A transaction is not an Intermediary Transaction with respect to the following persons under the following circumstances:

If one of the foregoing safe harbor exceptions does not apply to a person, that person engaged in a transaction pursuant to the Plan, and the transaction has all four components described in section 3, the determination of whether the person participated in an Intermediary Transaction for purposes of § 1.6011-4 in any given taxable year is made under the general rule in § 1.6011-4(c)(3)(i)(A).

A taxpayer is not eligible for the relief provided in §§ IV through VIII of this notice unless all of the applicable requirements of this § III are met, as well as the requirements of the particular section providing the applicable relief and the notice and the reporting requirements of § IX. In each instance, the taxpayer claiming the relief has the burden of demonstrating that the taxpayer was eligible for the relief and that the requirements of this notice have been met. Any application of the relief provided in this notice is subject to examination by the IRS.

The relief provided under §§ IV through VIII of this notice is not available unless, in addition to meeting the applicable requirements of the relevant section, the service recipient takes commercially reasonable steps to avoid a recurrence of the operational failure. If the same or a substantially similar operational failure has occurred previously, the relief is not available for any taxable year of the service provider beginning after December 31, 2009, unless the service recipient or service provider demonstrates that the service recipient had established practices and procedures reasonably designed to ensure that such an operational failure would not recur and had taken commercially reasonable steps to avoid a recurrence of the operational failure and that the operational failure occurred despite the service recipient’s diligent efforts.

The relief provided in §§ V through VIII is not available if a federal income tax return of the relevant service provider for the service provider’s taxable year in which the operational failure occurred is under examination with respect to the plan. For this purpose, an individual service provider is treated as under examination with respect to the plan if the individual is under examination with respect to the individual’s federal income tax return (for example, Form 1040) for the taxable year.

Sections IV through VIII of this notice do not provide relief for plan terms and provisions that fail to meet the requirements of § 409A or for operational failures that are not described in those sections.^[1] The Treasury Department and the IRS are requesting comments as to whether an additional program to address plan document failures would be feasible and advisable (see § XI of this notice). In addition, relief is not available under §§ IV through VIII of this notice with respect to any exercise of a stock right that otherwise would result in a failure to comply with § 409A. Relief otherwise available under §§ IV through VIII of this notice is conditioned upon the timely filing and providing of the information required by § IX of this notice. The relief provided by §§ IV through VIII of this notice applies only to operational failures that are inadvertent and unintentional. For this purpose, an inadvertent and unintentional operational failure means a failure to comply with plan provisions that satisfy the requirements of § 409A(a), or an inadvertent unintentional failure to follow the requirements of § 409A(a) in practice, due to one or more inadvertent and unintentional errors in the operation of the plan. In addition, the relief provided in this section is not available if the failure is directly or indirectly related to participation in any listed transaction under §1.6011-4(b)(2)).

If to qualify for any applicable relief a service provider is required to repay to the service recipient an amount erroneously paid or made available to the service provider, such as required in §§ IV.A, IV.B, V.B, V.C, VII.B and VII.C, the amount erroneously paid or made available to the service provider refers to the gross amount paid to, or on behalf of, the service provider, before the application of any withholding requirements such as the Federal employment tax withholding requirements. The service provider may satisfy the requirement to repay the service recipient the amount erroneously paid to the service provider and interest (if applicable) by paying the service recipient the equivalent amount on or before the applicable deadline. Alternatively, in lieu of such repayment, the service recipient may reduce the service provider’s compensation that otherwise would have been paid on or before such applicable deadline by an equivalent amount. To the extent that, in lieu of repayment, the service recipient reduces other compensation that would have been paid to the service provider, the other compensation that would have been paid to the service provider, but instead is used to repay the erroneous payment or interest (if applicable), is includible in income (and wages if the service provider is an employee).

The amount will not be treated as repaid by the service provider if, in connection with such payment, the service recipient pays the service provider, or otherwise provides a benefit (including an obligation to pay an amount or provide a benefit in the future), intended as a substitute for all or part of the amount the service provider is required to repay the service recipient.

The relief provided in §§ IV through VIII is not available with respect to any erroneous payment occurring during any taxable year of the service provider in which the service recipient experiences a substantial financial downturn, or otherwise experiences financial or other issues, if such downturn or other issue indicates a significant risk that the service recipient will not be able to pay the amount deferred when the payment becomes due.

Certain sections of this notice provide additional eligibility requirements for relief, or do not provide relief, if the affected service provider is an insider with respect to a service recipient. For purposes of this notice, a service provider is an insider with respect to a service recipient if the service provider is a director or officer of the service recipient or is directly or indirectly the beneficial owner of more than 10% of any class of any equity security of the service recipient, determined in accordance with the rules of the Securities and Exchange Commission under § 16 of the Securities Exchange Act of 1934, as amended, 15 USC 78p, without regard to whether the service recipient has any class of equity securities registered under § 12 of such Act, 15 USC 78l. See 17 CFR § 240.16a-1(a) (beneficial owner) and (f) (officer). In the case of a service recipient that is not a corporation, such rules are applied by analogy.

To apply the requirements of certain sections of this notice, a period of days must be calculated and applied. For example, the number of days that a service provider retained amounts erroneously paid to the service provider may be required to be calculated. For purposes of counting days under this notice, the first day of the period is disregarded and the last day is taken into account. For example, if on June 1, 2009, a service recipient erroneously paid a service provider an amount that the service provider repaid on June 30, 2009, there would be 29 days from the date of payment through the date of repayment. If the period of days required to be calculated ends upon the service provider’s repayment, and the repayment is made through a reduction of the service provider’s other compensation, the repayment date occurs on each date the compensation otherwise would have been paid to the service provider.

The relief provided in certain sections of this notice permits or requires that deferred amounts be adjusted to reflect earnings and losses, provided that such adjustments must be made by a specified deadline. If it is impracticable to make the adjustment by the applicable deadline, the adjustment will be treated as made if, on or before the applicable deadline, the service provider (in the case of earnings) or the service recipient (in the case of losses) has a legally binding right to have such adjustment made.

For purposes of this notice, references to sections of the Internal Revenue Code include references to any applicable guidance thereunder.

This § IV.A applies if during a service provider’s taxable year an operational failure occurs that is described in § IV.A.2(a) and the requirements of § IV.A.2(b) through (d) and § IV.A.4 are met. An amount to which this § IV.A applies is treated as having been timely deferred in accordance with the terms of the plan and any applicable deferral election (or as having continued to be deferred under the terms of the plan).

(a) A failure is described in this § IV.A.2(a) if an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, and § 409A, should not have been paid or made available to a service provider in a taxable year of the service provider, was erroneously paid or made available to the service provider in that year, other than a payment that fails to meet the requirements of § 409A(a)(2)(B)(i) (requirement to delay for six months payments to a specified employee upon separation from service). For rules relating to correction of certain payments that fail to meet the requirements of § 409A(a)(2)(B)(i), see § IV.B of this notice.

(b) The service provider repays to the service recipient the amount that was erroneously paid or made available to the service provider on or before the last day of the service provider’s taxable year in which such amount was erroneously paid or made available. If the service provider was not an insider (as defined in § III.G) at any time during the taxable year in which such amount was erroneously paid or made available, and if repayment of such amount would cause an immediate and heavy financial need as defined in §1.401(k)-1(d)(3)(iii), in lieu of immediate repayment the service recipient and the service provider may enter into a legally binding agreement to have such amounts repaid over a specified period that ends not later than 24 months from the due date (without extensions) for the federal income tax return for the service provider’s taxable year during which the amount was erroneously paid or made available to the service provider, provided that the service provider must also pay interest on the amount repaid to the service recipient. For this purpose, the interest rate must be no less than the short-term applicable Federal rate (AFR) under § 1274(d)(1), based on annual compounding, for the month in which the erroneous payment was paid or made available. If the amount paid or withheld on a repayment date is less than the entire erroneous payment, for each repayment date the interest calculation is applied by substituting the unpaid balance immediately before the repayment for the amount of the erroneous payment. The repayment requirement of this § IV.A.2(b) will not be met unless all payments (including interest) are made by the end of the period specified in such agreement.

(c) Immediately after such repayment (or agreement to repay) the service provider has a legally binding right under the plan to be paid the amount that would have been due if such amount had not been erroneously paid or made available to the service provider during such taxable year, at the same time and in the same form of payment that the amount would have been payable if such amount had not been erroneously paid or made available to the service provider during such taxable year.

(d) If the total of all amounts to which this § IV.A applies that are erroneously paid or made available under a plan (as defined for purposes of § 409A) in a service provider’s taxable year exceeds the limit on elective deferrals that would apply to a qualified plan under § 402(g)(1)(B) for the year in which the erroneous payment was made and the service provider was an insider (as defined in § III.G of this notice) with respect to the service recipient at any time during the taxable year in which the erroneous payment was made, the service provider pays interest to the service recipient at the time the service provider repays the amount to the service recipient equal to the amount of the erroneous payment (E) multiplied by an interest rate that is no less than the short-term applicable Federal rate (AFR) under § 1274(d)(1) (r) multiplied by a fraction, the numerator of which is the number of days from the erroneous payment date to the repayment date (n₁ ) and the denominator of which is the number of days in such taxable year (n₂ ), or (E x r x n₁ /n₂ ). For purposes of the preceding sentence, r is the short-term AFR, based on annual compounding, for the month in which the erroneous payment was paid or made available to the service provider. If the amount paid or withheld on a repayment date is less than the entire erroneous payment, for each repayment date the interest calculation is applied by substituting the unpaid balance immediately before the repayment for the amount of the erroneous payment. For rules regarding the counting of days, see § III.H of this notice.

The amount erroneously paid to the service provider that is repaid by the service provider to the service recipient is not required to be included in income by the service provider, or reported as income to the service provider on a Form W-2 or Form 1099 by the service recipient. To the extent employment taxes have been withheld and paid with respect to such payment and would not otherwise have been due absent such payment, appropriate adjustments should be made in accordance with the applicable rules under § 6413. To the extent that, in lieu of repayment, the service recipient reduces other compensation that would have been paid to the service provider, the other compensation that would have been paid to the service provider, but instead is used to repay the erroneous payment or to pay any required interest on the erroneous payment, is includible in income (and wages if the service provider is an employee); however, any employment taxes withheld and paid with respect to the original erroneous payment may be applied to satisfy the requirement to withhold and pay employment taxes on such compensation, in which case no adjustment to the employment taxes previously withheld and paid should be made.

For purposes of this § IV.A, the service provider’s account balance or other amount of deferred compensation under the plan may be adjusted for earnings (or losses) retroactive to the date the amount should have been credited to the service provider’s account or otherwise deferred (or if the amount should have otherwise remained deferred compensation after the end of the service provider’s taxable year, retroactive to the date the amount was paid or made available), provided that such adjustment must be made on or before the last day of such taxable year.

In each of the following examples, it is assumed that Employee is an individual whose taxable year is the calendar year and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example 1: Employee, who is not an insider with respect to Employer, makes a timely election to defer 50% of a bonus payable in 2009 pursuant to an account balance plan maintained by Employer. The bonus is $100,000. Employer erroneously defers only 10% of the bonus, or $10,000, and pays Employee the other $90,000 in 2009 (including the $40,000 that should have been deferred). The deferral is treated as made in accordance with the terms of the plan and the deferral election if, on or before December 31, 2009, the additional $40,000 is credited to Employee’s account balance and Employee pays Employer $40,000. The $40,000 erroneously paid to Employee is not required to be included in income by Employee or reported as income by Employer on Form W-2. Alternatively, in lieu of the $40,000 repayment by Employee to Employer, compensation otherwise payable to Employee in 2009 (such as salary payments) may be reduced by $40,000, provided that the $40,000 reduction in Employee’s compensation used to repay the amount (but not the $40,000 erroneous payment) is included in income by Employee and reported as wages by Employer on the 2009 Form W-2. Employer may also adjust Employee’s account to reflect the earnings (or losses) that would have been allocated to Employee’s account had the amount been timely deferred and credited to Employee’s account balance, if such adjustment for earnings (or losses) is made on or before December 31, 2009. For example, if the original $10,000 deferral would have been credited with 10% in deemed investment earnings, the deferral plus earnings would be $11,000. This amount must be increased by the $40,000 repaid by Employee and may also be increased by an additional $4,000 ($40,000 multiplied by 10%), to result in the $55,000 account balance that would have been reflected had the amount been properly deferred. If the original incorrect deferral would have been charged with 10% in deemed investment losses, the deferral less losses would be $9,000. This account balance must be increased by the $40,000, but may also be reduced by $4,000, for a net increase of $36,000, to result in the $45,000 account balance that would have been reflected had the amount been properly deferred.

Example 2: Employee, who is an insider with respect to Employer, makes a timely election to defer 80% of a $100,000 bonus payable on July 1, 2010, pursuant to an account balance plan maintained by Employer. Employer erroneously defers only 10% of the bonus, or $10,000, and pays Employee the other $90,000 (including $70,000 that should have been deferred) on July 1, 2010. Assume for purposes of this example that the short-term AFR, based on annual compounding, for July 2010 is 4.0%. Employer notifies Employee of the error and Employee pays Employer $70,705.75 on October 1, 2010, consisting of the $70,000 erroneous payment plus interest equal to $705.75 ($70,000 x .04 x 92/365) (because the erroneous payment exceeds the limit on elective deferrals that would apply to a qualified plan under § 402(g)(1)(B) for 2010 and Employee is an insider). The $70,000 is not required to be included in income by Employee or reported as income by Employer on Form W-2. Alternatively, in lieu of the $70,705.75 payment by Employee to Employer, compensation otherwise payable to Employee in 2010 (such as salary payments) may be reduced by $70,000 plus applicable interest, in which case the reduction in Employee’s compensation used to repay the amount plus applicable interest (but not the erroneous $70,000 payment) must be reported by Employer as wages on the 2010 Form W-2 issued to Employee and included in Employee’s income for 2010. Employer may also adjust Employee’s account to reflect the earnings that would have been allocated to Employee’s account had the amount been timely deferred and credited to Employee’s account balance, if such adjustment for earnings is made on or before December 31, 2010. Employer must include in income any interest paid to Employer.

With respect to an amount to which this § IV.B applies, the service provider will not be treated as having failed to comply with § 409A(a)(2)(B)(i) (if applicable) and the terms of the plan and any applicable deferral election as a result of the amount being paid or made available at the earlier date.

This § IV.B applies if during a service provider’s taxable year an operational failure occurs that is described in § IV.B.2(a) and the requirements of § IV.B.2(b) and § IV.B.4 are met.

(a) A failure is described in this § IV.B.2(a) if an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, should not have been paid or made available to a service provider until a later date in the same taxable year, was erroneously paid or made available to the service provider more than 30 days before such later due date, or an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, and § 409A(a)(2)(B)(i) (requirement to delay for six months payments to a specified employee upon separation from service) and the applicable guidance, (i) would have been payable during the six months following the service provider’s separation from service if the service provider had not been a specified employee, (ii) because the service provider was a specified employee the amount should not have been paid or made available to a service provider within the six months after the service provider’s separation from service, and (iii) such amount was erroneously paid or made available to the service provider during such six-month period.

(b) On or before the last day of the service provider’s taxable year in which the amount was paid or made available, the service provider repays to the service recipient the amount that was erroneously paid or made available to the service provider, and immediately after such repayment the service provider has a legally binding right to receive such amount from the service recipient on the date that (i) if the repayment is made on or before the date the amount would otherwise have been payable under the terms of the plan and the applicable deferral election, is the same number of days after the date the amount would otherwise have been payable as the number of days from the date the service recipient made the erroneous payment to the service provider through the date the service provider repaid the erroneous payment to the service recipient, and (ii) if the repayment is made after the date the amount would otherwise have been payable under the terms of the plan and the applicable deferral election, is the same number of days after the date the amount is repaid as the number of days from the date the service recipient made the erroneous payment to the service provider through the date the amount would otherwise have been payable under the terms of the plan and the applicable deferral election. For rules regarding the counting of days, see § III.H of this notice.

