While many, if not most, supplemental retirement agreements (SERPs) and deferred compensation arrangements do not require the participating executive to sign a release in order to receive payment, many employment contracts along with other agreements tied to compensation, employment or severance often do. If you have a SERP or deferred compensation arrangement or another agreement that has a requirement to sign a release at separation from service you could be caught in a huge tax trap.
If the release has any flexibility in the date it can be signed and made effective, and that date can cross a calendar year end, it could trigger substantial tax penalties under Section 409A of the Internal Revenue Code, which is applicable to SERPs and deferred compensation arrangements as well as most other arrangements that defer or spread payment for more than 12 months.
The problem is that if there is flexibility in the timing of the signing of the release that could allow the benefit recipient to push the payment to the next calendar year, thereby delaying the taxation of the benefit, a 409A violation occurs. It gives distribution timing flexibility which is prohibited. Since all deferral arrangements generally are considered as a single program, a release in an employment or severance agreement will likely not only cause the severance or other payment to be caught in violation, but could extend to an entirely separate SERP or deferred compensation program.
The solution is for the “service recipient” – generally the employer, to amend the applicable plans or agreements to provide for a specific 60 or 90 day period following the event that triggers the payment and further provide that if the designated period overlaps the end of a calendar year, the payment cannot be made until the later year.
If you are an employee or other service provider and you participate in such an arrangement, you should talk with your employer or other service recipient to make sure that such an amendment is made and that the proper notice is provided with the employer’s or service provider’s tax return. It is always good advice to talk with tax counsel.
In order to qualify as a correction, and meet IRS requirements, the amendment must be made by December 31, 2012.
For further information or assistance contact Barry N. Koslow, JD, at bkoslow@mkaplanners.com.
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