A violation of Section 409A can cause the acceleration of income taxes and the imposition of significant penalties. In some cases, however, taxes and penalties can be avoided if corrective action is taken on a timely basis. Violations of Section 409A are categorized as document failures, or as operational errors. The situation covered in this AALU Bulletin relates to a non-qualified retention bonus plan with respect to which a document failure was noticed and corrected before the benefits under the plan were vested. However, taxes and penalties were still imposed because the correction was not made prior to the year in which the vesting occurred.
Nonqualified Deferred Compensation Section 409A Compliance
“…although the correction cured the defect in the agreement and brought it into full compliance with Section 409A, the bonus must still be included in the employee’s income in the third year of the agreement…”