If the requirements of this § IV.B are met, the original payment from the service recipient to the service provider that has been repaid to the service recipient is not required to be reported as income on Form W-2 or Form 1099, as applicable. To the extent employment taxes have been withheld and paid with respect to such payment, and would not otherwise have been due absent such payment, appropriate adjustments should be made under the applicable rules under § 6413. However, the subsequent payment of the amount by the service recipient to the service provider is required to be reported appropriately as income on Form W-2 or Form 1099, as applicable, and subject to the applicable employment taxes. If the payment is deductible by the service recipient, the taxable year in which such deduction is allowable will be determined in accordance with § 404(a)(5) and the service recipient’s method of accounting.

For purposes of this § IV.B, the service provider’s account balance or other amount of deferred compensation under the plan may not be adjusted for earnings, but may be adjusted for losses, retroactive to the date the amount was erroneously paid or made available, provided that such adjustment must be made on or before the applicable deadline for repayment.

In each of the following examples, it is assumed that Specified Employee is an individual whose taxable year is the calendar year, at all relevant times Specified Employee is a specified employee of Employer for purposes of § 409A(a)(2)(B)(i), and Specified Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example 1: Under a nonqualified deferred compensation plan sponsored by Employer, Specified Employee has a legally binding right to a payment of deferred compensation on the first day of the seventh month following Specified Employee’s separation from service. Specified Employee separates from service on December 15, 2008, so that the payment is due on July 1, 2009. Employer erroneously pays Specified Employee the amount of deferred compensation on March 1, 2009 (122 days before the original payment due date). Employer discovers the error on May 1, 2009, and Specified Employee repays the amount to Employer on June 1, 2009 (92 days after the erroneous payment). Provided that immediately after such repayment Specified Employee has a legally binding right to receive the amount from Employer on October 1, 2009 (92 days after the July 1, 2009 original payment due date) and Employer does not repay the amount to Specified Employee before that date, Specified Employee will not be treated as having failed to comply with § 409A(a)(2)(B)(i) and the terms of the plan and the applicable deferral election solely as a result of the early payment.

Example 2: Under a nonqualified deferred compensation plan sponsored by Employer, Specified Employee has a legally binding right to a payment of deferred compensation payable as a lump sum payment December 1, 2009 (and so not subject to the six-month delay requirement of § 409A(a)(2)(B)(i)). Employer erroneously pays Specified Employee the amount of deferred compensation on September 1, 2009 (91 days early). Employer discovers the error and Specified Employee repays the amount to Employer on November 1, 2009 (61 days after the erroneous payment). Provided that immediately after such repayment Specified Employee has a legally binding right to receive the amount from Employer on January 31, 2010 (61 days after the original payment due date) and Employer does not repay the amount to Specified Employee before that date, Specified Employee will not be treated as having failed to comply with the terms of the plan and the applicable deferral election solely as a result of the early payment. The erroneous payment is not includible in Specified Employee’s income, and is not required to be reported as income on the 2009 Form W-2. Such amount is includible in Specified Employee’s income in the year in which the amount is repaid by Employer to Specified Employee, and is required to be reported as income on that year’s Form W-2 and subject to applicable income taxes.

An excess amount to which this § IV.C applies is not treated as an amount deferred under the plan.

This § IV.C applies if during a service provider’s taxable year an operational failure occurs that is described in §§ IV.C.2(a) and the requirements of § IV.C.2(b) and (c) and § IV.C.3 are met.

(a) A failure is described in this § IV.C.2(a) if, under the terms of a plan and an applicable deferral election, and § 409A, an amount that should not have been deferred compensation under the plan is erroneously credited to the service provider’s account or otherwise treated as deferred compensation under the plan, and such excess amount otherwise would have been paid to the service provider during the service provider’s taxable year in which the excess amount was incorrectly credited to the service provider’s account or otherwise treated as deferred compensation under the plan. 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.

(b) The excess amount is paid to the service provider on or before the last day of the service provider’s taxable year in which the excess amount was incorrectly treated as deferred compensation.

(c) The amount to which the service provider has a legally binding right under the plan at the end of the year is adjusted to reflect the payment (for example, through a reduction in the account balance). The service recipient may (but is not required to) pay reasonable interest to (or otherwise reasonably compensate) the service provider to reflect the time value of money with respect to the late payment, provided that such interest or other compensation is paid or made available by the end of the service provider’s taxable year in which such amount was incorrectly treated as deferred compensation under the plan.

If the service provider was an insider with respect to the service recipient (as defined in § III.G of this notice) at any time during the service provider’s taxable year during which the failure occurred, the remaining account balance (or other deferred compensation under the plan) is adjusted for earnings retroactive to the date the excess amount was incorrectly credited to the service provider’s account or otherwise incorrectly treated as deferred under the plan, provided that such adjustment must be made on or before the last day of the service provider’s taxable year in which such amount was incorrectly treated as deferred compensation under the plan. If the service provider was not an insider, such adjustment may be made (but is not required). If the amount was subject to losses, the remaining account balance (or other deferred compensation under the plan) is not required to be adjusted, but may be adjusted for such losses retroactive to the date the excess amount was incorrectly credited to the service provider’s account or otherwise incorrectly treated as deferred under the plan, provided that such adjustment must be made on or before the last day of the service provider’s taxable year in which such amount was incorrectly treated as deferred compensation under the plan.

In the following example, it is assumed that Employee is an individual whose taxable year is the calendar year and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: Employee, who is an insider with respect to Employer and whose taxable year is the calendar year, makes a timely election pursuant to an account balance plan to defer 10% of a bonus otherwise payable in 2008. The bonus is $100,000. Employer erroneously defers 50% of the bonus, or $50,000, and pays Employee $50,000 (instead of deferring $10,000 and paying Employee $90,000). The excess $40,000 will not be treated as deferred under the plan if on or before December 31, 2008, Employer pays Employee $40,000 of the account balance under the plan. The remaining account balance must be adjusted for earnings and may be adjusted for losses that were allocable to such amount under the plan. Employer may (but is not required to) pay Employee reasonable interest on the $40,000 erroneous deferral provided such payment is made by December 31, 2008.

If this § IV.D applies to a stock right, the stock right is treated from the date of grant as not providing for a deferral of compensation for purposes of § 409A.

This § IV.D applies if during a service provider’s taxable year a failure occurs that is described in § IV.D.2(a) and the requirements of § IV.D.2(b) are met.

(a) A failure is described in this § IV.D.2(a) if, under the terms of a stock right, the stock right would not provide for a deferral of compensation under § 1.409A-1(b)(5)(i)(A) (excluded stock options) or § 1.409A-1(b)(5)(i)(B) (excluded stock appreciation rights), except that the exercise price of the stock right is erroneously established at less than the fair market value of the underlying stock on the date of grant.

(b) Before the stock right is exercised and not later than the last day of the service provider’s taxable year in which the service recipient granted the service provider the stock right, the exercise price is reset to an amount not less than the fair market value of the underlying stock on the date of grant.

In the following example, it is assumed that Employee is an individual whose taxable year is the calendar year and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: On January 1, 2009, Employer grants Employee a stock option to purchase 100 shares of stock, and the stock option otherwise would not provide for a deferral of compensation for purposes of § 409A except that due to an error the exercise price is set at an amount below the fair market value of the stock on January 1, 2009. On July 1, 2009, Employee partially exercises the stock option and purchases 40 shares, but retains a stock option to purchase 60 shares. Provided that before the earlier of January 1, 2009 or the exercise of the remaining stock option to purchase 60 shares, the exercise price of the stock option to purchase 60 shares is reset to a price at or above the fair market value of the underlying stock on January 1, 2009, the stock option to purchase 60 shares may qualify for the relief provided in this section. Because the exercise price was not reset before the exercise on July 1, 2009, the portion of the stock option that was exercised to purchase 40 shares is not eligible for the relief provided in this section.

The relief provided in this § V is available only with respect to service providers that are not insiders as defined in § III.G of this notice at any time during the service provider’s taxable year in which the operational failure occurs, or at any time during the immediately following taxable year. The relief is available with respect to such service providers regardless of whether the same or a substantially similar failure occurred with respect to a service provider that is an insider, but in no case is the relief available with respect to a service provider that is an insider at any time during either taxable year. For example, if an operational failure under an arrangement results in two erroneous $10,000 payments, one to a service provider that is an insider and one to a service provider that is not an insider, the relief provided in this § V may be available with respect to the service provider that is not an insider (provided that all other requirements are met), but is not available with respect to the service provider that is an insider. The relief provided in this § V may be available regardless of whether relief is also available under § VI or VII of this notice, so that the relief provided in this section may be utilized in lieu of the relief otherwise available under § VI or VII of this notice.

An amount to which this § V.B applies is treated as having been timely deferred in accordance with the terms of the plan and any applicable deferral election (or as having continued to be deferred under the terms of the plan).

This § V.B applies if during a service provider’s taxable year an operational failure that is described in § V.B.2(a) occurs and the requirements of § V.B.2(b) through (d) and §§ V.B.3 and 4 are met.

(a) A failure is described in this § V.B.2(a) if an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, and § 409A, should not have been paid or made available to a service provider in a taxable year of the service provider, erroneously was paid or made available in that year, and such payment is not a payment that fails to meet the requirements of § 409A(a)(2)(B)(i) (requirement to delay for six months payments to a specified employee upon separation from service).

(b) The service provider repays to the service recipient the amount that was erroneously paid or made available to the service provider during the service provider’s taxable year immediately following the taxable year in which such amount was erroneously paid or made available. If repayment of such amount would cause an immediate and heavy financial need as defined in §1.401(k)-1(d)(3)(iii), the service recipient and the service provider may enter into a legally binding agreement to have such amounts repaid over a specified period that ends not later than 24 months from the due date (without extensions) for the federal income tax return for the service provider’s taxable year during which the amount was erroneously paid or made available to the service provider. However, the repayment requirement of this § V.B.2(b) will not be met unless all payments are made by the end of the period specified in such agreement. If the amount erroneously paid or made available to the service provider is otherwise payable under the terms of the plan during the subsequent taxable year during which repayment would be required under this § V.B.2(b), no repayment is required. However, the service provider must pay the interest payment set forth in § V.B.2(d) below assuming that the first date during the subsequent taxable year at which the amount otherwise could have been paid in compliance with the plan terms is the date of repayment.

(c) Immediately after such repayment (or agreement to repay), the service provider has a legally binding right under the plan to be paid the amount that would have been due if such amount had not been erroneously paid or made available to the service provider during such taxable year, at the same time and in the same form of payment that the amount would have been payable if such amount had not been erroneously paid or made available to the service provider during such taxable year.

(d) The service provider pays interest to the service recipient at the time the service provider repays the amount to the service recipient with interest at a rate not less than the short-term applicable Federal rate (AFR) under § 1274(d)(1), based on annual compounding, for the month in which the erroneous payment was paid or made available, compounded as of the end of the service provider’s taxable year. For this purpose, the interest rate is the short-term AFR for the month in which the erroneous payment was paid or made available. If the amount paid on a repayment date is less than the entire erroneous payment, for each repayment date the interest calculation is applied by substituting the unpaid balance immediately before the repayment for the amount of the erroneous payment.

The amount erroneously paid to the service provider that is repaid by the service provider to the service recipient is required to be included in income by the service provider, and reported as income to the service provider on a Form W-2 or Form 1099 by the service recipient, for the year in which the erroneous payment is made. As part of the relief provided by this section, the service provider is permitted to take a deduction in determining adjusted gross income equal to the repayment to the service recipient (but not including any interest payment), but is required to include the subsequent payment in income (and the service recipient is required to report the amount as income on Form W-2 or Form 1099). To the extent that, in lieu of repayment, the service recipient reduces other compensation that would have been paid to the service provider, the other compensation that would have been paid to the service provider but that instead is used to repay the erroneous payment or to pay any required interest on the erroneous payment, is includible in income (and wages if the service provider is an employee); however, with respect to the amount repaid (excluding any interest payment), the service provider is permitted to take a deduction in determining adjusted gross income for the amount of the repayment.

For purposes of this § V.B, the service provider’s account balance or other amount of deferred compensation under the plan may be adjusted for earnings (or losses) retroactive to the date the amount should have been credited to the service provider’s account or otherwise deferred (or if the amount should have otherwise remained deferred compensation after the end of the service provider’s taxable year, retroactive to the date the amount was paid or made available), provided that such adjustment must be made on or before the last day of the taxable year in which the repayment is made.

In the following example, it is assumed that Employee is an individual whose taxable year is the calendar year, at all relevant times Employee is not an insider as defined in § III.G of this notice, and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: Employee makes a timely election to defer 20% of a $100,000 bonus payable on July 1, 2010, pursuant to an account balance plan maintained by Employer. Employer erroneously defers only 10% of the bonus, or $10,000, and pays Employee the other $90,000 (including $10,000 that should have been deferred) on July 1, 2010. Assume for purposes of this example that the short-term AFR for July 2010 is 4.0%. Employer notifies Employee of the error and Employee pays Employer $10,505.73 on October 1, 2011, consisting of the $10,000 erroneous payment plus $505.73 interest.^[2] The deferral is treated as made in accordance with the terms of the plan under this § V.B. For 2010, the $10,000 payment is required to be included in income by Employee and reported as wages by Employer on the 2010 Form W-2. For 2011, Employee may take a deduction with respect to the $10,000 repayment in determining adjusted gross income, but may not deduct the interest payment. Alternatively, in lieu of the $10,505.73 payment by Employee to Employer, compensation otherwise payable to Employee in 2011 (such as salary payments) may be reduced by $10,000 plus applicable interest, in which case the reduction in Employee’s compensation used to repay the amount plus applicable interest must be reported by Employer as wages on the 2011 Form W-2 issued to Employee and included in Employee’s income for 2011. In such a case, Employee may take a deduction with respect to the $10,000 repayment in determining adjusted gross income, but may not deduct the interest payment. Employer may also adjust Employee’s account to reflect the earnings that would have been allocated to Employee’s account had the amount been timely deferred and credited to Employee’s account balance, if such adjustment for earnings is made on or before December 31, 2011.

With respect to an amount to which this § V.C applies, the service provider will not be treated as having failed to comply with § 409A(a)(2)(B)(i) (if applicable) and the terms of the plan and any applicable deferral election as a result of the amount being paid or made available as described in § V.C.2(a) of this notice.

This § V.C applies if during a service provider’s taxable year an operational failure occurs that is described in § V.C.2(a) and the requirements of § V.C.2(b) and (c) and §§ V.C.3 and 4 are met.

(a) A failure is described in this § V.C.2(a) if an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, should not have been paid or made available to a service provider until a later date in the same taxable year, was erroneously paid or made available to the service provider during such taxable year but more than 30 days before such later due date, or an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, and § 409A(a)(2)(B)(i) (requirement to delay for six months payments to a specified employee upon separation from service), (i) would have been payable during the six months following the service provider’s separation from service if the service provider had not been a specified employee, (ii) because the service provider was a specified employee the amounts should not have been paid or made available to a service provider within six months after the service provider’s separation from service, and (iii) such amount was erroneously paid or made available to the service provider before the expiration of such six-month period.

(b) On or before the last day of the service provider’s taxable year immediately following the taxable year in which the amount was paid or made available, the service provider repays to the service recipient the amount that was erroneously paid or made available to the service provider.

(c) Immediately after such repayment the service provider has a legally binding right to receive such amount from the service recipient on the date that is the same number of days after the date the amount is repaid as the number of days from the date the service recipient made the erroneous payment to the service provider through the date the amount would otherwise have been payable under the terms of the plan and the applicable deferral election. For rules regarding the counting of days, see § III.H of this notice.

If the requirements of this § V.C are met, the original payment from the service recipient to the service provider that has been repaid to the service recipient is required to be reported as income on Form W-2 or Form 1099, as applicable. If the repayment by the service provider to the service recipient and the subsequent payment from the service recipient to the service provider both occur within the same taxable year of the service provider, the service provider is not permitted to deduct the repayment, but also is not required to include the subsequent payment in income (and the service recipient is not required to report the amount as income on Form W-2 or Form 1099). As part of the relief provided in this section, if the repayment by the service provider to the service recipient and the subsequent payment from the service recipient to the service provider do not occur within the same taxable year of the service provider, the service provider is permitted a deduction in determining adjusted gross income equal to the amount of the repayment, but is required to include the subsequent payment in income (and the service recipient is required to report the amount as income on Form W-2 or Form 1099). To the extent that, in lieu of repayment, the service recipient reduces other compensation that would have been paid to the service provider, the other compensation that would have been paid to the service provider, but instead is used to repay the erroneous payment is includible in income (and wages if the service provider is an employee); however, with respect to the amount repaid, the service provider is permitted a deduction in determining adjusted gross income equal to the amount of the repayment.

