For the purpose of determining whether this exception to the Section 409A rules applies, an independent contractor is considered to provide "significant services" to two or more unrelated service recipients if the revenues received from any one service recipient (including all related service recipients) do not exceed 70% of the total revenues that the independent contractor receives from the trade or business of providing those same services to other service recipients that are unrelated to one another and that are unrelated to the independent contractor. Unless the independent contractor fits this exception, any deferred compensation arrangement with the service provider must be in writing and meet the payment timing requirements of Code Section 409A.

Reimbursement Provisions That (Still?) Violate Code Section 409A
Scary as it may seem, we see new executive employment agreements with provisions for reimbursement of executive expenses (such as club dues, tax return preparation, relocation expenses, financial planning fees) that violate Code Section 409A. Section 409A applies to an executive employment agreement if an amount to which the executive has a legally binding right in a taxable year is payable more than two and one-half months after the end of that year.

Although unclear, the available guidance suggests that a legally binding right to reimbursement for a perk occurs before the reimbursable expense is incurred: either when the executive signs the employment agreement or, possibly, when the executive performs the services entitling him or her to that perk. There are several narrow exceptions from the Section 409A rules for certain expense reimbursements, but these seem applicable only to reimbursements after the executive's termination. Consequently, in order to avoid a violation of Section 409A, an employment agreement should clearly provide for reimbursement of expenses no later than two and one-half months after the year when the expense is incurred, or not at all.

If the expense reimbursement provisions of the executive's employment agreement violate Section 409A, the executive's other deferred compensation arrangements with the employer may be deemed to violate Section 409A, also subjecting the deferred amounts under these other arrangements to immediate taxation and penalties. What could be scarier?

New Tax-Qualified Plan Rules on the Horizon
For those who dread reading anything more about Section 409A for fear of discovering another absolutely necessary amendment to yet another nonqualified deferred compensation arrangement, relief is in sight. In early August, Congress passed a new law called the "Pension Protection Act of 2006." This new law is over 900 pages and has many, many new rules, some of which will require amendments, for tax-qualified deferred compensation plans-that is, defined benefit and defined contribution retirement and savings plans. Who would have envisioned such an easy (and reliable) cure for one's Section 409A amend-o-phobia?

In 2001, the annual limit for additions (or contributions) was dramatically increased until 2010 for defined contribution plans such as profit sharing, stock bonus, 401(k), and employee stock ownership plans (ESOPs). For 2006, this (annually indexed) increased limit for all defined contribution plans in which an individual participates is the lesser of 100% of his or her pay or $44,000, not including any age-50-or-older catch-up contribution that the individual can make for this year. The Pension Protection Act of 2006 makes permanent the increased defined contribution plan annual addition limit.

The Act also imposes new requirements for defined contribution plans that are invested in employer stock. If participant salary deferrals under a 401(k) plan (including a 401(k) plan that is part of an employee stock ownership plan, or KSOP) are invested in employer stock and this stock is publicly traded, the plan must permit the participant to diversify from this investment at any time. For employer contributions invested in publicly traded employer stock, the plan must permit participants to diversify from this investment after three years of service. These new diversification rules are generally effective in 2007 and do not apply to an ESOP that does not include a 401(k) plan or have employer matching contributions, or to an ESOP with employer stock that is not publicly traded.

Under the Act, any defined contribution plan must provide that participants will vest in their benefit from employer contributions under either a three-year cliff vesting schedule or a six-year graded vesting schedule, with at least 20% vesting per year after two years of service. This accelerated vesting requirement applies for all employer contributions made after December 31, 2006, but is delayed for certain ESOPs that are repaying an employer stock purchase loan.

The Pension Protection Act of 2006 also contains many new rules that address defined benefit plan funding, which are designed to prevent the termination of these plans without adequate monies to pay benefits; new 401(k) plan automatic enrollment rules to simplify discrimination testing in these plans; additional rollover rules; rules for qualified domestic relations orders; new reporting and disclosure rules; and new prohibited transaction exemptions, which will permit third-party service providers to offer additional services to plans. Federal tax advice disclaimer. Any tax advice in this article is intended for discussion purposes only; such advice is not intended for marketing, promoting, or recommending any transaction or for use by any person to prepare a tax return. Consequently, this advice is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under U.S. tax laws. (The foregoing statement is made in accordance with Circular 230, 31 C.F.R. Part 10.)

A partner in RJ&L's Colorado Springs office, Jan A. Steinhour practices exclusively in the area of employee benefits planning and administration. Her experience includes assistance to employers with pension and welfare benefits plan issues involving fiduciary responsibility, plan administration, benefits claims, and federal and state tax and labor law consequences. She frequently assists clients with design, implementation, and maintenance of executive compensation programs, severance programs, health benefits, stock option plans, golden parachute arrangements, and tax-qualified retirement plans. She can be reached at 719-386-3008 or by email at jsteinhour@rothgerber.com.