and specifies that payment will be made during the first 2 1/2 months of the year following vesting, the rules on timely payment will allow it to be paid at any time during that year. Related guidance provides that payments to be made only on involuntary termination or on voluntary termination under a window program or for "good reason" are not vested. As a result of the changes, the short-term deferral exception becomes applicable in more situations. For example, payments that become available only on an involuntary severance may be made without the six-month delay applicable to specified employees, even if other payments to the same individual are subject to the delay.

* The final regulations permit service recipients to devise alternative methods of identifying employees for whom distributions must be delayed for six months, provided the chosen method is reasonably likely to identify everyone who falls within the statutory definition of "specified employee" (which looks to the definition of "key employee" under Sec. 416) and not more than 200 employees are identified. Many employers were concerned that the classification of an employee as a specified employee could later be determined to be erroneous, resulting in inadvertent violations of Sec. 409A distribution rules (either through failure to observe the six-month delay for specified employees or improper postponement of distributions to specified employees). The final regulations make greater certainty possible.

* Certain "involuntary separation" payments are excepted from the rules of Sec. 409A. The final regulations provide that termination under a "good reason" provision can be an involuntary separation from service, possibly exempting related payments, if the "good reason" provision is not intended to avoid Sec. 409A. They also include a safe-harbor definition of "good reason" Payments on account of involuntary separation may be exempt from Sec. 409A if limitations on the amount and distribution period are met. This exemption makes it possible to make some payments to specified employees during the six-month period after severance from employment.

* Previous guidance under Sec. 409A required that payments from all similar plans be aggregated if a plan failed to meet distribution, acceleration, election, or funding rules. The final regulations retain this general rule but increase the aggregation categories from four to nine. (3) The increase in the number of these groups will limit the additional Sec. 409A tax to lesser amounts of compensation in the event payments do not conform to the rules.

Withholding guidance: The IRS issued Notice 2006-100 (4) to provide guidance on the reporting and wage withholding requirements applicable to nonqualified deferred compensation (NQDC) for 2005 and 2006. The notice granted reporting relief in 2006 for deferrals not includible in income under Sec. 409A. As a result, service recipients did not need to use Code Y in box 12 of Form W-2, Wage and Tax Statement, or box 15a of Form 1099-MISC, Miscellaneous Income, to report amounts deferred under NQDC plans in 2006. This relief did not extend to amounts includible in income as a result of Sec. 409A violations in 2005 or 2036. Therefore, service recipients were required to report this income on Form W-2 (using Code Z in box 12) or Form 1099-MISC (using box 15b) for 2005 or 2006. (5)

Notice 2006-100 confirmed that withholding is not required for the 20% additional tax on income attributable to Sec. 409A violations and that, if interest is required to be added to the amount due, it is calculated from the latest of January 1, 2005, the year amounts were deferred, or the year in which they are no longer subject to a substantial risk of forfeiture.

The final regulations did not contain reporting or withholding guidance; the preamble noted that the IRS would address those topics in the future.

Option granting practices: In late 2006, congressional hearings were held on option backdating. Options are considered backdated when the exercise price is established based on the stock's fair market value (FMV) at a date earlier than the grant date rather than the stock's FMV on the grant date. Government regulators viewed the practice as providing employees with advantages not available to other investors. In addition, options often had to be expensed for accounting purposes after it was determined that they were backdated. This changed the tax deduction associated with the options grant and created specific tax issues under the incentive stock option and NQDC provisions of the Code.

The issue of backdating (or misdating) options has increased focus on what constitutes the "grant date" The determination of the grant date is a facts-and-circumstances test, and the answer may be different for legal, tax, and financial accounting purposes. Generally, the analysis starts with the intended grant date and the actions or documentation supporting that intent. A grant date normally cannot occur before the recipient, the number of shares, the key terms, and the exercise price are set by an individual with authority to make grants on behalf of the company. Depending on the company's process, examples of possible grant dates include the date the board's compensation committee (or management in situations in which management is authorized to make grants) approves the grant, the date management transmits proposed grants for the compensation committee's review, or the date management allocates specific grants from a pool of awards approved by the compensation committee. Failure to follow corporate procedures carefully or simplified methods of setting exercise prices can result in failures to make the exercise price consistent with the FMV on the actual date of the grant, which may be required by the plan and is required for certain tax and accounting treatment.