For purposes of this § V.C, the service provider’s account balance or other amount of deferred compensation under the plan may not be adjusted for earnings, but may be adjusted for losses, retroactive to the date the amount was erroneously paid or made available, provided that such adjustment must be made on or before the applicable deadline for repayment.

In the following example, it is assumed that Employee is an individual whose taxable year is the calendar year, Employee is not an insider as defined in § III.G of this notice at all relevant times, and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: Under a nonqualified deferred compensation plan sponsored by Employer, Employee has a legally binding right to a payment of deferred compensation on the specified date of July 1, 2009. Employer erroneously pays Employee the amount of deferred compensation on May 1, 2009 (61 days before the original payment due date). Employer discovers the error on August 1, 2010, and Employee repays the amount to Employer on August 1, 2010. Provided that immediately after such repayment Employee has a legally binding right to receive the amount from Employer on October 1, 2010 (61 days after the August 1, 2010 repayment date) and Employer does not repay the amount to Employee before that date, Employee will not be treated as having failed to comply with the terms of the plan and the applicable deferral election solely as a result of the early payment.

An excess amount to which this § V.D applies is not treated as an amount deferred under the plan.

This § V.D applies if during a service provider’s taxable year an operational failure occurs that is described in § V.D.2(a) and the requirements of § V.D.2(b) through (d) and § V.D.3 are met.

(a) A failure is described in this § V.D.2(a) if, under the terms of a plan and an applicable deferral election, and § 409A, an amount that should not have been deferred compensation under the plan is erroneously credited to the service provider’s account or otherwise treated as deferred compensation under the plan, and such excess amount otherwise would have been paid to the service provider during the service provider’s taxable year in which the excess amount was incorrectly credited to the service provider’s account or otherwise treated as deferred compensation under the plan.

(b) The excess amount is paid to the service provider during the service provider’s taxable year immediately following the taxable year in which the excess amount was incorrectly treated as deferred compensation.

(c) The amount to which the service provider has a legally binding right under the plan at the end of such immediately following taxable year is adjusted to reflect the payment (for example, through a reduction in the account balance).

(d) The service recipient does not pay interest to (or otherwise compensate) the service provider to reflect the time value of money with respect to the late payment.

The remaining account balance (or other deferred compensation under the plan) must be adjusted for earnings and may be adjusted for losses retroactive to the date the excess amount was incorrectly credited to the service provider’s account or otherwise incorrectly treated as deferred under the plan, provided that such adjustment must be made on or before the last day of the service provider’s taxable year following the year in which such amount was incorrectly treated as deferred compensation under the plan.

In the following example, it is assumed that Employee is an individual whose taxable year is the calendar year, at all relevant times Employee is not an insider as defined in § III.G of this notice, and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: Employee makes a timely election pursuant to an account balance plan to defer 10% of a bonus otherwise payable in 2010. The bonus is $100,000. Employer erroneously defers 20% of the bonus, or $20,000, and pays Employee $80,000 (instead of deferring $10,000 and paying Employee $90,000). Employer pays Employee $10,000 of the account balance under the plan on July 1, 2011. Provided that Employee includes in income the $10,000 payment in 2011, Employee is not required to include any amount in income under § 409A. The remaining account balance must be adjusted for earnings and may be adjusted for losses that were allocable to such $10,000 amount under the plan. However, Employer may not pay Employee interest on the $10,000 erroneous deferral or otherwise compensate Employee for the loss of the use of such funds.

If this § V.E applies to a stock right, the stock right is treated from the date of grant as not providing for nonqualified deferred compensation for purposes of § 409A.

This § V.E applies if during a service provider’s taxable year a failure occurs that is described in § V.E.2(a) and the requirements of § V.E.2(b) are met.

(a) A failure is described in this § V.E.2(a) if, under the terms of a stock right, the stock right would not provide for a deferral of compensation under § 1.409A-1(b)(5)(i)(A) (excluded stock options) or § 1.409A-1(b)(5)(i)(B) (excluded stock appreciation rights), except that the exercise price of the stock right is erroneously established at less than the fair market value of the underlying stock on the date of grant.

(b) Before the stock right is exercised and not later than the last day of the service provider’s taxable year immediately following the service provider’s taxable year in which the service recipient granted the service provider the stock right, the exercise price is reset to an amount equal to or exceeding the fair market value of the underlying stock on the date of grant, and at all times before such increase in the exercise price the stock right otherwise would not have provided for a deferral of compensation for purposes of § 409A.

In the following example, it is assumed that Employee is an individual whose taxable year is the calendar year, Employee is not an insider as defined in § III.G of this notice at all relevant times, and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example. On January 1, 2009, Employer grants Employee a stock option to purchase 100 shares of stock, and the stock option otherwise would not provide for a deferral of compensation under § 409A except that due to an administrative error the exercise price is set at an amount below the fair market value of the stock on January 1, 2009. On July 1, 2010, Employee partially exercises the stock option and purchases 40 shares, but retains a stock option to purchase 60 shares. Provided that before the later of January 1, 2011 or the date the remaining stock option to purchase 60 shares is exercised, the exercise price of the stock option to purchase 60 shares is reset to a price at or above the fair market value of the underlying stock on January 1, 2009, the stock option to purchase 60 shares may qualify for the relief provided in this section. Because the exercise price was not reset before the July 1, 2010 exercise, the portion of the stock option that was exercised to purchase 40 shares is not eligible for the relief provided in this section.

If an operational failure to comply with § 409A(a) occurs, but the operational failure qualifies for the relief provided in this § VI and the taxpayer meets the requirements of this § VI, the amount required to be included in income under § 409A(a) as a result of the failure, and the resulting additional taxes under § 409A, are limited in accordance with the provisions of this section. The relief provided by this section is not available with respect to any failure unless all of the requirements of this section (including any applicable requirement to file an original or amended return, but not including the requirements of § IX of this notice) have been satisfied not later than the end of the second taxable year of the service provider following the taxable year of the service provider in which such failure occurred. The relief provided in this section is available even if additional relief would otherwise be available under § V or § VII of this notice if certain further actions were taken, so that the relief provided in this section may be utilized in lieu of the relief otherwise available under § V or § VII of this notice.

With respect to an amount to which § VI.B applies, the amount includible in income under § 409A(a) as a result of a payment described in § VI.B.2(a) is limited to the amount that should have been treated as deferred compensation under the plan (or should have continued to be deferred compensation under the plan) but was instead paid or made available to the service provider, and does not include any other amounts deferred under the plan. In addition, with respect to such amount includible in income under § 409A(a), the service provider is required to pay the additional tax under § 409A(a)(1)(B)(i)(II) (the additional 20% tax), but is not required to pay the additional tax under § 409A(a)(1)(B)(i)(I) (the premium interest tax).

This § VI.B applies if during a service provider’s taxable year an operational failure occurs that is described in § IV.B.2(a) and the requirements of § IV.B.2(b) and (c) and § VI.B.3 are met.

(a) A failure is described in this § IV.B.2(a) if an amount should have been treated as deferred compensation under the terms of the plan and any applicable deferral election, and § 409A, but the amount was not credited to the service provider’s account or otherwise treated as deferred compensation during the service provider’s taxable year, or did not remain deferred compensation after the end of such year, and because the amount was not credited to the service provider’s account or otherwise treated as deferred compensation under the plan during such year, or did not remain deferred compensation under the plan after the end of such year, the amount was paid or made available to the service provider during the service provider’s taxable year. For purposes of this section, a payment of an amount (including a payment of an amount that is one of a series of installment payments or life annuity payments) that (a) under the terms of the plan and § 409A(a)(2)(B)(i) is required to be delayed for at least six months following a separation from service, but is paid within that six-month-period, or (b) is paid in the same taxable year in which the amount was payable under the plan, but more than 30 days before such due date, may be treated as the payment of an amount that should have continued to be deferred compensation.

(b) Sections IV.A, IV.B, V.B, V.C, VII.B and VII.C of this notice do not apply because relief is not available under such sections with respect to the failure, the failure is not corrected under such sections, or otherwise.

(c) The amount paid or made available to the service provider does not exceed the limit on elective deferrals that would apply to a qualified plan under § 402(g)(1)(B) for the year of the operational failure. For purposes of this section, the plan includes any arrangements treated as a single plan under § 1.409A-1(c), so that this section will apply only if any and all erroneous payments under the plan, in the aggregate, of amounts that otherwise should have been treated as deferred compensation with respect to the service provider during the taxable year (or should have continued to be deferred compensation during the taxable year), do not exceed the limit on elective deferrals that would apply to a qualified plan under § 402(g)(1)(B) for such year.

The service recipient must report such payment on a Form W-2 (or Form W-2c) or Form 1099 (or corrected Form 1099), as applicable, as an amount includible in income under § 409A for the year in which the payment was made, including reporting such amount on a Form W-2, Box 12 using Code Z, if applicable. The service provider must include such amount in income on and pay the additional taxes under § 409A as described in this section with an original or amended federal income tax return for the taxable year in which the payment was made.

It is assumed for purposes of the following examples that Employee is an individual whose taxable year is the calendar year and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example 1: Employee makes a timely election to defer 10% of a bonus payable in 2008 pursuant to an account balance plan. The bonus is $100,000. Employer erroneously defers only 8% of the bonus, or $8,000, and pays Employee $92,000 (instead of deferring $10,000 and paying Employee $90,000). Employer discovers the error on February 1, 2010. As a payment to Employee, Employer must treat the amount as a wage payment for employment tax and reporting purposes, as appropriate, including reporting as income and wages on the 2008 Form W-2. Employer is permitted to report as income under § 409A on the 2008 Form W-2 (or 2008 Form W-2c), Box 12, using Code Z, only $2,000, and Employee is permitted to include in income under § 409A for 2008 only $2,000. Furthermore, Employee is permitted to pay the additional 20% tax only with respect to the $2,000 (or $400 in additional income tax), and is not required to pay the premium interest tax. However, to qualify for the relief, Employee must file an original or amended 2008 income tax return reflecting the additional tax on or before December 31, 2010.

Example 2: Employee is a specified employee entitled under a nonqualified deferred compensation plan to a life annuity commencing upon the first day of the seventh month following the specified employee’s separation from service. The annuity payments are $5,000 per month. Employee separates from service on April 18, 2008, and is scheduled to receive an initial annuity payment on November 1, 2008. Due to a miscalculation of the specified employee’s separation from service date, Employee receives a $5,000 payment on October 1, 2008, before the end of the six-month period following Employee’s separation from service. Employer and Employee do not discover the error until 2010. Employer must treat the amount paid to Employee as a wage payment for employment tax and reporting purposes, as appropriate, including reporting as income on the 2008 Form W-2. Employer is permitted to report as income under § 409A on the 2008 Form W-2 (or 2008 Form W-2c), Box 12, using Code Z, only $5,000, and Employee is permitted to include in income under § 409A in 2008 only $5,000. Furthermore, Employee is permitted to pay the additional 20% tax only with respect to the $5,000 (or $1,000 in additional income tax), and is not required to pay the premium interest tax. However, to qualify for the relief, Employee must file an original or amended 2008 income tax return reflecting the additional tax on or before December 31, 2010.

With respect to amounts to which § VI.C applies, the amount includible in income under § 409A(a) as a result of an operational failure described in § VI.C.2(a) is limited to the excess amount paid to the service provider, and does not include any other deferred compensation under the plan, and such amount is includible in income only when paid to the service provider in accordance with this section. In addition, with respect to this amount includible in income under § 409A(a), the service provider is required to pay the additional 20% tax, but is not required to pay the premium interest tax.

This § VI.C applies if during a service provider’s taxable year an operational failure occurs that is described in § VI.C.2(a) and the requirements of § VI.C.2(b) through (d) and §§ VI.C.3 and 4 are met:

(a) A failure is described in this § VI.C.2(a) if, under the terms of the plan and any applicable deferral election, and § 409A, an amount of deferred compensation under the plan should have been paid or made available to the service provider during the service provider’s taxable year, or an amount is treated as deferred compensation under the plan that should have been paid or made available to the service provider during the service provider’s taxable year, but such amount erroneously is not paid or made available to the service provider.

(b) Sections IV.C, V.D and VII.D of this notice do not apply because relief is not available under such sections with respect to the failure, the failure is not corrected under such sections, or otherwise.

(c) The amount that should have been paid or made available to the service provider during that service provider’s taxable year does not exceed the limit on elective deferrals that would apply to a qualified plan under § 402(g)(1)(B) for such year. For purposes of this section, the plan includes any arrangements treated as a single plan under § 1.409A-1(c), so that this section will apply only if any and all erroneous deferrals under the plan, in the aggregate, of amounts that otherwise should have been paid during the service provider’s taxable year to the service provider do not exceed the applicable limit on elective deferrals that would apply to a qualified plan under § 402(g)(1)(B).

(d) By the end of the service provider’s second taxable year following the year in which the failure occurred, the service recipient pays the service provider the amount that should have been paid or made available to the service provider.

The service recipient must report such payment on a Form W-2 or Form 1099, as applicable, for the year of the payment in accordance with the requirements of this section. If the service recipient properly reports the payment as includible in income under § 409A on a Form W-2, if applicable, for the year in which the payment was made, including reporting such amount on Form W-2, Box 12 using Code Z, the service recipient will not be subject to penalties or liability for the failure to properly withhold under § 3402(d). The service provider must include such amount in income and pay the additional taxes under § 409A(a) as described in this section on an original or amended federal income tax return.

Any earnings allocable to such amounts through the date of the payment must either be forfeited or added to the payment to the service provider, and any losses allocable to such amounts through the date of the payment must either be permanently disregarded or subtracted from the payment to the service provider.

It is assumed for purposes of the following example that Employee is an individual whose taxable year is the calendar year and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: Employee makes a timely election to defer 8% of a bonus payable in 2009 into an account balance plan. The bonus is $100,000. Employer erroneously defers 10% of the bonus, or $10,000, and pays Employee $90,000 (instead of deferring $8,000 and paying Employee $92,000). Employer discovers the error on February 1, 2010. On March 1, 2010, at which time Employee’s account balance includes $150 in earnings on the excess $2,000 credited to the account, Employer pays Employee $2,150. Employer reports the $2,150 as income under § 409A on the 2010 Form W-2, Box 1 and Box 12, using Code Z. Provided that Employee reports such income and pays the applicable taxes, including the additional § 409A taxes, on a 2010 Form 1040, Employee is not required to include any additional amounts deferred under the plan in income under § 409A(a) or to include any amount in income under § 409A for years before 2010, and with respect to the $2,150 includible in income under § 409A is required to pay only the additional 20% tax (or $425 in additional income tax), and not the premium interest tax. Employer may also have paid Employee only the $2,000 excess deferred amount if the $150 in earnings on such amount were forfeited.

If an operational failure to comply with § 409A(a) occurs but the operational failure qualifies for the relief provided in this § VII and is corrected in accordance with this § VII, the amount required to be included in income under § 409A(a) as a result of the failure, and the resulting additional taxes under § 409A, are limited in accordance with the provisions of this section. The relief provided by this section is not available with respect to any failure unless all of the requirements of this section (including any requirement to file an original or amended return, but not the requirements of § IX of this notice) have been satisfied not later than the end of the second taxable year of the service provider following the taxable year of the service provider in which such failure occurred.

With respect to amounts to which §VII.B applies, the amount includible in income under § 409A(a) as a result of a payment described in § VII.B.2(a) is limited to the amount that should have been treated as deferred compensation under the plan (or should have continued to be deferred compensation under the plan) but was instead paid or made available to the service provider, and does not include any other amounts deferred under the plan. In addition, with respect to such amount includible in income under § 409A(a), the service provider is required to pay the additional tax under § 409A(a)(1)(B)(i)(II) (the additional 20% tax) for the year in which the amount is includible in income under § 409A(a) (the year of the failure), but is not required to pay the additional tax under § 409A(a)(1)(B)(i)(I) (the premium interest tax). If the requirements of this section are met, for taxable years following the year during which the failure occurred, the amount repaid by the service provider is treated as an amount previously included in income for purposes of § 409A(c).

