Company decided it didn't want to deal with 409A--was going to undergo a change in control in early 2006--and so decided it would go ahead and terminate it's deferred comp plan in 2005 and distribute the amounts in accordance with Q&A 18(c) of 2005-1. Company adopted resolutions terminating plan in 2005 and apparently paid out and reported all distributions in 2005 except for a couple of relatively small amounts. Those amounts for whatever reason did not get paid until mid-January 2006. Company reported distributions as income in 2005 or 2006 as they were made. Question is what to think of the failure to make all distributons prior to 2006 under the Plan and how to read the deadline requirement included in 18(c).

18(c) says that all the amounts deferred under a plan be paid and reported as income in the taxable year in which the termination occurs so as not to have the amendment treated as a material modification. I read the "taxable year" portion here to mean the employee's taxable year so that all amounts are paid and distributed to employees in the year of termination. Here that would require all distributions to have been made in 2005 and recognized and reported in income in 2005 since employees are all on a calendar tax year. (Note, however, that the company is on a September 30 fiscal year so all amounts were paid out within the same year as termination if looking at the company's tax year.)

If having termination and pay out within the company's tax year argument does not work, what does the failure mean. All of the distributions under the Plan (including those paid in 2005) were paid out in violation of 409A and would be subject to 20% excise tax? Alternatively, only those amounts not paid in 2005 would be in violation? What are the risks to the company here where it timely reported and withheld on the distributions. Since it doesn't have duty to withhold on the 20% excise tax (if applicable) is risk simply that maybe it should have reported all distributions in income in 2005 rather than a couple in 2006?

Yuck. No good faith compliance argument? Maybe argue the short-term deferral rule in Q/A 4(c) applies since the amounts were paid out within 2.5 months after the service providers taxable year after the lapse of the substantial risk of forfeiture? I just hope there was no collusion to pay in January instead of December...

Thanks XTitan. Unfortunately we inherited the mess from folks no longer on the scene so it's unclear why the delay. My guess is that it was just an administrative goof rather than any sort of collusion as there were two pots of funds under the plan and all of one pot (the bigger pot) got paid out in 2005 as required with the second pot coming later. The recipients of these amounts had large income / other distributions in both 2005 and 2006 so it's not obvious to me they would have gained anything from a tax liability perspective by delaying.

Not sure I follow the good faith compliance point? Is it just that they tried to do this and came close and seems like an administrative goof so should not blow whole plan? If so, I like that argument and think that's probably what happened here but my concern is that the Notice provision seems so clear on needing to pay out in year of termination that it would seem difficult to point to anything short of that as being good faith compliance (i.e., other than the possible company tax year argument, this seems one of the clearer 409A provisions out there).

Many thanks.