To be exempt from Sec. 409A, options that were granted or became vested after December 31, 2004, must, among other requirements, have an exercise price no lower than the FMV on the grant date. Hence, these options with lower exercise prices must comply with Sec. 409A or they will be exposed to severe tax consequences.

In partial response, on February 8, 2007, the IRS released Announcement 2007-18, (6) which provided a compliance resolution program for employers willing to pay Sec. 409A-related taxes on behalf of employees who exercised misdated options in 2006. To participate, employers needed to notify the Service by February 28, 2007. (7)

The announcement provided a limited period during which employers whose employees exercised discounted options in 2006 could pay the 20% Sec. 409A tax (and any applicable interest charges) for the employees. (8) The employer's payment of these taxes had to be treated as additional compensation paid to the employee in 2007. The employer could, but was not required to, gross up the payments to make employees whole. The payments were deductible by the employer. The program was not open to officers, directors, or principal shareholders of public companies unless the discounted options were originally reported properly on the company's financial statements.

Employers participating in the program were not required to report the payment of Sec. 409A-related taxes on Form W-2 using Code Z. Employers that had already provided Forms W-2 to employees with Code Z could use Form W-2c, Corrected Wage and Tax Statement, to remove the Code Z. The program did not affect the employer's obligation to report the income recognized on the option's exercise or to comply with applicable withholding requirements for exercising the option.

Notice 2006-79 (9) provided additional transition relief. Until December 31, 2007, most discounted stock options can be cancelled and reissued to comply with Sec. 409A or the stock right exemption to 409A. The transition period was not extended, however, for options granted by public companies to directors, officers, or principal shareholders except to the extent that a compensation expense related to the grant of their discounted options was timely reported in accordance with GAAP. For those individuals, action to reform their options to comply with the Sec. 409A rules had to be completed by December 31, 2006.

Business Expense Deductions for Employee Use of Aircraft

In 2004, Congress limited business expense deductions for executives' use of aircraft for entertainment. (10) In Notice 2005-45, (11) the IRS provided interim guidance regarding the change and requested public comments on the expense allocation methods developed for the notice. On June 15, 2007, the Service issued proposed regulations (12) under Sec. 274, which generally follow the principles expressed in Notice 2005-45, with some modifications based on comments.

The proposed regulations retain the notice's method of allocating expenses to entertainment flights provided to "specified individuals" (13) under which aggregate flight and expense data for the year are determined and then allocated among the specified individuals' entertainment flights on the basis of either hours or seat miles. In response to comments, the proposed regulations also provided the option of allocating expenses on a flight-by-flight basis. Under this method, the taxpayer allocates expenses to each flight and then allocates per capita expenses for the flight among the passengers. (For more on these proposed regulations, see Tax Clinic, p. 646.)

Consistency rules: The proposed regulations would relax the consistency rules of Regs. Sec. 1.61-21(g) to permit taxpayers to value the entertainment use of aircraft by specified individuals under the FMV rules of Regs. Sec. 1.61-21(b), but continue to value flights for employees other than specified individuals traveling for entertainment by using either the standard industrial fare level (SIFL) formula of Regs. Sec. 1.61-21(g) or the general FMV rule of Regs. Sec. 1.61-21(b). However, the proposed regulations preserve the consistency rule of Regs. Sec. 1.61-21(g) in all other aspects. In other words, if an employer values any nonspecified employee's personal use of the corporate aircraft (or any specified employee's nonentertainment personal use of the corporate aircraft) using the SIFL formula in a given year, it must use the SIFL valuation for all other flights during that calendar year (except for the personal entertainment flights of specified employees). The same rule applies with respect to valuation using the FMV rules of Regs. Sec. 1.61-21 (g).