This § VII.B applies if during a service provider’s taxable year an operational failure occurs that is described in § VII.B.2(a) and the requirements of § VII.B.2(b) through (d) and §§ VII.B.3 and 4 are met:

(a) A failure is described in this § VII.B.2(a) if an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, and § 409A, should not have been paid or made available to a service provider in a taxable year of the service provider, was erroneously paid or made available to the service provider in that year, and such payment does not fail to meet the requirements of § 409A(a)(2)(B)(i) (requirement to delay for six months payments of a specified employee upon separation from service). For rules relating to correction of certain payments that fail to meet such requirements, see § VII.C of this notice;

(b) Sections IV.A, IV.B, V.B, V.C and VI.B of this notice do not apply because relief is not available under such sections with respect to such failure, the failure is not corrected under such sections, or otherwise;

(c) The service provider repays to the service recipient the amount that was erroneously paid or made available to the service provider on or before the last day of the service provider’s second taxable year following the year in which the erroneous overpayment occurred, and immediately after such repayment the service provider has a legally binding right under the plan to be paid the amount that would have been due if such amount had not been erroneously paid or made available to the service provider, at the same time and in the same form of payment that the amount would have been payable if such amount had not been erroneously paid or made available to the service provider.

(d) If the service provider is an insider (as defined in this § III.G) with respect to the service recipient, the service provider pays interest to the service recipient at the time the service provider repays the amount to the service recipient at a rate not less than the short-term applicable Federal rate (AFR) under § 1274(d)(1), based on annual compounding, for the month in which the erroneous payment was paid or made available, compounded as of the end of the service provider’s taxable year. For this purpose, the interest rate is the short-term AFR for the month in which the erroneous payment was paid or made available. If the amount paid on a repayment date is less than the entire erroneous payment, for each repayment date the interest calculation is applied by substituting the unpaid balance immediately before the repayment for the amount of the erroneous payment.

The service recipient must report the erroneous payment as an amount includible in income under § 409A on a Form W-2 (or Form W-2c), under Box 12, Code Z, or Form 1099 (or corrected Form 1099), as applicable, for the year in which the erroneous payment was made. The service provider must include the amount of the erroneous payment in income under § 409A on and pay the additional taxes under § 409A(a) with an original or amended federal income tax return for the year in which the erroneous payment was made, and must not claim a deduction or other adjustment reflecting the repayment for the year in which the service provider repays the amount to the service recipient.

For purposes of this § VII.B, the service provider’s account balance or other amount of deferred compensation under the plan may be adjusted for earnings (or losses) retroactive to the date the amount should have been credited to the service provider’s account or otherwise deferred (or if the amount should have otherwise remained deferred compensation after the end of the service provider’s taxable year, retroactive to the date the amount was paid or made available), provided that such adjustment must be made on or before the applicable deadline for repayment.

It is assumed for purposes of the following example that Employee is an individual whose taxable year is the calendar year, at all relevant times Employee is not an insider with respect to Employer as defined in § III.G, and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: Employee makes a timely election to defer 50% of a bonus payable in 2008 pursuant to an account balance plan. The bonus is $300,000. Employer erroneously defers only 25% of the bonus, or $75,000, and pays Employee $225,000 (instead of deferring $150,000 and paying Employee $150,000). Employer discovers the error on June 1, 2010. Employee pays $75,000 to Employer on July 1, 2010 (or alternatively, Employer retains $75,000 of compensation that Employee was otherwise due on July 1, 2010). As a payment to Employee, Employer must treat the 2008 payment as a wage payment for employment tax and reporting purposes, as appropriate, including reporting as income and wages on the 2008 Form W-2. Employer is permitted to report as income under § 409A on the 2008 Form W-2 (or 2008 Form W-2c), Box 12, using Code Z, only $75,000, and Employee is permitted to include in income under § 409A for 2008 only $75,000. Furthermore, for 2008 Employee is permitted to pay the additional 20% tax only with respect to the $75,000 (or $15,000 in additional income tax), and is not required to pay the premium interest tax. The 2010 Form W-2 provided to the Employee must not reflect any reduction in income due to the repayment, including if the repayment were made through the reduction in compensation otherwise payable to the Employee, and Employee is not permitted a deduction or any other adjustment to income on Employee’s 2010 Form 1040 reflecting the repayment. For future taxable years, Employee is treated for purposes of § 409A(c) as having previously included in income $75,000 of the amount deferred under the plan.

With respect to amounts to which § VII.C applies, the amount includible in income under § 409A(a) as a result of a payment described in § VII.C.2(a) is limited to the amount that should have been treated as deferred compensation under the plan (or should have continued to be deferred compensation under the plan) but was instead paid or made available to the service provider, and does not include any other amounts deferred under the plan. In addition, with respect to such amount includible in income under § 409A(a), the service provider is required to pay the additional tax under § 409A(a)(1)(B)(i)(II) (the additional 20% tax), but is not required to pay the additional tax under § 409A(a)(1)(B)(i)(I) (the premium interest tax). Provided that the requirements of this section are met, for taxable years following the year during which the failure occurred, the amount repaid by the service provider is treated as an amount previously included in income for purposes of § 409A(c).

This § VII.C applies if during a service provider’s taxable year an operational failure occurs that is described in § VII.C.2(a) and the requirements of § VII.C.2(b) through (d) and §§ VII.C.3 and 4 are met.

(a) A failure is described in this § VII.C.2(a) if an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, should not have been paid or made available to a service provider until a later date in the same taxable year, erroneously was paid or made available to the service provider during such taxable year more than 30 days before such later date, or an amount of nonqualified deferred compensation that, under the terms of the plan and any applicable deferral election, and § 409A(a)(2)(B)(i) (requirement to delay for six months payments to a specified employee upon separation from service), (i) would have been payable less than six months after the service provider’s separation from service if the service provider had not been a specified employee, (ii) because the service provider was a specified employee the amounts should not have been paid or made available within the six-month period following the service provider’s separation from service, and (iii) such amounts were erroneously paid or made available to the service provider within such six-month period.

(b) Sections IV.B, V.C, and VI.B of this notice do not apply because relief is not available under such sections with respect to such failure, the failure is not corrected under such sections, or otherwise.

(c) On or before the end of the second taxable year during which the failure occurred, the service provider repays to the service recipient the amount that was erroneously paid or made available to the service provider.

(d) Immediately after such repayment, the service provider has a legally binding right to receive such amount from the service recipient on the date that is that same number of days after the amount is repaid as the number of days from the date the service recipient made the erroneous payment to the service provider through the date the amount would otherwise have been payable under the terms of the plan and the applicable deferral election, and the repaid amount is not paid or made available to the service provider before such date (for rules regarding the counting of days, see § III.H of this notice).

The service recipient must report the erroneous payment as an amount includible in income under § 409A on a Form W-2 (or Form W-2c), under Box 12, Code Z, or Form 1099 (or corrected Form 1099), as applicable, for the year in which the erroneous payment was made. The service provider must include the amount of the erroneous payment in income under § 409A on and pay the additional taxes under § 409A(a) with an original or amended federal income tax return for the year in which the erroneous payment was made, and not claim a deduction or other adjustment reflecting the repayment for the year in which the service provider repays the amount to the service recipient.

For purposes of this § VII.C, the service provider’s account balance or other amount of deferred compensation under the plan may not be adjusted for earnings, but may be adjusted for losses, retroactive to the date the amount was erroneously paid or made available, provided that such adjustment must be made on or before the applicable deadline for repayment.

In each of the following examples, it is assumed that Specified Employee is an individual whose taxable year is the calendar year, at all relevant times Specified Employee is a specified employee of Employer for purposes of § 409A(a)(2)(B)(i) and an insider with respect to Employer as defined in § III.G of this notice, and Specified Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example 1: Under a nonqualified deferred compensation plan sponsored by Employer, Specified Employee has a legally binding right to a $100,000 payment of deferred compensation on the first day of the seventh month following Specified Employee’s separation from service. Specified Employee separates from service on November 15, 2008 so that the payment is due on June 1, 2009. Employer erroneously pays Specified Employee $100,000 on April 1, 2009 (61 days before the due date). Employer discovers the error on July 1, 2010, and Specified Employee repays the $100,000 to Employer on July 1, 2010. Immediately after such repayment Specified Employee has a legally binding right to receive $100,000 from Employer on August 31, 2010 (61 days after the July 1, 2010 repayment date) and Employer does not repay the amount to Specified Employee before that date. Employer treats the payment as a 2009 wage payment for employment tax and reporting purposes, as appropriate, including reporting as income and wages on the 2009 Form W-2. Employer must report as income under § 409A on the 2009 Form W-2 (or 2009 Form W-2c), Box 12, using Code Z, only the $100,000 payment, and Specified Employee is permitted to include in income under § 409A for 2009 only $100,000. Furthermore, Specified Employee is permitted to pay the additional 20% tax only with respect to the $100,000 (or $20,000 in additional income tax), and is not required to pay the premium interest tax. The 2010 Form W-2 provided to Specified Employee must not reflect any reduction in income due to the repayment, including if the repayment were made through the reduction in compensation otherwise payable to Specified Employee, and Specified Employee is not permitted a deduction or any other adjustment to the 2010 Form 1040 reflecting the repayment. For 2010, Specified Employee is treated as having previously included in income $100,000 of the amount deferred under the plan for purposes of § 409A(c).

Example 2: Under a nonqualified deferred compensation plan sponsored by Employer, Specified Employee has a legally binding right to a $100,000 payment of deferred compensation on the specified date of July 1, 2009 (so that the payment is not subject to § 409A(a)(2)(B)(i)). Employer erroneously pays Specified Employee the $100,000 on May 1, 2009 (61 days before the due date). Employer discovers the error on December 1, 2010, and Specified Employee repays the amount to Employer on December 1, 2010. Immediately after such repayment Specified Employee has a legally binding right to receive the amount from Employer on January 31, 2011 (61 days after the December 1, 2010 repayment date) and Employer does not repay the amount to Specified Employee before that date. Employer treats the 2009 payment as a wage payment for employment tax and reporting purposes, as appropriate, including reporting as income and wages on the 2009 Form W-2. Employer is permitted to report as income under § 409A on the 2009 Form W-2 (or 2008 Form W-2c), Box 12, using Code Z, only the $100,000 payment, and Specified Employee is permitted to include in income under § 409A for 2009 only $100,000. Furthermore, Employee is permitted to pay the additional 20% tax only with respect to the $100,000 (or $20,000 in additional income tax), and is not required to pay the premium interest tax. The 2010 Form W-2 provided to Specified Employee must not reflect any reduction in income due to the repayment, including if the repayment were made through the reduction in compensation otherwise payable to Specified Employee, and Specified Employee is not permitted a deduction or any other adjustment to the 2010 Form 1040 reflecting the repayment. Beginning with the taxable year 2010, Specified Employee is treated as having previously included in income $100,000 of the amount deferred under the plan for purposes of § 409A(c).

With respect to amounts to which § VII.D applies, the amount includible in income under § 409A(a) as a result of a failure described in § VII.D.2(a) is limited to the excess amount paid to the service provider, and does not include any other deferred compensation under the plan, and the amount is includible in income only when paid to the service provider in accordance with this section. In addition, with respect to this amount includible in income under § 409A(a), the service provider is required to pay the additional 20% tax, but is not required to pay the premium interest tax. Provided that the service provider includes such amount in income, pays the additional taxes and otherwise meets the requirements of this notice, for taxable years after the year of the failure the amount is treated as previously included in income for purposes of § 409A(c).

This § VII.D applies if an operational failure occurs during a service provider’s taxable year that is described in § VII.D.2(a) and the requirements of § VII.D.2(b) through (c) and §§ VII.D.3 and 4 are met.

(a) A failure is described in this § VII.D.2(a) if, under the terms of the plan and any applicable deferral election, and § 409A, an amount of deferred compensation under the plan should have been paid or made available to the service provider during the service provider’s taxable year, or an amount is treated as deferred compensation under the plan that should have been paid or made available to the service provider during the service provider’s taxable year, but such amount erroneously is not paid or made available to the service provider;

(b) Sections IV.C, V.D and VI.C of this notice do not apply because relief is not available under such sections with respect to the failure, the failure is not corrected under such sections, or otherwise;

(c) By the end of the service provider’s second taxable year following the taxable year during which the failure occurred, the service recipient pays the service provider the amount that should have been paid or made available to the service provider.

The service recipient must report such payment on a Form W-2 (or Form W-2c) or Form 1099 (or corrected Form 1099), as applicable, for the taxable year in which the payment was scheduled to be made under the terms of the plan (or, in the case of an amount that should not have been deferred, the taxable year in which the payment was scheduled to be made but for the erroneous deferral). If the service recipient properly reports the payment as includible in income under § 409A on a Form W-2, if applicable, for the year in which the payment was scheduled to be made, including reporting such amount on Form W-2, Box 12 using Code Z, the service recipient will not be subject to penalties or liability for the failure to properly withhold under § 3402(d). The service provider must include such amount in income on and pay the additional taxes under § 409A(a) with an original or amended federal income tax return for the taxable year in which the payment was scheduled to be made under the terms of the plan (or, in the case of an amount that should not have been deferred, the taxable year in which the payment was scheduled to be made but for the erroneous deferral).

The remaining account balance (or other deferred compensation under the plan) must be adjusted for earnings and may be adjusted for losses retroactive to the date the excess amount was incorrectly credited to the service provider’s account or otherwise incorrectly treated as deferred under the plan, provided that such adjustment must be made on or before the last day of the service provider’s taxable year in which such amount was paid to the service provider under § VII.D.2(c). The service recipient may not pay the service provider interest, or otherwise compensate the service provider for the use of such funds.

It is assumed for purposes of the following example that Employee is an individual whose taxable year is the calendar year, at all relevant times Employee is an insider with respect to Employer as defined in § III.G of this notice, and Employee and Employer both satisfy the applicable requirements of §§ III and IX of this notice.

Example: Employee makes a timely election to defer 10% of a bonus payable in 2009 into an account balance plan. The bonus is $300,000. Employer erroneously defers 20% of the bonus, or $60,000, and pays Employee $240,000 (instead of deferring $30,000 and paying Employee $270,000). Employer discovers the error on February 1, 2010, so that the excess deferred amount of $30,000 is not corrected by December 31, 2009. On March 1, 2010, at which time Employee’s account balance includes $1,500 in earnings on the excess $30,000 credited to the account, Employer pays Employee $30,000 and Employee forfeits the $1,500 in earnings. Employer reports the $30,000 as income under § 409A on the 2009 Form W-2, Box 1 and Box 12, using Code Z. Provided that Employee reports such income and pays the applicable taxes, including the additional § 409A taxes, on a timely filed 2009 Form 1040 (or amended 2009 Form 1040), and satisfies the other applicable requirements of this § VII, Employee is permitted to include in income under § 409A only $30,000 and to pay only the additional 20% tax (or $6,000 in additional income tax), and not the premium interest tax. Beginning with the taxable year 2010, Specified Employee is treated as having previously included in income $30,000 of the amount deferred under the plan for purposes of § 409A(c).

A service recipient described in § IV of this notice must attach to its timely-filed (including extensions) original federal income tax return for its taxable year in which the failure occurred a statement entitled “§ 409A Relief under § IV of Notice 2008-113” setting out the information required by § IX.A.1 of this notice, and must provide to each service provider affected by such failure a statement entitled “§ 409A Relief under § IV of Notice 2008-113” setting out the information required by § IX.A.2 of this notice by no later than the date (with extensions) on which it is required to provide an information return (Form W-2 or Form 1099) to such service provider for the calendar year in which such failure occurred (or if no information return is required for such service provider, not later than the January 31 following the calendar year in which such failure occurred). Notwithstanding the foregoing, to qualify for the relief described in § IV.D of this notice (Correction of Exercise Price of Otherwise Excluded Stock Rights), the service recipient is not required to provide a statement to such service provider with respect to such failure. In addition, each taxpayer relying on the relief provided in § IV of this notice must make reasonable efforts to provide notice to the examining agent upon the commencement of an examination of such taxpayer’s federal tax return that the taxpayer was relying upon the relief provided under this notice for years covered by the examination (except in the case of a service provider for whom a correction has been made under § IV.D of this notice).

