The IRS has recently released its much anticipated proposed regulations (the "Regulations") under Section 409A of the Code. The regulations and related supplementary explanation exceed 230 pages in length and cover many of the key issues that were not addressed in IRS Notice 2005-1 (the "Notice"), including guidance concerning the timing and form of distributions, the definition of "performance-based compensation," the manner in which delayed payments can be made to "key employees," and compliance with the prohibition against accelerating distributions.

Overview of Effective Date and Transition Rules
In view of the extensive scope of the Regulations, the following discussion is limited to a summary of the effective date and key transition rules that employers must be cognizant of as they move forward in developing their Section 409A compliance programs. Future Advisories will provide a more in-depth analysis of discrete aspects of Section 409A and the Regulations. For a general summary of Section 409A, please refer to our Tax Advisory - New Law Makes Dramatic Changes to the Rules Governing Deferred Compensation, dated October 27, 2004.

Effective Date Provisions: The Regulations are generally effective for tax years beginning on or after January 1, 2007. Until such time, the guidance under the Notice will remain in effect. Accordingly, a plan is not required to comply with the Regulations. Interim compliance with the Regulations, however, will be considered to be "good faith" compliance with Section 409A.

The Regulations are intended to expand upon, and should be read consistently with, the provisions of the Notice. To the extent the provisions of the Regulations are inconsistent with the Notice, a plan may comply with the provisions of the Regulations in lieu of the corresponding provisions of the Notice.

Transition Relief: Under the Notice, the IRS provided employers a variety of transition rules that were intended to afford employers sufficient time to comply with Section 409A. This transition period was generally limited to calendar year 2005. The Regulations extend through the end of 2006 certain, but not all, aspects of the transition rules.

Amendment and Operation of Plan - In order to provide employers and practitioners time to implement the Regulations, the IRS has extended to December 31, 2006 the deadline by which plan documents must be amended to conform with Section 409A. Until such time, the Regulations provide that a plan will be treated as complying with Section 409A only if the plan is operated in "good faith" compliance with Section 409A and the Notice.

Changes in Payment Elections - The Notice provided that a plan could be amended to provide for new payment elections with respect to amounts subject to Section 409A without violating the subsequent deferral and anti-acceleration rules. This election was required to be made by December 31, 2005. The Regulations extend these provisions through December 31, 2006, except that any such election cannot affect amounts that would otherwise be received by the taxpayer in 2006. Compliance with this transition rule will require that, on or before December 31, 2006: (i) the plan be amended to permit the new payment elections, and (ii) the participant make any required election.

Payments Based on Elections Under Qualified Plans - Under Section 409A, elections under a nonqualified plan that mirror or depend upon an election under a qualified plan will generally not comply with Section 409A because, in part, the time and form of any such payment elections would not be established at the time the deferral was made. In order to allow employers to conform any such nonqualified plans with Section 409A, the Notice permitted any such payment elections to continue in effect through December 31, 2005. The Regulations extend this relief through December 31, 2006, provided that the determination of any payment is made in accordance with the terms of the nonqualified plan as in effect on October 3, 2004.

Initial Deferral Elections - The Notice provided that initial deferral elections with respect to compensation to be earned on or before December 31, 2005, could be made as late as March 15, 2005. The IRS has not extended this relief under the Regulations and therefore deferral elections with respect to 2006 compensation will generally need to be made by the end of 2005.

Initial Deferral Elections With Respect to Forfeitable Rights – The Regulations contain a favorable expansion of the election rules with to respect grants of nonqualified compensation that occur in the middle of the year where such grants were unforeseeable (e.g., restricted stock unit grants). Where such grants are subject to a forfeiture condition requiring the continued performance of services for a period of at least 12 months, the initial deferral election may be made no later than 30 days after the date of grant, provided that the election is made at least 12 months in advance of the end of the service period. When utilizing this approach, employers will need to exercise caution with awards that vest in installments.

Cancellation of Deferrals and Termination of Participation in a Plan – The Notice provided a limited time during which a plan adopted prior to December 31, 2005, could provide a participant with the right to terminate participation in the plan or cancel an outstanding deferral election with respect to amounts subject to Section 409A. The IRS has not extended this transition relief under the Regulations and therefore any such termination or cancellation must be accomplished by December 31, 2005. In this regard, the exercise of a stock option or SAR (that provides for a deferral of compensation) on or before such date will be treated as a cancellation of a deferral.

Termination of Grandfathered Plans – The Notice also provided that the termination of a grandfathered arrangement on or before December 31, 2005, will not be treated as a material modification, provided that all amounts deferred thereunder are included in compensation in the year of the termination. The IRS has not extended this transition relief under the Regulations and therefore any such termination must be accomplished by December 31, 2005.

Substitution of Non-discounted Stock Options and SARs for Discounted Options and SARs – The Notice provided that it will not be a material modification to replace an option or SAR (that provides for a deferral of compensation) with an option or SAR that would not have resulted in a deferral of compensation as of the original date of grant. Any such replacement was required to be made on or before December 31, 2005. The IRS has extended this transition relief until December 31, 2006. However, if an employee exercises a discounted option or non-compliant SAR in 2006, any such exercise will be a violation or Section 409A (the transition rule for canceling and option or SAR, as discussed above, only extends through the end of 2005).

What Employers Should Do Now: Employers must act quickly to determine whether they will take advantage of any transition relief scheduled to expire on December 31, 2005. It will also be necessary to revise deferral election procedures to ensure that deferrals relating to 2006 compensation are timely accomplished under existing plans.

TAX ADVICE DISCLAIMER: Any federal tax advice contained in this communication (including attachments) was not intended or written to be used, and it may not be used, by you for the purpose of (1) avoiding any penalty that may be imposed by the Internal Revenue Service or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein. If you would like such advice, please contact us.