Section 162(m) issues: Notice 2005-45 provided that compensation income arising from the entertainment use of aircraft is subject to the compensation deduction disallowance of Sec. 162(m) if the recipient is a covered employee. Comments on Notice 2005-45 suggested that expenses related to entertainment use were not deducted as compensation and should not be subject to Sec. 162(m). The IRS rejected this analysis, taking the position that any amount included in an employee's income for entertainment flights is remuneration for services and therefore subject to Sec. 162(m) disallowance rules.

Guidance on the Definition of "Covered Employee"

On June 4, 2007, the IRS released Notice 2007-49 (14) to update the definition of "covered employee" for purposes of Sec. 162(m). Generally, Sec. 162(a)(1) allows a deduction for all ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business, including a reasonable allowance for salaries or other compensation. However, under Sec. 162(m), a publicly held corporation's compensation deduction for the compensation paid to a covered employee for the tax year can be based on no more than $1 million of compensation (with various exceptions).

Sec. 162(m)(3) defines "covered employee" to include an employee who is, as of the close of the tax year, the corporation's chief executive officer (or an individual acting in such capacity) and other individuals whose compensation must be reported to shareholders under the Securities Exchange Act of 1934 "by reason of such employee being among the 4 highest compensated officers for the taxable year (other than the chief executive officer)" The regulations under Sea 162(m) further provide that whether an individual is the CEO or among the four highest compensated officers is determined under the Exchange Act's executive compensation disclosure rules.

On September 8, 2006, the Securities and Exchange Commission (SEC) issued amended rules altering the composition of the group of executives covered by the Exchange Act disclosure requirements. (15) The new rules require disclosure for a company's principal executive officer (PEO), principal financial officer (PFO), and three most highly compensated executive officers other than the PEO and PFO. The amended definition is effective for fiscal years ending on or after December 15, 2006.

Because the Sec. 162(m) definition of covered employees is determined by reference to the Exchange Act, the Service issued Notice 2007-49 to conform the definition to the SEC amendments. The notice provides that, for years ending on or after December 31, 2006, the covered employee group consists only of the PEO and the three most highly compensated officers for the tax year other than the PEO and PFO. The PFO, therefore, cannot be a covered employee for purposes of Sec. 162(m), regardless of his or her compensation. (16)

As a result, for years ending on or after December 15, 2006, Sec. 162(m) does not limit the deduction for compensation to a PFO. Practitioners may wish to review 2006 returns to make any necessary adjustments. In addition, financial accounting that did not properly take these deductions into account may need to be adjusted. Finally, certain deferred compensation plans that had delayed payment until the compensation deduction ceased to be limited by Sec. 162(m) will now need to pay.

Welfare Benefits

HSA Enhancement

In its waning hours, the 109th Congress sent the president the Health Opportunity Patient Empowerment Act of 2006, (17) which included a package of provisions to improve health savings accounts (HSAs).

The first change liberalized the "comparable contribution requirement" for HSAs. Employers do not have to contribute to employees' HSAs, but if they do, they must make comparable contributions to the accounts of all comparable participating employees. Contributions are comparable if they are the same dollar amount or the same percentage of the high-deductible health plan's (HDHP) deductible. Participating employees are considered comparable, with some exceptions, if they are covered by any HDHP that the employer offers. (18) The act made the comparable contribution requirement more flexible by permitting employers to make larger HSA contributions for non-highly compensated employees than for highly compensated employees, effective for tax years beginning after December 31, 2006. (19) The highly versus non-highly compensated employee concept is borrowed from qualified plan rules. (20)

The second change permits the transfer of an employee's balance in either a health flexible spending account (health FSA) or health reimbursement account (HRA) into an HSA. Congress believed that some employers were unwilling to adopt HSA-based consumer-directed health plans because of problems coordinating HSAs with their existing HRAs and health FSAs. Employees generally may not fund HSAs while covered by HRAs or health FSAs, because those arrangements represent additional, non-HDHP health care coverage that an HSA "eligible individual" cannot have.