The service recipient must attach a statement to its federal income tax return stating that it is relying upon § IV of this notice with respect to a correction of a failure to comply with § 409A and setting out the following information with respect to each such failure:

(a) The name and taxpayer identification number of each service provider affected by the failure and whether such service provider is an insider with respect to the service recipient. Where the same or a substantially similar operational failure has occurred with respect to multiple service providers, the information required in § IX.A.1(b) through (e) of this notice may be supplied only once with respect to such operational failure, provided that the identification of each service provider affected by the operational failure in this § IX.A.1(a) references such information and the amount involved in the operational failure with respect to such service provider.

(b) Identification of the nonqualified deferred compensation plan with respect to which such failure occurred.

(c) A brief description of the failure and the circumstances under which it occurred, including the amount involved and date on which the failure occurred.

(d) A brief description of the steps taken to correct the failure and the date on which such correction was completed.

(e) A statement that the operational failure is eligible for the correction under the terms of this notice, and that the service recipient has taken all actions required, and otherwise met all requirements, for such correction.

The service recipient must provide the following information to each service provider affected by correction of a failure to comply with § 409A who is entitled to relief under § IV of this notice (other than § IV.D of this notice (Correction of Exercise Price of Otherwise Excluded Stock Rights)) with respect to such failure:

(a) A statement that the service provider is entitled to the relief provided in § IV of this notice with respect to a failure to comply with § 409A.

(b) The information described in § IX.A.1(b) through (e) of this notice.

A service recipient described in § V, § VI, or § VII of this notice must attach to its timely-filed (including extensions) original federal income tax return for its taxable year in which it discovers the failure, and for a service recipient described in § VIII of this notice its timely-failed (including extensions) original federal income tax return for the taxable year including January 1, 2009, a statement entitled “§ 409A Relief under § [INSERT APPROPRIATE SECTION] of Notice 2008-113” setting out the information required by § IX.B.1 of this notice. In addition, not later than the date (with extensions) on which it is required to provide an information return (Form W-2 or 1099) for the calendar year in which it discovers such failure to a service provider who is affected by such failure (or if no information return is required for such service provider, not later than the January 31 following the calendar year in which it discovers such failure), or in the case of a service recipient described in § VIII, not later than January 31, 2010, such service recipient must provide to each such service provider a statement entitled “§ 409A Relief under § [INSERT APPROPRIATE SECTION] of Notice 2008-113” setting out the information required by § IX.B.2 of this notice. A service provider who is relying on the relief provided in § V, § VI, or § VII of this notice with respect to a failure to comply with § 409A must attach to the service provider’s timely-filed (including extensions) original federal income tax return for the year in which such failure was discovered (or for a service provider who is relying on the relief provided in § VIII of this notice, the service provider’s timely-filed (including extensions) original federal income tax return for 2009) the information required by § IX.B.3 of this notice. In addition, each taxpayer relying on the relief provided in § V, § VI, § VII or § VIII of this notice must make reasonable efforts to provide notice to the examining agent upon the commencement of an examination of such taxpayer’s federal tax return that the taxpayer was relying upon the relief provided under this notice for years covered by the examination.

The service recipient must attach a statement to its return setting out the following information with respect to each failure described in § V, § VI, § VII or § VIII of this notice:

(a) The name and taxpayer identification number of each service provider affected by the failure. Where the same or a substantially similar operational failure has occurred with respect to multiple service providers, the information required in § IX.B.1(b) through (e) of this notice may be supplied only once with respect to such operational failure, provided that the identification of each service provider affected by the operational failure in this § IX.B.1(a) references such information and the amount involved in the operational failure with respect to such service provider.

(b) Identification of the nonqualified deferred compensation plan with respect to which such failure occurred.

(c) A brief description of the failure and the circumstances under which it occurred, including the amount involved and date on which the failure occurred.

(d) A brief description of the steps taken by the service recipient to avoid a recurrence of the failure, including the date on which such steps were implemented.

(e) A statement that the operational failure is eligible for the correction under the terms of this notice, and that the service recipient has taken all actions required, and otherwise met all requirements, for such correction.

The service recipient must provide the following information to each service provider affected by a failure to comply with § 409A who is entitled to relief under § V, § VI, § VII or § VIII of this notice with respect to such failure:

(a) A statement that the service provider is entitled to the relief provided in § V, § VI, § VII, or § VIII of this notice (as applicable) with respect to a failure to comply with § 409A and that the service provider must attach a copy of the statement to the service provider’s income tax return for the taxable year in which the failure was discovered.

(b) The information described in § IX.B.1(b) through (e) of this notice.

The service provider must attach to the service provider’s income tax return a copy of the statement the service provider received from the service recipient with respect to each such failure.

Section 409A was added to the Internal Revenue Code (Code) by section 885 of the American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418). Section 409A generally provides that if certain requirements are not met at any time during a taxable year, amounts deferred under a nonqualified deferred compensation plan for that year and all previous taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Section 409A also includes rules applicable to certain trusts or similar arrangements associated with nonqualified deferred compensation.

On December 20, 2004, the IRS issued Notice 2005-1, 2005-1 C.B. 274, setting forth initial guidance on the application of section 409A, and providing transition guidance in accordance with the terms of the statute. On April 10, 2007, the Treasury Department and the IRS issued final regulations under section 409A. (T.D. 9321, 2007-19 I.R.B. 1123 [72 FR 19234], April 17, 2007). The final regulations are applicable for taxable years beginning after December 31, 2008. See Notice 2007-86, 2007-46 I.R.B. 990. Notice 2005-1 and the final regulations do not address the calculation of the amount includible in income under section 409A if a plan fails to meet the requirements of section 409A and the calculation of the additional taxes applicable to such income. On November 30, 2006, the Treasury Department and the IRS issued Notice 2006-100, 2006-2 C.B. 1109, providing interim guidance for taxable years beginning in 2005 and 2006 on the calculation of the amount includible in income if the requirements of section 409A were not met, and requesting comments on these issues for use in formulating future guidance. On October 23, 2007, the Treasury Department and the IRS issued Notice 2007-89, 2007-46 I.R.B. 998, providing similar interim guidance for taxable years beginning in 2007. See §601.601(d)(2)(ii)(b).

Commentators submitted a number of comments addressing the topics covered by these proposed regulations in response to Notice 2005-1, Notice 2006-100, Notice 2007-89, and the regulations, all of which were considered by the Treasury Department and the IRS in formulating these proposed regulations.

These proposed regulations address the calculation of amounts includible in income under section 409A(a), and related issues including the calculation of the additional taxes applicable to such income. Section 409A(a) generally provides that amounts deferred under a nonqualified deferred compensation plan in all years are includible in income unless certain requirements are met. The requirements under section 409A(a) generally relate to the time and form of payment of amounts deferred under the plan, including the establishment of the time and form of payment through initial deferral elections and restrictions on the ability to change the time and form of payment through subsequent deferral elections or the acceleration of payment schedules. As provided in the regulations previously issued under section 409A, a nonqualified deferred compensation plan must comply with the requirements of section 409A(a) both in form and in operation.

Taxpayers may also be required to include amounts in income under section 409A(b). Section 409A(b) generally applies to a transfer of assets to a trust or similar arrangement, or to a restriction of assets, for purposes of paying nonqualified deferred compensation, if such trust or assets are located outside the United States, if such assets are transferred during a restricted period with respect to a single-employer defined benefit plan sponsored by the service recipient, or if such assets are restricted to the provision of benefits under a nonqualified deferred compensation plan in connection with a change in the service recipient’s financial health. These proposed regulations do not address the application of section 409A(b), including the calculation of amounts includible in income if the requirements of section 409A(b) are not met. For guidance on the calculation of such amounts for taxable years beginning on or before January 1, 2007, including the application of the Federal income tax withholding requirements, see Notice 2007-89. The Treasury Department and the IRS anticipate issuing further interim guidance for later taxable years on the calculation of the amount includible in income under section 409A(b) and the application of the Federal income tax withholding requirements to such an amount.

Commentators asked how section 409A(a) applies if a plan fails to comply with section 409A(a) during a taxable year and the service provider continues to have amounts deferred under the plan in subsequent years during which the plan otherwise complies with section 409A(a) both in form and in operation. The statutory language may be construed to provide that a failure is treated as continuing during taxable years beyond the year in which the initial failure occurred, if the failure continues to affect amounts deferred under the plan. For example, if an amount has been improperly deferred under the plan, the statutory language could be construed to provide that the plan fails to comply with section 409A(a) during all taxable years during which the improperly deferred amounts remain deferred. However, this position could cause harsh results and would add administrative complexity. For example, a service provider could be required to include in income, and pay additional taxes on, amounts deferred over a number of taxable years even if the sole failure to comply with section 409A(a) occurred many years earlier. In addition, even if there were no failure in the current year, to determine a taxpayer’s liability for income taxes with respect to nonqualified deferred compensation for a particular year, the taxpayer and the IRS would need to examine the plan’s form and operation for every year in which the service provider had an amount deferred under the plan to determine if there was a failure to comply with section 409A(a) during any of those years.

For these reasons, the proposed regulations do not adopt this interpretation and instead generally would apply the adverse tax consequences that result from a failure to comply with section 409A(a) only with respect to amounts deferred under a plan in the year in which such noncompliance occurs and all previous taxable years, to the extent such amounts are not subject to a substantial risk of forfeiture and have not previously been included in income. Therefore, under the proposed regulations, a failure to meet the requirements of section 409A(a) during a service provider’s taxable year generally would not affect the taxation of amounts deferred under the plan for a subsequent taxable year during which the plan complies with section 409A(a) in form and in operation with respect to all amounts deferred under the plan. This would apply even though the amount deferred under the plan as of the end of such subsequent taxable year includes amounts deferred in earlier years during which the plan failed to comply with section 409A(a) (including, for example, amounts deferred pursuant to an untimely deferral election in the earlier year), as long as there was no failure under the plan in a later year. Because there would be no continuing or permanent failure with respect to a plan that fails to comply with section 409A(a) during an earlier year, each taxable year would be analyzed independently to determine if there was a failure. As a result, assessment of tax liabilities due to a plan’s failure to comply with the requirements of section 409A(a) in a closed year would be time-barred. But, if a service provider fails to properly include amounts in income under section 409A(a) for a taxable year during which there was a failure to comply with section 409A(a), and assessment of taxes with respect to such year becomes barred by the statute of limitations, then the taxpayer’s duty of consistency would prevent the service provider from claiming a tax benefit in a later year with respect to such amount (such as, for example, by claiming any type of “basis” or “investment in the contract” in the year the service recipient paid such amount to the service provider pursuant to the plan’s terms).

Under the general rule in the proposed regulations, if all of a taxpayer’s deferred amounts under a plan are nonvested and the taxpayer makes an impermissible deferral election or accelerates the time of payment with respect to some or all of the nonvested deferred amount, the nonvested deferred amount generally would not be includible in income under section 409A(a) in the year of the impermissible change in time and form of payment (although if there were vested amounts deferred under the plan, such amounts would be includible in income under section 409A(a)). In the subsequent taxable year in which the service provider becomes vested in the deferred amount, the plan might comply with section 409A(a) in form and in operation, so that under the general rule no income inclusion would be required and no additional taxes would be due for that year as a result of the late deferral election or acceleration of payment. In proposing to adopt this interpretation of the statute, the Treasury Department and the IRS do not intend to create an opportunity for taxpayers who ignore the requirements of section 409A(a) with respect to nonvested amounts to avoid the payment of taxes that would otherwise be due as a result of such a failure to comply. To ensure that this rule does not become a means for taxpayers to disregard the requirements of the statute, the proposed regulations would disregard a substantial risk of forfeiture for purposes of determining the amount includible in income under section 409A^[3] with respect to certain nonvested deferred amounts, if the facts and circumstances indicate that the service recipient has a pattern or practice of permitting such impermissible changes in the time and form of payment with respect to nonvested deferred amounts (regardless of whether such changes also apply to vested deferred amounts). If such a pattern or practice exists, an amount deferred under a plan that is otherwise subject to a substantial risk of forfeiture is not treated as subject to a substantial risk of forfeiture if an impermissible change in the time and form of payment (including an impermissible initial deferral election) applies to the amount deferred or if the facts and circumstances indicate that the amount deferred would be affected by such pattern or practice.

Section 409A(a)(1)(A) generally provides that if at any time during a taxable year a nonqualified deferred compensation plan fails to meet the requirements of section 409A(a)(2) (payments), section 409A(a)(3) (the acceleration of payments), or section 409A(a)(4) (deferral elections), or is not operated in accordance with such requirements, all compensation deferred under the plan for the taxable year and all preceding taxable years is includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Accordingly, to calculate the amount includible in income upon a failure to meet the requirements of section 409A(a), the first step is to determine the total amount deferred under the plan for the service provider’s taxable year and all preceding taxable years. The second step is to calculate the portion of the total amount deferred for the taxable year, if any, that is either subject to a substantial risk of forfeiture (nonvested) or has been included in income in a previous taxable year. The last step is to subtract the amount determined in step two from the amount determined in step one. The excess of the amount determined in step one over the amount determined in step two is the amount includible in income and subject to additional income taxes for the year as a result of the plan’s failure to comply with section 409A(a). Sections III.B through III.D of this preamble explain how the proposed regulations would address the first step in the process of determining the amount includible in income under section 409A, calculating the total amount deferred for the taxable year.

In general, under the proposed regulations, the amount deferred under a plan^[4] for a taxable year and all preceding taxable years would be referred to as the total amount deferred for a taxable year and would be determined as of the last day of the taxable year. Therefore, for calendar year taxpayers, such as most individuals, the relevant calculation date would be December 31. Determining the total amount deferred for the taxable year as of the last day of the taxable year during which a plan fails to comply with section 409A(a) would allow taxpayers to avoid the administrative burden of tracking amounts deferred under a plan on a daily basis, because adjustments would not be made to reflect notional earnings or losses or other fluctuations in the amount payable under the plan as they occur during the taxable year, but would be applied only on a net basis as of the last day of the taxable year. For example, if a service provider has a calendar year taxable year, and if the service provider’s account balance under a plan is $105,000 as of July 1, but is only $100,000 as of December 31 of the same year, due solely to deemed investment losses (with no payments made under the plan during the year), the total amount deferred under the plan for that taxable year would be $100,000.

Similarly, the total amount deferred for a taxable year would not necessarily be the greatest total amount deferred for any previous year, even if no amount has been paid under the plan. For example, if a service provider has a calendar year taxable year, and if the service provider’s account balance under a plan as of December 31, 2010 is $105,000, as of December 31, 2011 is $100,000, and as of December 31, 2012 is $95,000, and if those decreases are due solely to deemed investment losses (and no payments were made under the plan in 2011 or 2012), then the total amount deferred for 2011 would be $100,000 and the total amount deferred for 2012 would be $95,000.

If a service recipient pays an amount deferred under a plan during a taxable year, the amount remaining to be paid to (or on behalf of) the service provider under the plan as of the last day of the taxable year will have been reduced as a result of such payment. To reasonably reflect the effect of payments made during a taxable year, the proposed regulations provide that the sum of all payments of amounts deferred under a plan during a taxable year, including all payments that are substitutes for an amount deferred, would be added to the amounts deferred outstanding as of the last day of the taxable year (determined in accordance with the regulations) to calculate the total amount deferred for such taxable year. To lower the administrative burden of the calculation, the proposed regulations provide that the addition of such payments to the total amount deferred for the taxable year would not be increased by any interest or other amount to reflect the time value of money. The total amount deferred for a taxable year would include all payments, regardless of whether the service recipient made some or all of the payments in accordance with the requirements of section 409A(a). For example, if during a taxable year an employee receives a single sum payment of the entire amount deferred under a plan, the employee would have a total amount deferred under the plan for the taxable year equal to the amount paid.

