Your company sponsors an annual bonus program. Bonuses are tied to company calendar year performance. The bonus plan says that payments are to occur by March 15th of the year following the performance year. March 15th has always struck you as an odd date.
A friend at another company calls you up, very excited. Her company’s financial performance last year was stellar, and she’s expecting a large payment by March 15th. Another friend at a different company mentions that he’s buying new furniture on the 17th. The proximate cause? Annual bonuses are paid on March 15th.
It is no coincidence that companies often pay out annual bonuses around March 15th. In the case of a company with a calendar year tax year, paying bonuses by March 15 will generally allow the company to deduct the bonuses in the tax year which ends on the prior December 31. But there may be another reason for structuring bonus payouts in this manner: to comply with Code Section 409A.
Code Section 409A generally applies when the right to an amount arises in one year, but the amount can be paid in the next. So, for example, an annual bonus paid shortly after the end of a calendar year could potentially be subject to Code Section 409A.
However, amounts paid by the 15th day of the third month following the end of the year in which the amount “vests” are exempt from Code Section 409A as “short term deferrals.” Thus, March 15th.
But what happens if your company needs to delay scheduled annual bonus payments past March 15th? What if, for example, calculating the company performance for the bonus year takes longer than anticipated, and pushes the payments to March 20th? Surely Code Section 409A doesn’t care about short delays. . .
Code Section 409A cares about most short delays. If your payment is even one day late, it could fall out of the safe confines of the “short term deferral” exception and into the cold and hard rules of Code Section 409A proper. The only exceptions available are for unforeseeable exigent circumstances or because making the payment would jeopardize the company as a going concern. But these exceptions are limited – if there is a practice of regularly making payments after March 15th, there could be Code Section 409A issues.
There is a saving grace. You can structure your bonus plan to both be exempt from Code Section 409A and comply with Code Section 409A’s fixed payment rules. This would require, for example, using a fixed date (e.g. January 1) or period (e.g. January 1 through March 15th) for payment, but providing a March 15th outside payment drop dead date.
What does this approach buy you? If the payment occurs after March 15 but on or before the following December 31, there is no Code Section 409A violation (although there may be a contractual violation).
Are you confident that payments that are made after March 15 but still in the same year in which they should have been made do not constitute a 409A failure? Are you relying on the language in the final regulations that if a payment is to be made upon a specified event (including date or payment period) and the payment is made either upon the specified event or upon a later date in the same calendar year in which the event occurs, it is treated as having been made upon the payment event?
Don’t get me wrong; I love your conclusion that paying after March 15 is not a 409A violation, but I am somewhat concerned by Section IV.C. of Notice 2008-113, which provides a procedure for correcting excess deferred amounts that are then paid in the same taxable year as the erroneous deferral. How is an erroneous deferral different than saying you’ll pay a bonus on March 15 but not paying until later? Further, Section IX.A. of Notice 2008-113 requires information reporting of operational failures that are corrected in the same year as the failure, so the employer has to make a choice that is clearly documented for the Service about whether to treat this as a failure.
Based on Section IV.C of Notice 2008-113, it appears to me that the IRS views a partial year erroneous deferral that is still paid within the calendar year as a 409A violation that requires correction. However, if you can explain to me why I am wrong or how to distinguish a payment that is made days (or weeks or months) late from an erroneous deferral described in Section IV.C. of Notice 2008-113, I would be grateful. Thanks for your thoughtful blog entry on this topic.
Good thoughts.
The thought is that if you specify a payment window – say January 1 through March 15 – you have a window that potentially gets you into the short term deferral rule and have specified a payment period for 409A purposes. If you go beyond that period, the payment may still be timely if paid during the year in which the period occurs under the rule you note.
We note that Dan Hogans, who was with the IRS at the time, made the following comment on the subject at a conference in 2007: “You might want to specify a date in the following year but no later than March 15 [because if you miss the payment date and] don’t have a valid excuse, then you are in limbo. If you have specified a date, you still have until the end of the year to make payment. . .This is a way to straddle the short-term deferral rule and the required payment deadline.”
I read Section IV.C of Notice 2008-113 as applying to current year deferrals, and not previously deferred amounts. For example, an election to defer current year comp. under a traditional deferred comp. plan would have to be honored, and corrected under 2008-113 if too much was deferred. I don’t see Section IV.C as applying to previously deferred amounts, which is where an annual bonus would be if it wasn’t a short term deferral. Note that Section IV.C notes the following:
“However, a service recipient’s failure to timely pay in the proper taxable year of a service provider amounts that were deferred in one or more previous taxable years of the service provider is not a failure described in this § IV.C.2(a), but see § 1.409A-3(d) for certain circumstances under which such payments may be treated as made in accordance with a designated payment date.”
Section 1.409A-3(d) sets up the “pay by the end of the year” rule you note.