Quailed distributions: To help remedy this structural impediment, the bill created a five-year window during which employers may allow their employees' health FSAS or HRAs to make "qualified HSA distributions," which are tax-free transfers from an FSA or HRA to an HSA. The goal was to make it easier for employers to replace existing health FSAs and HRAs with consumer-directed health plans based on HDHPs and HSAs only. The mechanism is similar to a direct rollover from a qualified plan to an individual retirement account. However, the favorable tax treatment of the qualified HSA distribution is conditioned on the employee's maintaining HDHP eligibility and coverage for the 12-month period beginning on the date of distribution. The confluence of rules regarding the commencement of eligible-individual status, the end of health FSA or HRA coverage, and the forfeiture of unused health FSA balances at the end of each plan year presents challenges for employees who wish to take advantage of qualified HSA distributions.

In response, the IRS published Notice 2007-22, (21) which provided a procedural road map for employers to follow to ensure that special distributions from HRAs or FSAS to an HSA are accorded tax-exempt status. The notice provided detailed examples of successful (and unsuccessful) qualified HSA distributions. It also provided transition rules (available only through March 15, 2007) for employers that wished to offer qualified HSA distributions for health FSA or HRA balances remaining at the end of 2006.

Finally, the act included a provision permitting individuals to make one-time qualified HSA funding distributions from their IRAs. These transfers, which cannot exceed the individual's otherwise applicable HSA contribution limit for the year, are subject to rules similar to those that apply to the qualified HSA distributions described above.

Additional HSA guidance: Separately, the IRS released other HSA guidance during the past year. In late May 2007, it published proposed regulations on two "comparable contribution" issues (22) as a supplement to the final regulations released in July 2006. (23) The proposed regulations provide a way for employers to comply with comparable contribution requirements for employees who are eligible to establish an HSA but either did not set one up or failed to notify the employer about the establishment by December 31. The proposed regulations would require the employer to notify employees of the need to famish information about their HSAs, provide sample language for the notice, and set deadlines for making contributions to the accounts of employees who respond. The proposal also would allow employers to make accelerated contributions to the HSAs of employees who have incurred more qualifying medical expenses than the employer's cumulative HSA contributions at that time, as long as similarly situated employees were treated uniformly.

In Letter Puling 200704010, the IRS provided examples of other insurance coverage that is compatible with an HDHP and therefore does not prevent the establishment of an HSA. The ruling examined 11 policies offering coverage of various types. Nearly all of them qualified as "permitted insurance" under the ruling, though certain provisions were disallowed, indicating that HSA account holders can have significant coverage and still maintain an HSA.

Cafeteria Plan Prop. Regs.

Sec. 125, governing cafeteria plans, was added to the Code in 1978, (24) and the proposed regulations were issued in 1984, 1989, 1997, and 2000. However, the IRS finalized only the portions of the proposed regulations on the effects of the Family and Medical Leave Act and the circumstances under which participants may change cafeteria plan elections. (25) In August 2007, the IRS issued new proposed regulations (REG-14269505) that completely replace the old proposed regulations, adjusting some existing rules and adding provisions to address subsequent additions to the statute (such as HSAs). The proposed effective date for the new regulations is plan years beginning on or after January 1, 2009, though taxpayers may rely on these proposed regulations until they are finalized.

A number of different types of plans fall within the scope of Sec. 125. The regulations apply somewhat different rules to each of the following: (1) "flex" plans, which allow participants to choose among a variety of qualified benefits; (2) premium-only plans, in which the only choice is between cash and pretax contributions to a health plan; (3) medical flexible spending accounts, which reimburse out-of-pocket medical expenses; (4) dependent care flexible spending accounts, which reimburse the costs of caring for employees' dependents; and (5) adoption flexible spending accounts, which reimburse adoption expenses.