Because the total amount deferred would be determined as of the last day of the taxable year, losses that occur during a taxable year (due to losses on deemed investments, actuarial losses, and other similar reductions in the amount payable under a plan) generally would be netted with any gains that occur during the same taxable year (due to deemed investment or actuarial gains, additional deferrals, or other additions to the amount payable under the plan). To that extent, deemed investment losses, actuarial losses, or other similar reductions could offset deemed investment or actuarial gains, additional deferrals, or other increases in the amount deferred under the plan for purposes of determining the total amount deferred for the taxable year. This would apply regardless of whether a deemed loss occurs before or after the date of any specific failure to comply with section 409A(a). For example, assume a service provider begins a taxable year with a $10,000 balance under an account balance plan. During the year, the service provider has an additional deferral to the plan of $5,000 and incurs net deemed investment losses of $2,000. No payments are made pursuant to the plan during the year, the employee has no vested legally binding right to further deferrals to the plan, and there are no other changes to the account balance. The total amount deferred for the taxable year would equal the $13,000 account balance ($10,000 + $5,000 - $2,000) as of the last day of the taxable year.

Under section 409A(d)(5), income (whether actual or notional) attributable to deferred compensation constitutes deferred compensation for purposes of section 409A. See §1.409A-1(b)(2). For example, if a service provider must include a deferred amount in income because an account balance plan in which the service provider participates fails to satisfy the requirements of section 409A(a), notional earnings credited with respect to such amount constitute deferred compensation and are subject to section 409A. If the plan also fails to comply with the requirements of section 409A(a) during a subsequent taxable year, the notional earnings must be included in income and are subject to the additional taxes under section 409A(a), notwithstanding that the “principal” amount of deferred compensation has already been included in income under section 409A(a) for a previous year.

In this respect, the treatment of earnings on nonqualified deferred compensation for purposes of section 409A is significantly different from the treatment of such earnings for purposes of section 3121(v)(2) (application of Federal Insurance Contributions Act (FICA) tax to nonqualified deferred compensation). As a result, notional earnings ordinarily are deferred compensation that is subject to section 409A even if such earnings would not constitute wages for purposes of the FICA tax when paid to the service provider because of the special timing rule under section 3121(v)(2) and §31.3121(v)(2)-1(a)(2). Accordingly, the proposed regulations provide that earnings that are credited with respect to deferred compensation during a taxable year or that were credited in previous taxable years, and earnings with respect to deferred compensation that are paid during such taxable year, must be included in determining the total amount deferred for the taxable year.

Section 409A(a)(1)(A)(i) states that if at any time during a taxable year a nonqualified deferred compensation plan fails to meet the requirements of section 409A(a), all compensation deferred under the plan for the taxable year and all preceding years shall be includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture (vested) and not previously included in gross income. The statutory reference to the deferred compensation required to be included in income under section 409A(a) does not distinguish between amounts deferred in a taxable year before a failure to meet the requirements of section 409A(a), and amounts deferred in the same taxable year after such failure. Accordingly, under the proposed regulations the total amount deferred under a plan for a taxable year would refer to the total amount deferred as of the last day of the taxable year, regardless of the date upon which a failure occurs. For example, if a plan is amended during a service provider’s taxable year to add a provision that fails to meet the requirements of section 409A(a), the total amount deferred as of the last day of the taxable year would be includible in income under section 409A(a). This would include all payments under the plan during the taxable year, including payments made before the amendment (regardless of whether such payments are made in accordance with the requirements of section 409A(a)). Similarly, if the plan in operation fails to meet the requirements of section 409A(a) during the taxable year, the total amount deferred for the taxable year would include all payments under the plan during the taxable year, including payments made before and after the date the failure occurred.

The proposed regulations provide that amounts deferred under a plan during a taxable year in which a failure occurs must be included in income under section 409A(a) even if such deferrals occur after the failure and are otherwise made in compliance with section 409A(a). For example, salary deferrals for periods during a taxable year after an impermissible accelerated payment under the same plan during the same taxable year would be required to be included in the total amount deferred for the taxable year and included in income under section 409A(a), regardless of whether the salary deferrals are made in accordance with an otherwise compliant deferral election.

Under §1.409A-1(b)(4), an arrangement may not provide for deferred compensation if the amount is payable, and is paid, during a limited period of time following the later of the date the service provider obtains a legally binding right to the payment or the date such right is no longer subject to a substantial risk of forfeiture (generally referred to as the applicable 2¹/₂ month period). Whether an amount will be treated as a short-term deferral or as deferred compensation may not be determinable as of the last day of the service provider’s taxable year, because it may depend upon whether the amount is paid on or before the end of the applicable 2¹/₂ month period. For purposes of calculating the total amount deferred for a taxable year, the proposed regulations provide that the right to a payment that, under the terms of the arrangement and the facts and circumstances as of the last day of the taxable year, may or may not be a short-term deferral, is not included in the total amount deferred. In addition, even if such amount is not paid by the end of the applicable 2¹/₂ month period so that the amount would be deferred compensation, the amount would not be includible in the total amount deferred until the service provider’s taxable year in which the applicable 2¹/₂ month period expired. For example, assume that as of December 31, 2010, an employee whose taxable year is the calendar year is entitled to an annual bonus that is scheduled to be paid on March 15, 2011, and that the bonus would qualify as a short-term deferral if paid on or before the end of the applicable 2¹/₂ month period, which ends on March 15, 2011. The bonus would not be included in the total amount deferred for 2010. This would be true regardless of whether the bonus is paid on or before March 15, 2011. However, the bonus would be includible in the total amount deferred for 2011 if the bonus is not paid on or before March 15, 2011.

Generally, the proposed regulations provide that the total amount deferred under a plan for a taxable year is the present value as of the close of the last day of a service provider’s taxable year of all amounts payable to the service provider under the plan, plus amounts paid to the service provider during the taxable year. For this purpose, present value generally would mean the value as of the close of the last day of the service provider’s relevant taxable year of the amount or series of amounts due thereafter, where each such amount is multiplied by the probability that the condition or conditions on which payment of the amount is contingent would be satisfied (subject to special treatment for certain contingencies), discounted according to an assumed rate of interest to reflect the time value of money. A discount for the probability that the service provider will die before commencement of payments under the plan would be permitted to the extent that the payments would be forfeited upon the service provider’s death. The proposed regulations provide that the present value cannot be discounted for the probability that payments will not be made (or will be reduced) because of the unfunded status of the plan, the risk associated with any deemed investment of amounts deferred under the plan, the risk that the service recipient or another party will be unwilling or unable to pay amounts deferred under the plan when due, the possibility of future plan amendments, the possibility of a future change in the law, or similar risks or contingencies. The proposed regulations further provide that restrictions on payment that will or may lapse with the passage of time, such as a temporary risk of forfeiture that is not a substantial risk of forfeiture, are not taken into account in determining present value. However, any potential additional deferrals contingent upon a bona fide requirement that the service provider perform services after the taxable year, such as potential salary deferrals, service credits or additions due to increases in compensation, would not be taken into account in determining the total amount deferred for the taxable year.

For purposes of calculating the present value of the benefit, the proposed regulations require the use of reasonable actuarial assumptions and methods. Whether assumptions and methods are reasonable for this purpose would be determined as of each date the benefit is valued for purposes of determining the total amount deferred.

The proposed regulations also provide certain rules relating to the crediting of earnings, generally providing that the schedule for crediting earnings will be respected if the earnings are credited at least once a year. In general, if the rules with respect to the crediting of earnings are met, any additional earnings that would be credited after the end of the taxable year only if the service provider continued performing services after the end of the year would not be includible in the total amount deferred for the year. If the right to earnings is based on an unreasonably high interest rate, the proposed regulations generally would characterize the unreasonable portion of earnings as a current right to additional deferred compensation. In addition, if earnings are based on a rate of return that does not qualify as a predetermined actual investment or a reasonable interest rate, the proposed regulations provide that the general calculation rules as applied to formula amounts would apply.

The proposed regulations provide other general rules that address issues such as plan terms under which amounts may be payable when a triggering event occurs, rather than on a fixed date, or plan terms under which the amount payable is determined in accordance with a formula, rather than being set at a fixed amount. In addition, the proposed regulations provide specific rules under which the total amounts deferred under certain types of nonqualified deferred compensation plans would be determined. The rules applicable to specific types of plans would apply in conjunction with the general rules. As a result, under the proposed regulations, an amount of deferred compensation may be includible in income under section 409A(a) even if the same amount would not yet be includible in wages under section 3121(v)(2).

To calculate the total amount deferred under a nonqualified deferred compensation plan, it is necessary to determine the time and form of payment pursuant to which the amount will be paid. Under the proposed regulations, if an amount deferred under a plan could be payable pursuant to more than one time and form of payment under the plan, the amount would be treated as payable in the available time and form of payment that has the highest present value. For this purpose, a time and form of payment generally would be an available time and form of payment to the extent a deferred amount under the plan could be payable pursuant to such time and form of payment under the plan’s terms, provided that if there is a bona fide requirement that the service provider continue to perform services after the end of the taxable year to be eligible for the time and form of payment, the time and form of payment would not be treated as available. If an alternative time and form of payment is available only at the service recipient’s discretion, the time and form of payment would not be treated as available unless the service provider has a legally binding right under the principles of §1.409A-1(b)(1) to any additional value that would be generated by the service recipient’s exercise of such discretion. If a service provider has begun receiving payments of an amount deferred under a plan and neither the service provider nor the service recipient can change the time and form of payment of such deferred amount without the other party’s approval, then no other time and form of payment under the plan would be treated as available if such approval requirement has substantive significance.

In certain instances, a service provider will be eligible for an alternative time and form of payment only if the service provider has a certain status as of a future date. For example, a time and form of payment may be available only if the service provider is married at the time the payment commences. The proposed regulations generally provide that for purposes of determining whether the service provider will meet the eligibility requirements so that an alternative time and form of payment is available, the service provider is assumed to continue in the service provider’s status as of the last day of the taxable year. However, if the eligibility requirement is not bona fide and does not serve a bona fide business purpose, the eligibility requirement would be disregarded and the service provider would be treated as eligible for the alternative time and form of payment. For this purpose, an eligibility condition based upon the service provider’s marital status, parental status, or status as a U.S. citizen or lawful permanent resident would be presumed to be bona fide and to serve a bona fide business purpose.

If the calculation of the present value of the amount payable to a service provider under a plan requires assumptions relating to the timing of the payment because the payment date is, or could be, a triggering event rather than a specified date, the proposed regulations specify certain assumptions that must be applied to make such calculation. First, the possibility that a particular payment trigger would occur generally would not be taken into account if the right to the payment would be subject to a substantial risk of forfeiture if that payment trigger were the only specified payment trigger. For example, if an amount is payable upon the earlier of the attainment of a specified age or an involuntary separation from service (as defined in the §1.409A-1(n)), the present value of the amount payable upon involuntary separation from service would not be taken into account if the payment would be subject to a substantial risk of forfeiture if that were the only payment trigger. However, if multiple triggers with respect to the same payment would, applied individually, constitute substantial risks of forfeiture, such triggers would not be disregarded under this rule unless all such triggers, applied in the aggregate, would also constitute a substantial risk of forfeiture. Second, the possibility that an unforeseeable emergency, as defined in §1.409A-3(i)(3), would occur and result in a payment also would not be taken into account for purposes of calculating the amount deferred.

If an amount is payable upon a service provider’s death, it generally would not be necessary to make assumptions concerning when the service provider would die because any additional value due to the amount becoming payable upon the service provider’s death generally would be treated as an amount payable under a death benefit plan, and amounts payable under a death benefit plan are not deferred compensation for purposes of section 409A(a). Similarly, such assumptions generally would not be necessary for an amount payable upon a service provider’s disability, because any additional value due to the amount becoming payable upon the service provider’s disability generally would be payable under a disability plan, and amounts payable under a disability plan are not deferred compensation for purposes of section 409A. See §1.409A-1(a)(5).

In other cases where it is necessary to make assumptions concerning when a payment trigger would occur to determine the amount deferred under a plan, taxpayers generally would be required to assume that the payment trigger would occur at the earliest possible time that the conditions under which the amount would become payable reasonably could occur, based on the facts and circumstances as of the last day of the taxable year. However, the proposed regulations provide a special rule for amounts payable due to the service provider’s separation from service, termination of employment, or other event requiring the service provider’s reduction or cessation of services for the service recipient. In such a case, the total amount deferred would be calculated as if the service provider had met the required reduction or cessation of services as of the close of the last day of the service provider’s taxable year for which such calculation was being made. These rules would apply regardless of whether the payment trigger has or has not occurred as of any future date upon which the amount deferred for a prior taxable year was being determined.

The Treasury Department and the IRS recognize that for some service providers, the earliest possible time that a payment trigger reasonably could occur will not be the most likely time the trigger will occur. Similarly, the Treasury Department and the IRS recognize that for many service providers, the assumption that the service provider ceases providing services as of the end of the taxable year may not be realistic. The Treasury Department and the IRS request comments on alternative standards that could be utilized for these payment triggers.

An alternative approach might presume a date upon which the service provider will separate from service such as, for example, 100 months after the last day of the service provider’s taxable year for which the amount deferred is being calculated. Cf. §1.280G-1 Q&A 24(c)(4). Such a standard, however, would not reflect the value of additional deferred compensation that would be paid only if the service provider separates from service before the end of the 100-month period, such as an early retirement subsidy or a window benefit, unless special rules were developed to address such situations. Another issue that arises is whether such a standard should apply if the service provider is likely to retire during the next 100 months, such as if a service provider has attained a certain age, number of years of service, or level of financial independence. However, the Treasury Department and the IRS are concerned whether an approach involving the application of individualized standards to determine the probability that a particular service provider will separate from service will be administrable in practice.

Once the date that a payment will occur has been fixed (either as a specified date under the plan’s terms or through application of the rules in the proposed regulations), it is necessary to quantify the amount of the payment to which the service provider will be entitled to calculate the total amount deferred under a nonqualified deferred compensation plan. However, certain plans may define the amount payable by a formula or other method that is based on factors that may vary in future years. In general, if, at the end of the service provider’s taxable year, the amount to be paid in a future year is a formula amount, the proposed regulations provide that the amount payable in the future year for purposes of calculating the total amount deferred must be determined using reasonable assumptions.

A deferred amount generally would be a formula amount subject to the reasonable assumptions standard if calculating the payment amount is dependent upon factors that are not determinable after taking into consideration all of the assumptions and other calculation rules provided in the proposed regulations. For example, a future payment equal to one percent of a corporation’s net profits over five calendar years generally would be a formula amount until the last day of the fifth year, because the corporation’s net profits over the five calendar years could not be determined by applying the assumptions and rules set out in the proposed regulations until the end of the fifth calendar year.

A deferred amount would not be a formula amount at the end of the taxable year merely because the information necessary to determine the amount is not readily available, if such information exists at the end of such taxable year. For example, if a deferred amount is based upon the service recipient’s profits for its taxable year that coincides with the service provider’s taxable year, the amount would be considered a non-formula amount at the end of the taxable year because the information necessary to determine the service recipient’s profits exists, although such information may not be immediately accessible.

The right to have a deferred amount credited with reasonable earnings that may vary, for example because the earnings are based on the value of a deemed investment, would not affect whether the right to the underlying deferred amount is a formula amount. In addition, the amount of earnings to which the service provider has become entitled at the end of a particular taxable year would not be treated as a formula amount, regardless of whether such earnings could subsequently be reduced by future losses. For example, assume a service provider has a $10,000 account under an account balance plan, to be paid out in three years subject to earnings based on a mutual fund designed to replicate the performance of the S&P 500 index. At the end of Year 1, the account balance is $10,500. For Year 1, the service provider would have a total amount deferred equal to $10,500, notwithstanding that the amount could be reduced by future losses based on losses in the mutual fund.

Under the proposed regulations, the amount deferred under an account balance plan for a taxable year generally equals the aggregate balance of all accounts under the plan as of the close of the last day of the taxable year, plus any amounts paid from such plan during the taxable year, so long as the aggregate account balance is determined using not more than a reasonable interest rate or the return on a predetermined actual investment. This rule would apply regardless of whether the applicable interest rate used to determine the earnings was higher or lower than the applicable Federal rate (AFR) under section 1274(d), provided that the interest rate was no more than a reasonable rate of interest. For a description of the proposed rules on how to calculate the total amount deferred if the right to earnings is based on an unreasonably high interest rate, see section III.C.1 of this preamble.

Under the proposed regulations, the total amount deferred for a taxable year under a nonaccount balance plan generally is calculated under the general calculation rule. See section III.C of this preamble. For example, if a service provider has the right to be paid on a specified future date a fixed amount that is not credited with earnings, the total amount deferred for a year generally would be the present value as of the last day of the service provider’s taxable year of the amount to which the service provider has a right to be paid in the future year (assuming no payments were made under the plan during the year). Increases in the present value of the payment in subsequent years due to the passage of time would be treated as earnings in the years in which such increases occur. For example, a right to a payment of $10,000 in Year 3 may have a present value in Year 1 equal to $8,900, and a present value in Year 2 equal to $9,434, so that the total amount deferred in Year 1 would be $8,900, the total amount deferred in Year 2 would be $9,434, and the total amount deferred in Year 3 would be $10,000 (assuming no payments were made during any year except Year 3). Any potential additional service credits or increases in compensation after the end of the taxable year for which the calculation is being made would not be taken into account in determining the total amount deferred for the taxable year.

In general, the proposed regulations provide that the total amount deferred under an outstanding stock right is the amount of money and the fair market value of the property that the service provider would receive by exercising the right on the last day of the taxable year, reduced by the amount (if any) the service provider must pay to exercise the right and any amount the service provider paid for the right, which is commonly referred to as the spread. Accordingly, for an outstanding stock option, the total amount deferred generally would equal the underlying stock’s fair market value on the last day of the taxable year, less the sum of the exercise price and any amount paid for the stock option. For an outstanding stock appreciation right, the total amount deferred generally would equal the underlying stock’s fair market value on the last day of the taxable year, less the sum of the exercise price and any amount paid for the stock appreciation right. For this purpose, the stock’s fair market value would be determined applying the principles set forth in §1.409A-1(b)(5).

The Treasury Department and the IRS recognize that the spread generally is less than the fair market value of the stock right, which is used for purposes of determining the amount taxable under other Code provisions such as section 83 (if a stock option has a readily ascertainable fair market value), section 4999, and section 457(f). However, because these types of stock rights typically will fail to comply with section 409A(a) in multiple years, a taxpayer who holds such a stock right generally will be required to include amounts in income under section 409A in more than one taxable year. Therefore, the Treasury Department and the IRS believe that it is more appropriate to use the spread for purposes of applying section 409A(a) to stock rights.

A deferred amount that is payable only upon an involuntary separation from service generally will be treated as subject to a substantial risk of forfeiture until the service provider involuntarily separates from service. Accordingly, under the proposed regulations the amount of deferred compensation generally would not be required to be calculated until the service provider has involuntarily separated from service. In addition, if the amount were payable upon either an involuntary separation from service or some other trigger, such as a fixed date, the possibility of payment upon an involuntary separation from service generally would be ignored for purposes of determining the total amount deferred under the arrangement. See section III.C.2 of this preamble. Once an involuntary separation from service has occurred, the amount deferred under the plan would be determined using the rules that would apply to the schedule of payments if the right to payment were not contingent upon an involuntary separation from service. For example, if the amounts payable are installment payments and the remaining installment payments include interest credited at a reasonable rate, the total amount deferred under the plan would be determined under the rules governing account balance plans. If more than one type of deferred compensation arrangement were provided under the separation pay agreement, the amount deferred under each arrangement would be determined using the rules applicable to that type of arrangement. The total amount deferred for the taxable year would be the sum of all of the amounts deferred under the various arrangements constituting the plan.

The proposed regulations provide a method of calculating the amount deferred under a reimbursement arrangement, including an arrangement where the benefit is provided as an in-kind benefit from the service recipient or the service recipient will pay directly the third-party provider of the goods or services to the service provider. For example, the amount deferred under an arrangement providing a specified number of hours of financial planning services after a service provider’s separation from service would be determined using the rules applicable to reimbursement arrangements, regardless of whether the service recipient reimburses the service provider for the service provider’s expenses in purchasing such services, provides the financial planning services directly to the service provider, or pays a third-party financial planner to provide such services. The rules for reimbursement arrangements would apply to all such types of arrangements, including arrangements that would not be disaggregated from a nonaccount balance plan under §1.409A-1(c)(2)(i)(E) because the amounts subject to reimbursement exceed the applicable limits.

The proposed calculation rules provide that if a service provider has a right to reimbursements but only up to a specified maximum amount, it is presumed that the taxpayer will incur the maximum amount of expenses eligible for reimbursement, at the earliest possible time such expenses may be incurred and payable at the earliest possible time the amount may be reimbursed under the plan’s terms. The service provider could rebut the presumption if the service provider demonstrates by clear and convincing evidence that it is unreasonable to assume that the service provider would expend (or would have expended) the maximum amount of expenses eligible for reimbursement. For example, if a service provider is entitled to the reimbursement of country club dues the service provider incurs in the next taxable year, not to exceed $30,000, if the service provider can demonstrate that the most expensive country club within reasonable geographic proximity of the service provider’s residence and work location will cost $20,000 per year, and that the service provider’s level of compensation and financial resources make it unreasonable to assume that the service provider would travel periodically to the locales of other, more expensive country clubs, the service provider can calculate the amount deferred based upon the $20,000 being eligible for reimbursement. The presumption of maximum utilization of expenses eligible for reimbursement generally would not apply if the expenses subject to reimbursement are medical expenses.

If a right to reimbursement is not subject to a maximum amount, the taxpayer would be treated as having deferred a formula amount, provided that the taxpayer would be required to calculate the amount based on the maximum amount that reasonably could be expended and reimbursed. The amount would be considered a nonformula amount as soon as the taxpayer incurs the expense that is subject to reimbursement, in an amount equal to the reimbursement to which the taxpayer is entitled. For example, a right to the reimbursement of half of the expenses the service provider incurs to purchase a boat without any limitation with respect to the cost would be treated as a deferral of a formula amount, until such time as the service provider purchases the boat.

The amount deferred under a split-dollar life insurance arrangement would be determined based upon the amount that would be required to be included in income in a future year under the applicable split-dollar life insurance rules. Determination of the amount includible in income would depend upon the Federal tax regime and guidance applicable to such arrangement. If the split-dollar life insurance arrangement is not subject to §1.61-22 or §1.7872-15 due to application of the effective date provisions under §1.61-22(j), the amount payable would be determined by reference to Notice 2002-8, 2002-1 C.B. 398, and any other applicable guidance. If the split-dollar life insurance arrangement is subject to §1.61-22 or §1.7872-15, the amount payable would be determined by reference to such regulations, based upon the type of arrangement. For this purpose, the amount includible in income generally would be determined by applying the split-dollar life insurance rules to the arrangement in conjunction with the general rules providing assumptions on payment dates of deferred amounts. However, in the case of an arrangement subject to §1.7872-15, to the extent the rules regarding time and form of payment and other payment assumptions under these proposed regulations conflict with the provisions of §1.7872-15, the provisions of §1.7872-15 would apply instead of the conflicting rules under these proposed regulations. As provided in Notice 2007-34, 2007-1 C.B. 996, the portion of the benefit provided under the split-dollar life insurance arrangement consisting of the cost of current life insurance protection is not treated as deferred compensation for this purpose. See §601.601(d)(2)(ii)(b).

Although certain foreign arrangements are a separate category under the plan aggregation rules (§1.409A-1(c)(2)(i)(G)), the amounts deferred under such arrangements would be determined using the same rules that would apply if the arrangements were not foreign arrangements. For example, the total amount deferred by a United States citizen participating in a salary deferral arrangement in France that meets the requirements of §1.409A-1(c)(2)(i)(G), but that otherwise would constitute an elective account balance plan under §1.409A-1(c)(2)(i)(A), would be determined using the rules applicable to account balance plans.

The calculation of the total amount deferred under a plan that does not fall into any of the enunciated categories (and accordingly is treated as a separate plan under §1.409A-1(c)(2)(i)(I)), would be determined by applying the general calculation rules.

This section III.E of the preamble addresses the second step in determining the amount includible in income under section 409A for a taxable year — the determination of the portion of the total amount deferred for a taxable year that was either subject to a substantial risk of forfeiture or had previously been included in income. That portion of the total amount deferred for the taxable year would not be includible in income under section 409A.

In general, the proposed regulations provide that the portion of the total amount deferred for a taxable year that is subject to a substantial risk of forfeiture (nonvested) is determined as of the last day of the service provider’s taxable year. Accordingly, all amounts that vest during the taxable year in which a failure occurs would be treated as vested for purposes of section 409A(a), regardless of whether the vesting event occurs before or after the failure to meet the requirements of section 409A(a). For example, if a plan fails to comply with section 409A(a) due to an operational failure on July 1 of a taxable year, and the substantial risk of forfeiture applicable to an amount deferred under the plan lapses as of October 1 of the same taxable year, that amount would be treated as a vested amount for purposes of determining the amount includible in income for the taxable year.

For a deferred amount to be treated as previously included in income, the proposed regulations would require that the service provider actually and properly have included the amount in income in accordance with a provision of the Internal Revenue Code. This would include amounts reflected on an original or amended return filed before expiration of the applicable statute of limitations on assessment and amounts included in income as part of an audit or closing agreement process. In addition, a deferred amount would be treated as an amount previously included in income only until the amount is paid. Accordingly, if a deferred amount is paid in the same taxable year in which an amount is included in income under section 409A, or all or a portion of an amount previously included in income is allocable to a payment made under the plan (see section VI.A of this preamble), in subsequent taxable years that amount would not be treated as an amount previously included in income. For example, if an employee includes $100,000 in income under section 409A(a), and $10,000 of the amount includible in income consists of a payment under the plan during the taxable year, only $90,000 would remain to be treated as a deferred amount previously included in income. Similarly, if in the next year the employee receives a payment, to the extent any or all of that $90,000 amount previously included in income is allocated to that payment so that all or a portion of the payment is not includible in gross income, the amount allocated would no longer be treated as an amount previously included in income.

A plan term that fails to meet the requirements of section 409A(a) may be retained in the plan over multiple taxable years. In addition, operational failures may occur in multiple years. This section III.F of the preamble discusses how section 409A(a) applies in such cases.

Each of the service provider’s taxable years would be analyzed independently to determine if amounts were includible in income under section 409A(a). See section II of this preamble. Thus, for any taxable year during which a failure occurs, all amounts deferred under the plan would be includible in income unless the amount has previously been included in income or is subject to a substantial risk of forfeiture. Generally, this means that a service provider who includes in income under section 409A(a) all amounts deferred under a plan for a taxable year would not be relieved of the requirement to include amounts in income for an earlier taxable year in which a failure also occurred. It would undermine the statutory purpose to allow a service provider to include an amount in income under section 409A(a) (or otherwise) on a current basis with respect to a failure that occurred in a prior taxable year and thereby eliminate the taxes owed for the earlier year, especially if intervening payments of deferred amounts have reduced the total amount deferred as of the end of such current year. In addition, this rule generally would prohibit a service provider from selecting from among several previous taxable years the most favorable year in which to include income. However, if an amount was actually and properly included in income under section 409A(a) in a previous year, the amount would be treated as an amount previously in income for purposes of all subsequent years. Accordingly, this rule would never make the same amount includible in income twice under section 409A(a).

For example, assume an employee participates in a nonqualified deferred compensation plan and defers $10,000 each year, credited annually with interest at 5 percent (assumed to be reasonable for purposes of this example), and receives no payments under the plan. The employee’s total amount deferred would be $10,500 for Year 1, $21,525 for Year 2, and $33,101 for Year 3. If the nonqualified deferred compensation plan fails to meet the requirements of section 409A(a) in each year, the employee would be required to include $10,500 in income under section 409A(a) for Year 1, $11,025 in income for Year 2, and $11,576 in income for Year 3. If the employee includes $33,101 in income under section 409A(a) for Year 3, the employee would not have properly reported income for Year 1 and Year 2. However, an amount included in income for Year 3 would be treated as previously included in income for purposes of any further failures in subsequent years. In addition, if the employee subsequently properly includes amounts in income for Year 1 and Year 2 on amended returns, the employee could claim a refund of the tax paid on the excess amounts included in income for Year 3. Similar consequences apply to the employer. If the employer fails to report and withhold on amounts includible in income under section 409A(a) in Year 1 and Year 2, the employer could not avoid liability for the failure to withhold in Year 1 and Year 2 by reporting the full amount and withholding in Year 3.

Because each taxable year would be analyzed independently, the IRS could elect to audit and assess with respect to a single taxable year, and require inclusion of all amounts deferred under the plan through that taxable year (even if failures also occurred in prior taxable years). Under those circumstances, the taxpayer could simply include amounts in income under section 409A(a) for that taxable year. However, before expiration of the applicable statute of limitations, the taxpayer could amend returns for previous taxable years and include in income amounts required to be included under section 409A(a), lowering the amount includible in income under section 409A(a) for the audited taxable year because, for purposes of that taxable year, those amounts would have been included in income in previous years. For example, an audit of Year 3 in the example above could result in an adjustment requiring $33,101 to be included in income under section 409A(a). However, before expiration of the applicable statute of limitations, the employee could amend the employee’s Year 1 and Year 2 Federal tax returns to include $10,500 in income under section 409A(a) for Year 1, and $11,025 in income under section 409A(a) for Year 2, and accordingly include only $11,576 in income under section 409A(a) for Year 3. However, the employee would be required to pay the additional section 409A(a) taxes for Year 1 and Year 2, including the premium interest tax. In addition, if amounts deferred under the plan had been paid in Year 1 or Year 2, the employee would be required to include those additional amounts in income under section 409A(a) for the year paid (meaning, if the payment had been included in income for the year in which it was paid, the employee would be required to amend the previously filed tax returns to pay the additional section 409A(a) taxes on such income).

Section 409A(a)(1)(B)(i)(II) provides that if compensation is required to be included in gross income under section 409A(a)(1)(A) for a taxable year, the income tax imposed is increased by an amount equal to 20 percent of the compensation that is required to be included in gross income. This amount is an additional income tax, subject to the rules governing the assessment, collection, and payment of income tax, and is not an excise tax.

Section 409A(a)(1)(B)(i)(I) provides that if compensation is required to be included in gross income under section 409A(a)(1)(A) for a taxable year, the income tax imposed is increased by an amount equal to the amount of interest determined under section 409A(a)(1)(B)(ii). This amount is an additional income tax, subject to the rules governing assessment, collection, and payment of income tax, and is not an excise tax or interest on an underpayment. Section 409A(a)(1)(B)(ii) provides that this premium interest tax is determined as the amount of interest at the underpayment rate (established under section 6621) plus one percentage point on the underpayments that would have occurred had the deferred compensation been includible in gross income for the taxable year in which first deferred or, if later, the first taxable year in which such deferred compensation is not subject to a substantial risk of forfeiture (vested). Thus, section 409A(a)(1)(B) requires that the premium interest tax be applied to hypothetical underpayments where the hypothetical underpayments are determined by first allocating the amounts deferred under the plan required to be included in income under section 409A(a) to the initial year (or years) the amount was deferred or vested, then determining the hypothetical underpayment that would have resulted had such amounts been includible in income at that time, and then determining the interest that would be due upon that hypothetical underpayment based upon a premium interest rate equal to the underpayment rate plus one percentage point.

Section 409A(a)(1)(B)(ii) provides for an additional tax based upon the interest that would be applied to the resulting underpayments of tax if the deferred compensation includible in income under section 409A(a) had been includible in income in previous years. Because the total amount deferred for the taxable year in which a failure occurs (the current year) may be less than the amounts deferred under the same plan in a previous year due to payments or deemed investment or other losses in the previous year, so that a portion of the amount deferred in the previous year would not be includible in income under section 409A(a) for the current year, commentators have asked what amounts deferred under the plan must be taken into account in determining the premium interest tax. Section 409A(a)(1)(B)(i) refers first to the compensation required to be included in gross income under section 409A(a)(1)(A). Accordingly, under the proposed regulations the amount required to be included in income under section 409A(a) for the taxable year is the only deferred amount required to be allocated to previous taxable years for purposes of determining the premium interest tax under section 409A(a)(1)(B)(i)(I).