Sec.125(d)(1) requires that a cafeteria plan be in writing. Critical changes under the proposed regulations involve the implementation and interpretation of this provision. Following an approach adopted long ago in the qualified plan context, the new proposed regulations would impose both form and operational compliance requirements. To satisfy the former, a plan document would have to include (among other items) (1) a description of the benefits available to participants; (2) eligibility provisions; (3) an explicit prohibition against participation by nonemployees (see discussion below); (4) procedures for participants' election among benefits; (5) procedures for making contributions through salary reduction or nonelective contributions; and (6) a stated maximum contribution per employee. The plan would then have to operate in conformity with both the regulatory requirements and written plan provisions.

Much like qualified plan disqualification, any defect in the form or operation of a cafeteria plan would be significant: The plan would cease to be a cafeteria plan, and all employees' benefits would be includible in taxable income. However, unlike the qualified plan regime, there is no determination letter process or Employee Plans Compliance Resolution System, (26) nor has the IP, S given any indication that it intends to establish one. If cafeteria plan compliance becomes an audit target, the degree of effort that employers will have to put into ensuring that plan documents are up to date, unambiguous, compliant with the regulations, and followed to the letter will be significant.

As noted above, the proposed regulations require plans to explicitly bar participation by individuals who are not the employer's common-law employees (e.g., sole proprietors, partners, 2% shareholders in subchapter S corporations, corporate directors, and independent contractors). Previously, most practitioners had assumed that nonemployees simply could not gain a tax benefit from participation in a cafeteria plan (because their benefits were includible in income), not that they had to be formally excluded from participation.

A second area of profound change in the proposed regulations deals with nondiscrimination issues. Sec. 125 does not exclude from income the benefits of highly compensated participants in a plan that discriminates in their favor in either coverage or benefits. (27)

The proposal would clarify the nondiscrimination standards, generally replacing facts-and-circumstances tests with cross-references to detailed qualified plan rules. The Sec. 410(b) nondiscriminatory classification test would be the standard for determining whether eligibility to participate in a cafeteria plan was weighted too heavily in favor of the highly compensated group. This test compares the percentage of those employees who are eligible for benefits with the percentage of eligible non-highly compensated employees, borrowing the definition of "highly compensated" from Sec. 414(q).

For benefits testing, the fundamental nondiscrimination rules set forth in the proposed regulations are, first, all similarly situated participants must have a uniform opportunity to elect qualified benefits and, second, the use of nonqualified benefits by highly compensated employees (HCEs) must not be disproportionate to compensation. In other words, a plan is discriminatory if HCEs predominantly choose qualified (generally nontaxable) benefits and non-HCEs generally prefer cash. As a numerical test, aggregate qualified benefits as a percentage of aggregate total compensation for the highly compensated group may not be higher than for the non-highly compensated.

Because all elections must be made before the beginning of the year, employers can, in theory, check for benefit discrimination beforehand and require HCEs to cut back their elections if necessary. However, this kind of policing may not prove to be practicable.

Additional IRS Guidance

Letter Ruling 200704017 states that partners are allowed to deduct contributions to their partnership's self-insured group health plan under Sec. 162 (1) and to exclude the plan's benefit payments from their gross incomes, as long as the plan has "the effect of accident or health insurance" The ruling is significant because partners are not employees and are not eligible for the Sec. 105(b) gross income exclusion for medical expense reimbursements or the Sec. 106(a) gross income exclusion for employer-provided health coverage. Unlike employees, partners may not pay group health insurance premiums on a pretax basis through Sec. 125 cafeteria plans.

Suggestions for Complying with Sec. 409A Deferred Compensation Plan Rules

G. Edgar Adkins, Jr., CPA, M.Acc., Partner, National Tax Office, Grant Thornton LLP, Washington, DC

1. Identify arrangements that provide for a deferral of compensation.

* Identify the service-provider relationships covered by the rules (e.g., employees, independent contractors, board member).

* Identify arrangements with service providers that are deferrals of compensation.

** An arrangement provides for a deferral of compensation if a service provider has a legally binding right during a tax year to compensation that is or may be payable in a later tax year.

--Some specific arrangements are exempt from the rules.

--All other arrangements are subject to the rules.

** Grandfathered amounts are not subject to the rules (e.g., amounts earned and vested prior to January 1, 2005).

Caution: Grandfathered status is lost if the arrangement is materially modified after October 3, 2004.

2. For each arrangement, decide between removing the deferral of compensation and complying with the rules.

* The deadline far this decision is December 31, 2007.

* After the deadline, an arrangement that defers compensation is always required to comply with the rules, even if the deferral feature is later eliminated.

* Weigh the benefits of providing deferred compensation against the costs of compliance and exposure to penalties.

3. Design each arrangement to comply with the rules.

* Compliance with the basic rules is required (e.g., restrictions on deferral elections, funding, and distributions).

* Decide whether to adopt various special exceptions to the rules that provide certain advantages but make plan administration more complex.

4. Develop and implement policies and administrative procedures.

* The complexity of the rules makes strung policies and procedures important.

* Designate an individual who has ultimate responsibility for developing policies and procedures and for ensuring that they are followed.

5. Obtain service-provider written elections as to time and form of payment by December 31, 2007.

Caution: Some elections result in noncompliance:

** An election in 2007 to postpone a payment that would otherwise be received in 2007.

** An election in 2007 causing a payment to be made in 2007 that would otherwise not be made in 2007.

6. Evaluate compliance for the period between January 1, 2005, and January 1, 2008.

* Final regulations are effective for tax years beginning on or after January 1, 2008.

* Until then, good-faith compliance is required.

** Compliance with the statute and Notice 2005-1 is required.

** Compliance is not required with either the proposed or final regulations.

** However, compliance with the proposed or final regulations is considered good-faith compliance.

* Review plan operations to determine whether violations have occurred and take appropriate actions.

7. Prepare a written plan by December 31, 2008.

* The final regulations specify the required content of the written plan.

* The written plan must specify the plan's terms as of January 1, 2008, but is not required to specify the terms for the period prior to January 1, 2008.

Note: These rules ore current as of September 2007 but are subject to change based on further IRS guidance. Deferred compensation plans that are maintained under a collective bargaining agreement that was in effect on October 3, 2004, are not required to comply with Sec. 409A until the earlier of December 31, 2009, or the date the collective bargaining agreement terminates.

For details on the regulations, see the accompanying article, "Current Developments in Employee Benefits and Pensions (Part I)."

For more information about this article, contact Ms. Walker at [e-mail] or Mr. Haberman at [e-mail].

Authors' note: The authors thank Robert Davis, Elizabeth Drigotas, Stephen LaGarde, and Tom Veal for their valuable contribution to this article.

Deborah Walker, CPA

Tax Partner

Deloitte Tax LLP 

Washington, DC

Michael A. Haberman, J.D., LL.M.

Manager

Deloitte Tax LLP

Washington, DC

(1) American Jobs Creation Act of 2004, P.L. 108-357, Section 885 (2004).

(2) Notice 2005-1, 2005-1 CB 274; Notice 2005-94, 2005-2 CB 1208 (guidance on 2005 reporting and withholding obligation); Notice 2006-4, 2006-3 IRB 307 (guidance on certain outstanding stock rights); Notice 2006-33, 2006-15 IRB 754 (guidance on application of Sec. 409A rules on overseas and springing mists); Notice 2006-64, 2006-29 IRB 88 (guidance on payments necessary to meet federal conflict of interest requirements); Notice 2006-79, 2006-43 IRB 763 (additional transition relief); Notice 2006-100, 2006-511 IRB 1109 (guidance on 2005 and 2006 reporting and withholding obligations). There is additional transitional guidance in Announcement 2007-18, 2007-9 IRB 625 (discussed below).

(3) The aggregation categories include elective account balance plans, nonelective account balance plans, nonaccount balance plans, separation pay plans, split-dollar arrangements, in-kind benefit and reimbursement plans, stock rights subject to Sec. 409A, foreign plans, and amounts deferred under any other plan (Regs. Sec. 1.409A-1(c)(2)).

(4) Notice 2006-100, 2006-51 IRB 1109.

(5) As a result of the comprehensive transition relief under Notice 2005-1, there were relatively few situations that would result in amounts becoming includible in gross income under Sec. 409A for tax year 2005. Transition guidance included the ability to either reform or terminate plans during 2005. When plans were terminated, amounts could be taken into income without being subject to a Sec. 409A penalty or related reporting. Any 2005 Forms W-2c (or original Forms W-2 if the only income in 2005 was a result of Sec. 409A) would not be considered late if filed by the deadline applicable for filing an information return reporting amounts includible in calendar year 2006.

(6) Announcement 2007-18, 2007-9 IRB 625.

(7) Employers who massed this deadline may be able to obtain a similar result through the IRS closing agreement process.

(8) The additional tax was equal to 20% of the excess of the stock's FMV on the exercise date over the exercise price paid by the employee. The amount of interest was calculated using an interest rate equal to the underpayment rate plus 1% and applying it to the income amount, which is assumed to be taxed at the 35% marginal tax rate. The income amount was the intrinsic value of the option at December 31, 2005. Interest was assessed at this rate from April 17, 2006, until the earlier of the tax payment or April 17, 2007.

(9) Notice 2006-79, 2006-43 IRB 763.

(10) Sec. 274(e)(2), as modified by the AJCA.

(11) Notice 2005-45, 2005-1 CB 1228.

(12) REG--147171-05, 72 Fed. Reg. 33,169 (June 15, 2007).

(13) The definition of "specified individual" in Notice 2005-45 is also retained in the proposed regulations. Under this definition, a specified individual is any individual who (1) is subject to the requirements of Section 16(a) of the Securities Exchange Act of 1934 with respect to the taxpayer (or a related party to the taxpayer) or (2) would be subject to such requirements if the taxpayer (or a related party) were an issuer of equity securities referred to in that section (Prop. Kegs. Sec. 1.274-9(b)). These individuals include an officer, a director, or a more-than-10% owner. "Officer" is defined as the president, principal financial officer, principal accounting officer (or, if there is no such accounting officer, the controller), any vice president in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions. Generally, a specified individual is the recipient of entertainment provided to a spouse or family member of the specified individual or to another person became of the person's relationship to the specified individual.

(14) Notice 2007-49, 2007-25 IRB 1429.

(15) 71 Fed. Keg. 53158 (September 8, 2006).

(16) This conclusion was reached by focusing on why an individual was included in the proxy disclosure. The PFO is now includible because of his or her position and not because he or she is one of the top four highest paid employees. In addition, because the proxy rules now require that only the three most highly compensated individuals be reported in SEC filings, the fourth most highly compensated individual is not a Sec. 162(m)-covered employee.

(17) Included in the Tax Relief and Health Care Act of 2006, P.L. No. 109-432 (enacted December 20, 2006).

(18) For purposes of applying the comparable contribution requirement, Sec. 223 allows employers to distinguish between employees with different types of cover age (i.e., single or family) and between full- and part-time employees. The regulations permit employers to create three subcategories of family coverage, allowing more precise comparisons.

(19) Sec. 4980G(d).

(20) The pertinent definition is supplied by the qualified plan rules at Sec. 414(q). See Sec. 4980G(d).

(21) Notice 2007-22, 2007-10 IRB 670.

(22) REG-143797-06, 72 Fed. Reg. 30,501 (June 1, 2007).

(23) TD 9277, 71 Fed. Reg. 43,056 (July 31, 2006).

(24) Revenue Act of 1978, P.L. 95-600, Section 134(a).

(25) Regs. Secs. 1.125-3 and -4.

(26) Rev. Proc. 2006-27, 2006-1 CB 945.

(27) Cafeteria plan nondiscrimination rules also have requirements about "key employees" (as defined under Sec. 416(i)(1)). Key employees must include in gross income any benefit attributable to a plan year for which their portion of the plan's statutory nontaxable benefits exceeds 25% of the amount provided to all participants in the aggregate. The key employee concentration test, which primarily affects very small companies, is little changed from the earlier proposed regulations. Prop. Regs. Sec. 1.125-7.