For example, assume an employee who participates in a plan has a total amount deferred in Year 1 of $100,000 and a total amount deferred in Year 2 of $80,000 due to deemed investment losses in Year 2. If the plan fails to meet the requirements of section 409A(a) in Year 2 (and not Year 1), the employee is required to include $80,000 in income under section 409A(a). In calculating the premium interest tax, the employee must allocate only the $80,000 required to be included in income under section 409A(a) to the year or years the amount was first deferred or vested, even though additional amounts were deferred under the plan in previous taxable years.

To calculate the premium underpayment interest tax, the taxable year or years during which the amount required to be included in income was first deferred or first vested must be determined. The proposed regulations provide that the amount deferred during a particular taxable year generally is the excess (if any) of the vested total amount deferred for that taxable year over the vested total amount deferred for the immediately preceding taxable year. For example, if a service provider first participated in a plan in the taxable year 2010 and has a vested total amount deferred under the plan for 2010 of $10,000, a vested total amount deferred for 2011 of $15,000, and a vested total amount deferred for 2012 of $25,000, then the service provider would be treated as having first deferred $10,000 during 2010, $5,000 during 2011, and $10,000 during 2012.

The general rule would apply in cases where during previous taxable years there have been no payments under the plan, no net deemed investment or other losses, and no amounts otherwise included in income. If a service provider has received a payment, incurred net deemed losses, or included an amount in income, the general rule would need to be modified. For example, assume that the vested total amount deferred for Year 1 is $100,000, for Year 2 is $200,000 (including a $50,000 payment), and for Year 3 is $250,000. If there is a failure to meet the requirements of section 409A(a) in Year 3, the service provider would be required to include $250,000 in income. The service provider would also need to determine the year or years during which the $250,000 was first deferred and vested for purposes of calculating the premium interest tax. The issue then arises whether the $50,000 payment in Year 2 was a payment of an amount first deferred and vested in Year 1 or Year 2. If the $50,000 payment is treated as a payment of an amount first deferred and vested in Year 1, then only $50,000 of the $100,000 deferred in Year 1 would remain to be treated as part of the $250,000 includible in income in Year 3. In contrast, if the $50,000 payment is treated as a payment of an amount first deferred in Year 2, then the entire $100,000 deferred in Year 1 would remain to be treated as part of the $250,000. Similar issues arise with respect to the treatment of deemed investment losses and amounts previously included in income.

Under the calculation method set forth in the proposed regulations, payments, deemed investment or other losses, and amounts included in income during taxable years before the year in which the failure occurs, generally are attributed to amounts deferred and vested in the earliest year or years in which there are amounts deferred. The proposed calculation method generally achieves this result by reducing the amount deferred for each year preceding the payment or deemed investment or other loss, and treating only the remaining deferred amounts as the source of the outstanding deferrals and payments includible in income under section 409A for the year in which the failure occurs. This proposed rule generally should result in the lowest possible amount of premium interest tax, because deferred amounts includible in income under section 409A would be treated as first deferred and vested in the latest possible years, resulting in less premium interest on the hypothetical underpayments.

The hypothetical underpayment would be calculated as if the amount were paid to the service provider as a cash payment of compensation during the taxable year. Further, the hypothetical underpayment would be calculated based on the taxpayer’s taxable income, credits, filing status, and other tax information for the year, based on the original return the taxpayer filed for such year, as adjusted as a result of any examination for such year or any amended return the taxpayer filed for such year that was accepted by the IRS. The hypothetical underpayment would reflect the effect that such additional compensation would have had on the amount of Federal income tax owed by the taxpayer for such year, including the continued availability of any deductions taken, and the use of any carryovers such as carryover losses. For purposes of calculating a hypothetical underpayment in a subsequent year (whether or not a portion of the deferred amount was first deferred and vested in the subsequent year), any changes to the taxpayer’s Federal income tax liability for the subsequent year that would have occurred if the portion of the deferred amount that was first deferred and vested during the previous taxable year had been included in the taxpayer’s income for the previous year would be taken into account. For example, if in calculating the hypothetical underpayment for one year, an additional amount of unused charitable contribution deductions is absorbed, the use of the additional charitable contributions would be reflected in determining the hypothetical underpayment for a subsequent year (meaning that the same portion of the charitable contribution could not be deducted twice in determining the hypothetical underpayments for more than one year).

Calculation of the premium interest tax would take into account only the consequences the additional income would have had on the Federal income tax due based on items of income and deduction, credits, filing status and similar information existing as of the end of the taxable year at issue. Other potential effects of the additional compensation payment on service provider or service recipient actions or elections would not be taken into account, including how such additional compensation could have affected participation in an employee benefit plan or other arrangement. For example, the impact such additional compensation would have had on contributions to a qualified plan, even if the additional compensation would have affected the amount the service provider would have been permitted or required to contribute, would be disregarded.

The Treasury Department and the IRS recognize that calculation of the premium underpayment interest tax may be cumbersome, potentially involving the recalculation of several years’ tax returns. In response, the Treasury Department and the IRS are considering whether safe harbor calculation methods could be devised that would reduce the calculation burden but still result in an appropriate amount of tax applicable to the amount includible in income under section 409A(a). Specifically, the Treasury Department and the IRS request comments on calculation methods that would more easily identify the taxable year or years during which an amount includible in income under section 409A(a) was first deferred and vested, and that would more easily determine the hypothetical underpayments applicable to such year or years. Comments should consider both how the safe harbor method would be applied by taxpayers, and the extent to which such methods could be applied by the IRS in the examination context.

Section 409A(c) provides that any amount included in gross income under section 409A is not required to be included in gross income under any other provision of the Code or any other rule of law later than the time provided in section 409A. Accordingly, if a service provider includes an amount in income under section 409A, the proposed regulations provide for a type of deemed “basis” or “investment in the contract” such that the amount would not be required to be included in income again (for example, when the amount was actually paid). For this purpose, the amount previously included in income would be treated as the inclusion in income of an amount deferred under the plan, but would not be allocated to any specific amount deferred under the plan. Accordingly, if an amount under the plan would be includible in income if section 409A were disregarded (for example, because an amount is paid under the plan), the amount previously included in income would be immediately applied to the amount paid under the plan such that the amount paid would not be required to be included in gross income a second time.

For example, assume that in Year 1 an employee defers $10,000 under a salary deferral elective account balance plan and is required to include that amount in income under section 409A. Assume that in Year 2 the employee defers $15,000 under the same salary deferral elective account balance plan, and an additional $5,000 under a bonus deferral elective account balance plan, both of which are compliant with section 409A. Assume that in Year 3 the employee receives a payment of $5,000 under the bonus deferral elective account balance plan. Because the payment would be treated for purposes of section 409A as made from a single elective account balance plan in which the employee participated, and because the employee has already included $10,000 in income under section 409A due to participation in the plan, the employee would apply $5,000 of the $10,000 that was previously included in income to the $5,000 payment and not include the $5,000 payment in gross income in Year 3 (or any subsequent year). The remaining amount previously included in income would be $5,000.

The employee could not elect the extent to which the amount previously included in income would be applied in this context. Rather, the amount previously included in income would be required to be applied immediately to the extent an amount deferred under the same plan would otherwise become includible in income under a Code section other than section 409A. The inclusion of any amount in income and the resulting amount previously included in income for subsequent years would not affect the potential for earnings related to such amounts to be subject to section 409A or to be required to be included in income under section 409A.

The application of section 409A(a) may require inclusion in income of amounts that the service provider ultimately never receives. This result may occur under four different circumstances. First, because a nonqualified deferred compensation plan generally involves an unfunded, unsecured promise of a service recipient to pay compensation in a future year, the funds to pay the deferred amount may not be available in the future year. For example, the service recipient may be insolvent, bankrupt or have ceased to exist at the time the payment is due.

Second, some amounts of deferred compensation may be included in income under section 409A(a) if the amounts are subject to a risk of forfeiture, but the risk of forfeiture does not qualify as a substantial risk of forfeiture. For example, a deferred amount payable only if the service provider does not compete with the service recipient for a defined period is not subject to a substantial risk of forfeiture. However, if the service provider actually competes with the service recipient, the service provider may forfeit the right to the amount.

Third, the deferred amount may be subject to deemed investment losses. If losses occur after the deferred amount has been included in income under section 409A(a), the amount paid to the service provider may be less than the amount included in income.

Fourth, in the case of a formula amount, the calculation of the deferred amount may result in the inclusion in income under section 409A(a) of an amount that is greater than the amount ultimately paid. For example, if a service provider receives a right to a certain percentage of the service recipient’s profits payable at separation from service, and determines that the total amount deferred under the plan is $100,000, once the profits are calculated the service provider may be entitled to a lesser amount.

The proposed regulations provide that a service provider who is required to include an amount in income under section 409A(a) with respect to a deferred amount under a nonqualified deferred compensation plan is entitled to a deduction at the time the service provider’s legally binding right to all deferred compensation under the plan (including all arrangements treated as a single plan under the aggregation rules) is permanently forfeited under the plan’s terms, or the right to such compensation is otherwise permanently lost. The available deduction would equal the excess of the amount included in income under section 409A(a) in a previous year over any amount actually or constructively received by the service provider. A right to an amount would not be treated as permanently lost merely because the deferred amount had decreased, for example due to deemed investment losses, if the service provider retains a right to an amount deferred under the plan. In addition, a right to an amount would not be treated as permanently forfeited or otherwise lost if the obligation to make such payment is substituted for another deferred amount or obligation to make a payment in a future year. However, the right to an amount would be treated as permanently lost if the right to the payment of the amount becomes wholly worthless. A service provider would not be entitled to a deduction with respect to an amount previously included in income under section 409A(a) if the service provider retains a right to any amount deferred under all arrangements treated as a single plan under §1.409A-1(c)(2). However, if the entire deferred amount payable under the plan has been paid out and the service recipient has no remaining liability to the service provider under the plan, any remaining unpaid deferred amount that had previously been included in income would be treated as permanently lost.

For example, if at the end of Year 1 an employee has an account balance of $100,000 which is required to be included in income under section 409A, and at the end of Year 2 an employee has an account balance of $90,000 due to notional investment losses, the employee would not be entitled to a deduction for Year 2. However, if in Year 3 the entire account balance of $95,000 is paid to the employee, so there no longer are any amounts deferred under the plan (determined after applying applicable aggregation rules) and nothing remains to be paid to the employee, the employee would be entitled to a $5,000 deduction for Year 3.

In the case of a service provider that is an employee, the available deduction generally would be treated as a miscellaneous itemized deduction, subject to the deduction limitations applicable to such expenses. Section 1341 would not be applicable to such deduction because inclusion of an amount in income as a result of noncompliance with section 409A(a) would not constitute receipt of an amount to which it appeared that the taxpayer had an unrestricted right in the taxable year of inclusion. In the first circumstance listed above, a service provider that does not receive payment of deferred compensation because of the bankruptcy or insolvency of the service recipient retains the legal right to the income even though the income is not collectible. In each of the three other circumstances in which such a deduction becomes available, the deferred compensation is not paid because of an event that occurred after the taxable year in which the amount deferred was included in income under section 409A, rather than from the absence of a right to the deferred compensation in the year in which it was includible in gross income. Finally, certain of such circumstances, such as the actual amount received differing from the amount included in income because the amount deferred was a formula amount, result from the inherent uncertainties in valuing rights to such amounts, rather than from a lack of a claim of right to income.

If a service provider is entitled to a deduction with respect to a deferred amount included in income under section 409A(a) that is subsequently permanently forfeited or otherwise lost, to the extent the service recipient has benefited from a deduction or increased the basis of an asset because the deferred amount was included in the service provider’s gross income, or such inclusion by the service provider has otherwise reduced or could otherwise reduce the service recipient’s gross income, the service recipient may be required to recognize income under the tax benefit rule and section 111, or make other appropriate adjustments to reflect that the deferred amount included in income by the service provider under section 409A(a) has been permanently forfeited or otherwise lost, and thus will not be paid by the service recipient.

The Treasury Department and the IRS anticipate issuing interim guidance during 2008 addressing the extent to which taxpayers may rely on the proposed regulations with respect to the calculation of the amounts includible in income under section 409A(a) and the calculation of the additional taxes under section 409A(a). The interim guidance is also expected to address the calculation of the amounts includible in income and additional taxes under section 409A(b) and service recipient reporting and withholding obligations with respect to amounts includible in income under section 409A(a) or (b) for taxable years beginning before the final regulations become applicable. The Treasury Department and the IRS anticipate that such interim guidance will provide that taxpayers may rely upon the proposed regulations in their entirety (but that taxpayers may not rely on part, but not all, of the proposed regulations).

Section 885(b) of the Act amended sections 6041 and 6051 to require that an employer or payer report all deferrals for the year under a nonqualified deferred compensation plan on a Form W-2, “Wage and Tax Statement” or a Form 1099-MISC, “Miscellaneous Income”, regardless of whether such deferred compensation is includible in gross income under section 409A(a) (annual deferral reporting). Notice 2007-89 permanently waives this requirement for 2007 Forms W-2 and Forms 1099. Notice 2006-100 permanently waives this requirement for 2005 and 2006 Forms W-2 and Forms 1099. The Treasury Department and the IRS anticipate that this reporting will be implemented beginning with the first taxable year for which these proposed regulations are finalized and effective. The Treasury Department and the IRS further anticipate that the annual deferral reporting rules will be based upon the principles set forth in these regulations as finalized, except that taxpayers will not be required to report deferred amounts that are not reasonably ascertainable (as defined in §31.3121(v)(2)-1(e)(4)(i)(B)) until such amounts become reasonably ascertainable. The Treasury Department and the IRS anticipate that the deferred amounts required to be reported will reflect earnings on the amounts deferred in previous years, if the amount of such earnings is reasonably ascertainable, because section 409A specifically treats earnings on deferred amounts as additional deferred amounts. The Treasury Department and the IRS request comments on the potential application of the standards set forth in these regulations to this reporting requirement, including suggestions for possible adaptations or modifications that may decrease the administrative burden of compliance while maintaining the integrity of the information reported.

Section 885(b) of the Act also amended section 3401(a) to provide that the term “wages” includes any amount includible in the gross income of an employee under section 409A, and amended section 6041 to require that a payer report amounts includible in gross income under section 409A that are not treated as wages under section 3401(a) (income inclusion reporting). Notice 2005-1 provides that an employer should report amounts includible in gross income under section 409A and in wages under section 3401(a) in box 1 of Form W-2 as wages paid to the employee during the year and subject to income tax withholding, and that the employer should also report such amounts in box 12 of Form W-2 using code Z. Notice 2005-1 also provides that a payer should report amounts includible in gross income under section 409A and not treated as wages under section 3401(a) as nonemployee compensation in box 7 of Form 1099-MISC, and should also report such amounts in box 15b of Form 1099-MISC. Notice 2006-100 provided guidance on income inclusion reporting for the 2005 and 2006 Forms W-2 and Forms 1099. Notice 2007-89 provided guidance on income inclusion reporting for the 2007 Forms W-2 and Forms 1099. The Treasury Department and the IRS anticipate issuing further interim guidance during 2008 on income inclusion reporting for 2008 Forms W-2 and Forms 1099 for taxable years beginning before the final regulations become applicable. The Treasury Department and the IRS anticipate that such interim guidance will provide that taxpayers may rely upon the proposed regulations in their entirety (but that taxpayers may not rely on part, but not all, of the proposed regulations).

Amounts includible in an employee’s income under section 409A also are treated as wages for purposes of section 3401. Notice 2007-89 provides guidance on a service recipient’s income tax withholding obligations for 2007. The Treasury Department and the IRS anticipate issuing further interim guidance during 2008 on a service recipient’s income tax withholding obligations for calendar years beginning before the final regulations become applicable. The Treasury Department and the IRS anticipate that such interim guidance will provide that taxpayers may rely upon the proposed regulations in their entirety (but that taxpayers may not rely on part, but not all, of the proposed regulations).

These regulations are proposed to be generally applicable for taxable years beginning on or after the issuance of final regulations. Before the applicability date of the final regulations, taxpayers may rely on these proposed regulations only to the extent provided in further guidance.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and Treasury Department request comments on the clarity of the proposed rules and how they can be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for April 2, 2009 at 10:00 a.m., in the auditorium. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written or electronic comments and an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and eight (8) copies) by March 9, 2009. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.409A-0 is amended by adding entries for §1.409A-4 to read as follows: