[Federal Register Volume 73, Number 236 (Monday, December 8, 2008)]
[Proposed Rules]
[Pages 74380-74403]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-28894]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-148326-05]
RIN 1545-BF50


Further Guidance on the Application of Section 409A to 
Nonqualified Deferred Compensation Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations on the calculation 
of amounts includible in income under section 409A(a) and the 
additional taxes imposed by such section with respect to service 
providers participating in certain nonqualified deferred compensation 
plans. The regulations would affect such service providers and the 
service recipients for whom the service providers provide services. 
This document also provides a notice of public hearing on these 
proposed regulations.

DATES: Written or electronic comments must be received by March 9, 
2009. Outlines of topics to be discussed at the public hearing 
scheduled for April 2, 2009, must be received by March 9, 2009.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-148326-05), room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC, 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
148326-05), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at http://www.Regulations.gov (IRS REG-148326-05). 
The public hearing will be held in the auditorium, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Stephen Tackney, at (202) 927-9639; concerning submissions of comments, 
the hearing, and/or to be placed on the building access list to attend 
the hearing, Funmi Taylor at (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    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 (2005-2 CB 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

[[Page 74381]]

section 409A. (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 IRB 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 (2006-51 IRB 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 IRB 998) providing similar interim 
guidance for taxable years beginning in 2007. See Sec.  
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.

Explanation of Provisions

I. Scope of 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.

II. Effect of a Failure To Comply With Section 409A(a) on Amounts 
Deferred in Subsequent Years

    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

[[Page 74382]]

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\1\ 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.
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    \1\ Under section 409A(e)(5), the Treasury Department and the 
IRS have the authority to disregard a substantial risk of forfeiture 
where necessary to carry out the purposes of section 409A.
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III. Calculation of the Amount Deferred Under a Plan for the Taxable 
Year in Which the Plan Fails To Meet the Requirements of Section 
409A(a) and all Preceding Taxable Years

A. In General

    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.

B. Total Amount Deferred

1. In General
    In general, under the proposed regulations, the amount deferred 
under a plan\2\ 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.
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    \2\ For this purpose, the term plan refers to a plan as defined 
under Sec.  1.409A-1(c), including any applicable plan aggregation 
rules.
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    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.
2. Treatment of Payments
    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

[[Page 74383]]

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.
3. Treatment of Deemed Losses
    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.
4. Treatment of Rights to Deemed Earnings on Amounts Deferred
    Under section 409A(d)(5), income (whether actual or notional) 
attributable to deferred compensation constitutes deferred compensation 
for purposes of section 409A. See Sec.  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 Sec.  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.
5. Total Amount Deferred for a Taxable Year Relates to the Entire 
Taxable Year, Regardless of Date or Period of Failure
    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.
6. Treatment of Short-Term Deferrals
    Under Sec.  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 2\1/2\ 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 2\1/2\ month period. For 
purposes of calculating the total amount deferred for a taxable year, 
the proposed

[[Page 74384]]

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 2\1/2\ 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 2\1/2\ 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 2\1/2\ 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.

C. Calculation of Total Amount Deferred--General Principles

1. General Rule
    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).
2. Rules Regarding Alternative Times and Forms of Payment
    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 Sec.  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

[[Page 74385]]

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 Sec.  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 Sec.  
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 Sec.  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. Sec.  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.
3. Treatment of Rights to Formula Amounts
    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

[[Page 74386]]

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.

D. Calculation of Total Amounts Deferred--Specific Types of Plans

1. Account Balance Plans
    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.
2. Nonaccount Balance Plans
    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.
3. Stock Rights
    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 Sec.  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.
4. Separation Pay Arrangements
    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

[[Page 74387]]

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.
5. Reimbursement Arrangements
    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 Sec.  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.
6. Split-Dollar Life Insurance Arrangements
    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 Sec.  1.61-22 or Sec.  1.7872-15 due to application of the 
effective date provisions under Sec.  1.61-22(j), the amount payable 
would be determined by reference to Notice 2002-8 (2002-1 CB 398) and 
any other applicable guidance. If the split-dollar life insurance 
arrangement is subject to Sec.  1.61-22 or Sec.  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 Sec.  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 Sec.  1.7872-15, the provisions of Sec.  1.7872-15 would 
apply instead of the conflicting rules under these proposed 
regulations. As provided in Notice 2007-34 (2007-17 IRB 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 Sec.  
601.601(d)(2)(ii)(b).
7. Foreign Arrangements
    Although certain foreign arrangements are a separate category under 
the plan aggregation rules (Sec.  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 Sec.  1.409A-1(c)(2)(i)(G), but that 
otherwise would constitute an elective account balance plan under Sec.  
1.409A-1(c)(2)(i)(A), would be determined using the rules applicable to 
account balance plans.
8. Other 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 Sec.  1.409A-1(c)(2)(i)(I)), would be 
determined by applying the general calculation rules.

E. Calculation of Amounts Includible in Income

    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.
1. Determination of the Portion of the Total Amount Deferred for a 
Taxable Year That Is Subject to a Substantial Risk of Forfeiture
    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

[[Page 74388]]

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.
2. Determination of the Portion of the Total Amount Deferred for a 
Taxable Year That Has Been Previously Included in Income
    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.

F. Treatment of Failures Continuing During More Than One Taxable Year

    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

[[Page 74389]]

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).

IV. Application of Additional 20 Percent Tax

    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.

V. Application of Premium Interest Tax

A. In General

    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.

B. Amounts to Which the Premium Interest Tax Applies

    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.

C. Identification of Initial Years of Deferral for Includible Amounts

1. Identification of Amounts Deferred in a Particular Taxable Year--
General Principles
    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.
2. Identification of Initial Years of Deferral--Treatment of Amounts 
Previously Included in Income, Payments, and Investment Losses
    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

[[Page 74390]]

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.

D. Calculation of the Hypothetical Underpayment

    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.

E. Potential Safe Harbor Calculation Methods

    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.

VI. Treatment of Payments, Forfeitures, or Permanent Losses of Deferred 
Amounts in Taxable Years After the Amount Is Included in Income Under 
Section 409A(a)

A. Payments of Deferred Compensation in Taxable Years After the 
Inclusion of Such Amounts in Income Under Section 409A(a)

    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

[[Page 74391]]

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.

B. Permanent Forfeiture or Loss of a Deferred Amount Previously 
Included in Income Under Section 409A(a)

    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.
1. Effect on Service Provider
    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 Sec.  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.
2. Effect on Service Recipient
    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

[[Page 74392]]

forfeited or otherwise lost, and thus will not be paid by the service 
recipient.

VII. Service Provider Income Inclusion and Additional Taxes and Service 
Recipient Reporting and Withholding Obligations

A. Service Provider Income Inclusion

    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).

B. Annual Deferral Reporting

    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 Sec.  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.

C. Income Inclusion Reporting and Income Tax Withholding

    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).

Proposed Effective Date

    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.

Special Analyses

    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.

Comments and Public Hearing

    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 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.

[[Page 74393]]

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.

Drafting Information

    The principal author of these regulations is Stephen Tackney of the 
Office of Division Counsel/Associate Chief Counsel (Tax Exempt and 
Government Entities). However, other personnel from the IRS and the 
Treasury Department participated in their development.

List of Subjects 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    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 Sec.  
1.409A-4 to read as follows:


Sec.  1.409A-0  Table of contents.

* * * * *
Sec.  1.409A-4 Calculation of amount includible in income and 
additional income taxes.

    (a) Amount includible in income due to failure to meet the 
requirements of section 409A(a).
    (1) In general.
    (i) Calculation formula.
    (ii) Each taxable year analyzed independently.
    (A) In general.
    (B) Treatment of certain deferred amounts otherwise subject to a 
substantial risk of forfeiture.
    (iii) Examples.
    (2) Identification of the portion of the total amount deferred 
for a taxable year that is subject to a substantial risk of 
forfeiture.
    (i) In general.
    (ii) Example.
    (3) Identification of amount previously included in income.
    (i) In general.
    (ii) Examples.
    (b) The total amount deferred under a plan for a taxable year.
    (1) Application of general rules and specific rules for specific 
types of plans.
    (2) General definition of total amount deferred.
    (i) General calculation rules.
    (ii) Actuarial assumptions and methods.
    (A) Requirement of reasonable actuarial assumptions and methods.
    (B) Use of an unreasonable actuarial assumption or method.
    (iii) Crediting of earnings and losses.
    (iv) Application of the general calculation rules to formula 
amounts.
    (A) In general.
    (B) Examples.
    (v) Treatment of payment restrictions.
    (vi) Treatment of alternative times and forms of a future 
payment.
    (A) In general.
    (B) Effect of status of service provider on available times and 
forms of payment.
    (vii) Treatment of payment triggers based upon events.
    (A) In general.
    (B) Certain payment triggers disregarded.
    (viii) Treatment of amounts that may qualify as short-term 
deferrals.
    (ix) Examples.
    (3) Account balance plans.
    (i) In general.
    (ii) Unreasonable rate of return.
    (A) Application.
    (B) Unreasonably high interest rate.
    (C) Other rates of return.
    (4) Reimbursement and in-kind benefit arrangements.
    (5) Split-dollar life insurance arrangements.
    (6) Stock rights.
    (7) Anti-abuse provision.
    (c) Additional 20 percent tax under section 
409A(a)(1)(B)(i)(II).
    (d) Premium interest tax under section 409A(a)(1)(B)(i)(I).
    (1) In general.
    (2) Identification of taxable year deferred amount was first 
deferred or vested.
    (i) Method of identification.
    (ii) Examples.
    (3) Calculation of hypothetical underpayment for the taxable 
year during which a deferred amount was first deferred and vested.
    (i) Calculation method.
    (ii) Examples.
    (4) Calculation of hypothetical premium underpayment interest.
    (i) Calculation method.
    (ii) Examples.
    (e) Amounts includible in income under section 409A(b) 
[Reserved].
    (f) Application of amounts included in income under section 409A 
to payments of amounts deferred.
    (1) In general.
    (2) Application of the plan aggregation rules.
    (3) Examples.
    (g) Forfeiture or other permanent loss of right to deferred 
compensation.
    (1) Availability of deduction to the service provider.
    (2) Application of the plan aggregation rules.
    (3) Examples.
    (h) Effective/applicability date.
* * * * *
    Par. 3. Section 1.409A-4 is added to read as follows:


Sec.  1.409A-4  Calculation of amount includible in income and 
additional income taxes.

    (a) Amount includible in income due to failure to meet the 
requirements of section 409A(a)--(1) In general--(i) Calculation 
formula. The amount includible in income for a service provider's 
taxable year due to a failure to meet the requirements of section 
409A(a) with respect to a plan is the excess (if any) of--
    (A) The service provider's total amount deferred under the plan for 
the taxable year, including the amount of any payments of amounts 
deferred under the plan to (or on behalf of) the service provider 
during such taxable year; over
    (B) The portion of such amount, if any, that is either subject to a 
substantial risk of forfeiture (as defined in Sec.  1.409A-1(d) and 
applying paragraph (a)(1)(ii)(B) of this section) or has been 
previously included in income (as defined in Sec.  1.409A-4(a)(3)).
    (ii) Each taxable year analyzed independently--(A) In general. An 
amount is includible in income under section 409A(a) for a taxable year 
only if a plan fails to meet the requirements of section 409A(a) during 
such taxable year. Whether an amount is includible in income for a 
taxable year due to a failure to meet the requirements of section 
409A(a) during such taxable year is determined independently of whether 
such amounts are also includible in income due to a failure to meet the 
requirements of section 409A(a) in a previous or subsequent taxable 
year. Accordingly, an amount may be includible in income for a taxable 
year during which a plan fails to meet the requirements of section 
409A(a), even if the same amount was includible in income in a previous 
taxable year, except to the extent provided in Sec.  1.409A-4(a)(3) 
(identification of amount previously included in income).
    (B) Treatment of certain deferred amounts otherwise subject to a 
substantial risk of forfeiture. For

[[Page 74394]]

purposes of determining the amount includible in income under section 
409A(a) and paragraph (a)(1)(i) of this section, if the facts and 
circumstances indicate that a service recipient has a pattern or 
practice of permitting impermissible changes in the time and form of 
payment with respect to nonvested deferred amounts under one or more 
plans, 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.
    (iii) Examples. The following examples illustrate the provisions of 
this paragraph (a)(1). For each of the examples, Employee A is an 
individual taxpayer with a calendar year taxable year. Employee A has a 
total amount deferred under a nonqualified deferred compensation plan 
of $0 in 2010, $100,000 in 2011, and $250,000 in 2012. No payments are 
made under the plan. The plan under which the amounts are deferred 
fails to meet the requirements of section 409A(a) during 2011 and 2012. 
The examples read as follows:

    Example 1. With respect to Employee A, at no time is any 
deferred amount subject to a substantial risk of forfeiture. 
Employee A has $100,000 includible in income under section 409A(a) 
for 2011, because no portion of the total deferred amount for 2011 
is subject to a substantial risk of forfeiture or has previously 
been included in income. If that $100,000 is included in income for 
2011, Employee A has $150,000 includible in income under section 
409A(a) for 2012 because for the taxable year 2012 the $100,000 is 
previously included in income (see paragraphs (a)(1)(i)(B) and 
(a)(3) of this section). If that $100,000 is not included in income 
for 2011, Employee A has $250,000 includible in income under section 
409A(a) for 2012. Employee A does not avoid the requirement to 
include $100,000 in income under section 409A(a) for 2011 by 
including $250,000 in income under section 409A(a) for 2012.
    Example 2. The same facts as Example 1, except that, with 
respect to Employee A, the statute of limitations on assessments has 
expired for 2011, but has not expired for 2012. Employee A has 
$250,000 includible in income under section 409A(a) for 2012, 
because no portion of the total deferred amount for 2012 is subject 
to a substantial risk of forfeiture or has previously been included 
in income.

    (2) Identification of the portion of the total amount deferred for 
a taxable year that is subject to a substantial risk of forfeiture--(i) 
In general. The portion of the total amount deferred for a taxable year 
that is subject to a substantial risk of forfeiture (as defined in 
Sec.  1.409A-1(d)) is determined as of the last day of the service 
provider's taxable year. Accordingly, an amount may be includible in 
income under section 409A(a) for a taxable year even if such amount is 
subject to a substantial risk of forfeiture during the taxable year if 
the substantial risk of forfeiture lapses during such taxable year, 
including if the substantial risk of forfeiture lapses after the date 
the nonqualified deferred compensation plan under which the amount is 
deferred first fails to meet the requirements of section 409A(a).
    (ii) Example. The following example illustrates the provisions of 
this paragraph (a)(2): Employee B is an individual taxpayer with a 
calendar year taxable year. Employee B has a total amount deferred 
under a nonqualified deferred compensation plan of $0 for 2010, 
$100,000 for 2011, and $250,000 for 2012. No payments are made under 
the plan. Under the terms of the plan, if Employee B voluntarily 
separates from service before July 1, 2012, Employee B will forfeit 50 
percent of the Employee B's total amount deferred under the plan. If 
Employee B voluntarily separates from service after June 30, 2012 but 
before July 1, 2013, Employee B will forfeit 20 percent of the total 
amount deferred under the plan. If Employee B voluntarily separates 
from service after June 30, 2013, Employee B will not forfeit any 
amount deferred under the plan. As of December 31, 2011, 50 percent of 
the total amount deferred under the plan ($50,000) is subject to a 
substantial risk of forfeiture, and the remaining amount deferred under 
the plan ($50,000) is not subject to a substantial risk of forfeiture. 
As of December 31, 2012, 20 percent of the total amount deferred under 
the plan ($50,000) is subject to a substantial risk of forfeiture, and 
the remaining amount deferred under the plan ($200,000) is not subject 
to a substantial risk of forfeiture. At all times the terms of the plan 
meet the requirements of section 409A(a) and the applicable 
regulations, and through May 31, 2012, the plan is operated in a manner 
that complies with the terms of the plan. On June 1, 2012, the plan is 
operated in a manner that fails to meet the requirements of section 
409A(a). For purposes of determining the amount includible in income 
under section 409A(a), except as provided in paragraph (a)(1)(ii)(B) of 
this section, the portion of the total amount deferred for 2012 that is 
subject to a substantial risk of forfeiture is $50,000 (20 percent of 
$250,000).

    (3) Identification of amount previously included in income--(i) In 
general. For purposes of this section, an amount is previously included 
in income only if the service provider has included the amount in 
income under an applicable provision of the Internal Revenue Code for a 
previous taxable year. An amount is treated as included in income for a 
taxable year only to the extent that the amount was properly includible 
in income and the service provider actually included the amount in 
income (including on an original or amended return or as a result of an 
IRS examination or a final decision of a court of competent 
jurisdiction). For future taxable years, the amount previously included 
in income is reduced to reflect any amount that was paid during the 
taxable year for which the amount was included in income, any amount 
allocated to a payment made under the plan under paragraph (f) of this 
section, and any amount deductible under paragraph (g) of this section.
    (ii) Examples. The following examples illustrate the provisions of 
this paragraph (a)(3). For all of the examples, Employee C is an 
individual taxpayer with a calendar year taxable year. Employee C has a 
total amount deferred under a nonqualified deferred compensation plan 
of $0 in 2010, $100,000 in 2011, and $250,000 in 2012. With respect to 
Employee C, the statute of limitations on assessments has not expired 
for 2011 or 2012. Except as otherwise explicitly provided in the 
following examples, Employee C has not included in income for 2011 on 
any original or amended tax return any amount deferred under the plan, 
none of the $250,000 total amount deferred for 2012 has previously been 
included in income, no payments are made under the plan, and at no time 
is any deferred amount subject to a substantial risk of forfeiture. The 
plan under which the amounts are deferred fails to meet the 
requirements of section 409A(a) during 2011 and 2012. The examples read 
as follows:

    Example 1. After filing an original Federal income tax return 
for 2011 that did not include any amount in income under section 
409A(a), on April 1, 2013, Employee C files an amended Federal 
income tax return for 2011 and properly includes $100,000 in income 
under section 409A(a) for 2011. For purposes of determining the 
amount includible in income under section 409A(a) for 2012, $100,000 
of the $250,000 total amount deferred for 2012 has previously been 
included in income with respect to the plan. For 2012, Employee C 
includes in income $150,000 under section 409A(a) on Employee C's 
original Federal income tax return. As of January 1, 2013, the 
amount that

[[Page 74395]]

Employee C has previously included in income under section 409A(a) 
with respect to the plan is $250,000.
    Example 2. The facts are the same as in Example 1, except that 
Employee C receives a $10,000 payment in 2011 so that the total 
amount deferred for 2012 is $240,000. For purposes of determining 
the amount includible in income under section 409A(a) for 2012, the 
$100,000 amount previously included in income is reduced by the 
$10,000 payment so that $90,000 of the $240,000 total amount 
deferred for 2012 has previously been included in income. For 2012, 
Employee C includes in income $150,000 under section 409A(a) on 
Employee C's original Federal income tax return. As of January 1, 
2013, the amount that Employee C has previously included in income 
under section 409A(a) with respect to the plan is $240,000.
    Example 3. The facts are the same as in Example 2. Due to deemed 
investment losses during 2013, Employee C has an $80,000 total 
amount deferred under the plan for 2013. On December 31, 2013, 
Employee C's total amount deferred ($80,000) is paid to Employee C 
as a single sum payment. Pursuant to paragraph (f) of this section, 
$80,000 of the $240,000 amount previously included in income is 
allocated to the $80,000 payment so that none of the $80,000 is 
includible in income. In addition, pursuant to paragraph (g) of this 
section, Employee C is entitled to deduct $160,000 for 2013 equal to 
the remaining amount previously included in income the right to 
which is permanently lost. Because the entire $240,000 amount 
previously included in income has been allocated to a payment under 
paragraph (f) of this section or was deductible under paragraph (g) 
of this section, no portion of such amount is treated as previously 
included in income for 2014 or any subsequent taxable year. As of 
January 1, 2014, the amount that Employee C has previously included 
in income under section 409A(a) with respect to the plan is $0.

    (b) The total amount deferred under a plan for a taxable year--(1) 
Application of general rules and specific rules for specific types of 
plans.Paragraph (b)(2) of this section provides general rules governing 
the determination of the total amount deferred under a plan for a 
taxable year, including the treatment of plans providing for 
alternative times and forms of payment and plans providing for certain 
payments the amount of which is determined by a formula that includes 
one or more variables dependent upon future events (formula amounts). 
Paragraphs (b)(3) through (b)(6) of this section provide specific rules 
governing the determination of the total amount deferred under certain 
types of plans. Except as otherwise provided, any applicable rules of 
paragraphs (b)(3) through (b)(6) of this section are applied in 
conjunction with the general rules provided in paragraph (b)(2) of this 
section.
    (2) General definition of total amount deferred--(i) General 
calculation rules. Except as otherwise provided, the total amount 
deferred for a taxable year equals the present value of the future 
payments to which the service provider has a legally binding right 
under the plan as of the last day of the taxable year, plus the amount 
of any payments of amounts deferred under the plan to (or on behalf of) 
the service provider during such taxable year. For purposes of this 
section, present value means the value, as of a specified date, of an 
amount or series of amounts due thereafter, determined in accordance 
with the rules and assumptions of this paragraph (b)(2), as applicable, 
where each amount is multiplied by the probability that the condition 
or conditions on which payment of the amount is contingent will be 
satisfied, also determined in accordance with the rules and assumptions 
set forth in this paragraph (b)(2), as applicable, discounted according 
to an assumed rate of interest to reflect the time value of money. For 
this purpose, a discount for the probability that an employee will die 
before commencement of benefit payments is permitted, but only to the 
extent that benefits will be forfeited upon death. In addition, 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 or actual investment of 
amounts deferred under the plan, the risk that the service recipient, 
the trustee, or another party will be unwilling or unable to pay, the 
possibility of future plan amendments, the possibility of a future 
change in the law, or similar risks or contingencies. If the amount 
payable under a plan or the value of a benefit under a plan is 
expressed in a currency other than the U.S. dollar, the total amount 
deferred is translated from foreign currency into U.S. dollars at the 
spot exchange rate on the last day of the service provider's taxable 
year. No adjustment is made to the total amount deferred to reflect the 
risk that the currency in which the amount payable or the value of the 
benefit is expressed may in the future increase or decrease in value 
with respect to the U.S. dollar or any other currency.
    (ii) Actuarial assumptions and methods--(A) Requirement of 
reasonable actuarial assumptions and methods. For purposes of this 
section, the present value must be determined as of the last day of the 
service provider's taxable year using actuarial assumptions and methods 
that are reasonable as of that date, including an interest rate for 
purposes of discounting for present value that is reasonable as of that 
date.
    (B) Use of an unreasonable actuarial assumption or method. If any 
actuarial assumption or method used to determine the total amount 
deferred for a taxable year under a plan is not reasonable, as 
determined by the Commissioner, then the total amount deferred is 
determined by the application of the AFR and, if applicable, the 
applicable mortality table under section 417(e)(3)(A)(ii)(I) (the 
417(e) mortality table), both determined as of the last month of the 
taxable year for which the amount deferred is being determined. For 
purposes of this section, AFR means the appropriate applicable Federal 
rate (as defined pursuant to section 1274(d)) based on annual 
compounding, for the last month of the taxable year for which the 
amount includible in income is being determined. The period for which 
excess interest will be credited, beginning with the last day of the 
taxable year and ending with the date the excess interest will no 
longer be credited (determined in accordance with the payment timing 
assumptions set forth in paragraph (b)(2)(vi) and (vii) of this 
section) is used to determine the appropriate AFR (short-term, mid-
term, or long-term).
    (iii) Crediting of earnings and losses. The earnings and losses 
credited under a plan as of the last day of the service provider's 
taxable year pursuant to the plan are given effect only to the extent 
the plan's terms reasonably reflect the value of the service provider's 
rights under the plan. For example, a plan's method of determining the 
amount of such earnings or losses generally will be respected for 
purposes of determining the total amount deferred for the taxable year, 
provided that the earnings and losses are credited at least once per 
taxable year. If earnings and losses are not credited at least 
annually, the total amount deferred is calculated as if the earnings or 
losses were credited as of the last day of the taxable year. In 
addition, any change in the schedule for crediting earnings during the 
taxable year for which the total amount deferred is calculated that 
would reduce the earnings credited for a taxable year in which an 
amount is required to be included in income under section 409A(a) is 
disregarded for such taxable year. For example, if a plan is amended 
during a taxable year that is a calendar year to change the date for 
crediting earnings from December 31 to July 1 of that year and the plan 
fails to meet the requirements of section 409A(a) during that year, the 
amendment is disregarded

[[Page 74396]]

for purposes of determining the total amount deferred for the year and 
December 31 is treated as the date for crediting earnings and losses. 
If no further changes are made to the plan with respect to the 
crediting of earnings and losses, for subsequent taxable years, July 1 
is treated as the date for crediting earnings and losses.
    (iv) Application of the general calculation rules to formula 
amounts--(A) In general. With respect to a right to a payment to which 
this paragraph applies, the amount payable for purposes of determining 
the total amount deferred for the taxable year must be determined based 
on all of the facts and circumstances existing as of the close of the 
last day of the taxable year. Such determination must reflect 
reasonable, good faith assumptions with respect to any contingencies as 
to the amount of the payment, both with respect to each contingency and 
with respect to all contingencies in the aggregate. An assumption based 
on the facts and circumstances as of the close of the last day of a 
taxable year may be reasonable even if the facts and circumstances 
change in a subsequent year so that if the amount payable were 
determined for such subsequent year, the amount payable would be a 
greater (or lesser) amount. In such a case, the increase (or decrease) 
due to the change in the facts and circumstances is treated as earnings 
(or losses). This paragraph (b)(2)(iv) applies to the extent that the 
amount payable in a future taxable year is a formula amount to the 
extent that the amount payable in a future taxable year is dependent 
upon factors that, after applying the assumptions and other rules set 
out in this section, are not determinable as of the end of the taxable 
year for which the total amount deferred is being calculated, so that 
the amount payable may not readily be determined as of the end of such 
taxable year under the other provisions of this section. If a portion 
of a deferred amount is determinable under the other rules of this 
paragraph (b)(2), the determination of the amount deferred with respect 
to such portion must be determined under the rules applicable to 
amounts that are not formula amounts, and only the balance of the 
deferred amount is determined under this paragraph.
    (B) Examples. The following examples illustrate the provisions of 
this paragraph (b)(2)(iv):

    Example 1. On January 1, 2020, a service provider receives a 
legally binding right to a payment of one percent of the service 
recipient's net profits for the calendar years 2020, 2021, and 2022, 
payable on the later of January 1, 2024 or the service provider's 
separation from service. The amount payable is a formula amount and 
this paragraph (b)(2)(iv) applies.
    Example 2. On January 1, 2020, a service provider receives a 
legally binding right to a payment of the greater of one percent of 
the service recipient's net profits for the calendar years 2020, 
2021, and 2022 or $10,000, payable on the later of January 1, 2024 
or the service provider's separation from service. The portion of 
the amount payable that is a $10,000 payment, payable at the later 
of January 1, 2024 or the service provider's separation from 
service, is not a formula amount. The portion of the amount payable 
that is the excess, if any, of one percent of the service 
recipient's net profits for the calendar years 2020, 2021, and 2022 
over $10,000 is a formula amount and this paragraph (b)(2)(iv) 
applies.
    Example 3. On January 1, 2020, a service provider receives a 
legally binding right to payment equal to the value of 10,000 shares 
of service recipient stock, payable on the later of January 1, 2024 
or the service provider's separation from service. Because the 
amount payable may increase or decrease only due to a change in 
value of a predetermined actual investment (10,000 shares of service 
recipient stock), the amount payable is not treated as a formula 
amount and this paragraph (b)(2)(iv) does not apply.

    (v) Treatment of payment restrictions. Except as specifically 
provided, a restriction on the payment of all or part of a deferred 
amount that will or may lapse under the terms of the plan, including a 
risk of forfeiture that is not a substantial risk of forfeiture as 
defined in Sec.  1.409A-1(d) or is disregarded under Sec.  1.409A-
4(a)(1)(ii)(B), is ignored for purposes of determining the total amount 
deferred under the plan. Accordingly, in calculating the total amount 
deferred, there is no reduction to account for a risk that the amount 
may be forfeited if the risk of forfeiture is not a substantial risk of 
forfeiture. For example, if an amount deferred is subject to forfeiture 
under a noncompetition provision applicable for a prescribed period, 
the forfeiture provision is disregarded for purposes of determining the 
total amount deferred for the taxable year.
    (vi) Treatment of alternative times and forms of a future payment--
(A) In general. For purposes of determining the total amount deferred 
for a taxable year, if payment of a deferred amount may be made at 
alternative times or in alternative forms, each amount deferred under 
the plan is treated as payable at the time and under the form of 
payment for which the present value is highest. A time and form of 
payment is available to the extent a deferred amount under the plan may 
be payable in such time and form of payment under the plan's terms. If 
the service recipient has commenced payment of a deferred amount in a 
time and form of payment under the plan, or the service provider or 
service recipient has elected a time and form of payment under the 
plan, and under the plan's terms neither party can change such time and 
form of payment without the consent of the other party (and such 
consent requirement has substantive significance), the time and form of 
payment elected or the time and form of payment in which payments have 
commenced is treated as the sole available time and form of payment for 
such amount. If an alternative time and form of payment is available 
only at the service recipient's discretion, the time and form of 
payment is not available unless the service provider has a legally 
binding right under the principles of Sec.  1.409A-1(b)(1) to any 
additional value that would be generated by the service recipient's 
exercise of such discretion. For purposes of determining the value of 
each available time and form of payment, the assumptions and methods 
described in this paragraph (b)(2)(vi) are applied, and then the value 
of each available time and form of payment is determined in accordance 
with the other applicable rules provided in paragraph (b) of this 
section.
    (B) Effect of status of service provider on available times and 
forms of payment. For purposes of determining whether a time and form 
of payment is available, if eligibility for a time and form of payment 
depends upon the service provider's status as of a future date, 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 will be disregarded and 
the service provider will 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 (including status as a 
registered domestic partner or similar requirement), parental status, 
or status as a U.S. citizen or lawful permanent resident under section 
7701(b)(6) is presumed to be bona fide and serve a bona fide business 
purpose. Notwithstanding the foregoing, if eligibility for a certain 
time or form of payment includes a bona fide requirement that the 
service provider provide additional services after the end of the 
taxable year, the time and form of payment is not treated as an 
available time and form of payment. The rules of this paragraph 
(b)(2)(vi)(B) apply regardless of whether the service

[[Page 74397]]

provider's status changes during a subsequent taxable year.
    (vii) Treatment of payment triggers based upon events--(A) In 
general. For purposes of determining the total amount deferred for a 
taxable year, if a payment trigger has occurred on or before the last 
day of the taxable year, a deferred amount payable upon such trigger is 
treated as payable at the time the payment is scheduled to be made 
under the terms of the plan. If the payment trigger has not occurred on 
or before the last day of the taxable year, the trigger is treated as 
occurring on the earliest possible date the trigger reasonably could 
occur based on the facts and circumstances as of the last day of the 
taxable year, and the deferred amount is treated as payable based upon 
the schedule of payments that would be triggered by such occurrence. 
Notwithstanding the foregoing, if the payment trigger requires a 
separation from service, a termination of employment, or other similar 
reduction or cessation of services, the service provider is treated as 
meeting such requirement as of the last day of the taxable year. For 
purposes of determining the earliest date the payment trigger 
reasonably could occur, whether the payment trigger actually occurs in 
a subsequent taxable year is disregarded. For purposes of this 
paragraph (b)(2)(vii), a payment trigger means an event (not including 
the mere passage of time) upon which an amount may become payable. 
Generally if an amount would be payable in a different time and form of 
payment depending upon some characteristic of an event, each type of 
event upon which an amount would become payable is treated as a 
separate payment trigger. For example, if an amount would be payable as 
a single sum payment if one subsidiary corporation of a service 
recipient that consists of multiple corporations is sold, but as an 
installment payment if another subsidiary corporation of the same 
service recipient is sold, then the sale of the one subsidiary 
corporation is treated as a separate payment trigger from the sale of 
the other subsidiary corporation.
    (B) Certain payment triggers disregarded. The possibility that the 
following payment triggers will occur in the future is disregarded for 
purposes of determining the total amount deferred (but not for purposes 
of determining whether the plan otherwise complies with the 
requirements of section 409A(a)):
    (1) A payment trigger that, if the trigger were the sole trigger 
determining when the amount would become payable, would cause the 
amount to be subject to a substantial risk of forfeiture, provided that 
if there is more than one payment trigger applicable to an amount that 
otherwise would be disregarded under this paragraph (b)(2)(vii)(B)(1), 
none of such payment triggers will be disregarded unless all such 
payment triggers, if applied in combination as the only payment 
triggers, would also cause the amount to be subject to a substantial 
risk of forfeiture.
    (2) An unforeseeable emergency (as defined in Sec.  1.409A-
3(i)(3)).
    (viii) Treatment of amounts that may qualify as short-term 
deferrals. For purposes of calculating the total amount deferred for a 
taxable year, 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 be a short-term deferral as defined under Sec.  
1.409A-1(b)(4), is not included in the total amount deferred. In 
addition, even if such amount is not paid by the end of the applicable 
2\1/2\ month period so that the amount is deferred compensation, the 
amount is not includible in the total amount deferred until the service 
provider's taxable year in which the applicable 2\1/2\ month period 
expires.
    (ix) Examples. The following examples illustrate the provisions of 
paragraphs (b)(2)(vi) through (viii) of this section. For all of the 
examples, the service provider is an individual taxpayer who is an 
employee of the service recipient, the service provider has a calendar 
year taxable year, and the total amount deferred is being calculated 
for the taxable year ending December 31, 2010. In each case, the 
service provider is not entitled to earnings on the amount deferred. 
The examples read as follows:

    Example 1. Employee D, who is employed by Employer Z, is 
entitled to commence receiving payments at age 65. The plan provides 
that Employee D will receive a single sum payment, except that, 
after Employee D attains age 62 but before Employee D attains age 64 
(whether or not Employee D is then employed by Employer Z), Employee 
D can elect to receive payments as a single life annuity. Employee D 
is age 54 as of December 31, 2010. For purposes of determining the 
available times and forms of payment, Employee D is assumed to 
survive to age 62 and be eligible to elect a single life annuity. 
Accordingly, for purposes of determining the total amount deferred 
for 2010, the amount is treated as payable as either a single sum 
payment or a single life annuity, whichever is more valuable.
    Example 2. Employee E is entitled to a single life annuity 
commencing on January 1, 2020 if Employee E is not married as of 
January 1, 2020. Employee E is entitled to either a single life 
annuity or a subsidized joint and survivor annuity commencing on 
January 1, 2020 if Employee E is married as of January 1, 2020. 
Employee E is not married as of December 31, 2010. For purposes of 
determining the total amount deferred for 2010, Employee E is 
assumed to remain unmarried indefinitely, so that the subsidized 
joint and survivor annuity is not an available form of payment. 
Accordingly, for purposes of determining the total amount deferred 
for 2010, the amount is treated as payable as a single life annuity 
commencing January 1, 2020.
    Example 3. Employee F is entitled to a series of three payments 
of $1,000 due on January 1, 2020, January 1, 2021, and January 1, 
2022. Under the plan's terms, Employer X has the discretion to 
accelerate one or more of the payments, provided that no payment may 
be made before January 1, 2020. Because there is no reduction in the 
amount payable if a payment is accelerated, an accelerated payment 
is more valuable than a payment made in accordance with the three-
year schedule of payments. If Employee F does not have a legally 
binding right to a single sum payment on January 1, 2020 (or any 
other form of accelerated payment), then an accelerated payment is 
not an available time and form of payment and, for purposes of 
determining the total amount deferred for 2010, the amount is 
treated as payable as a series of three payments of $1,000 on 
January 1, 2020, January 1, 2021, and January 1, 2022.
    Example 4. The facts are the same as in Example 3, except that 
Employer X has no discretion to accelerate one or more of the 
payments. Rather, Employee F has the right to accelerate one or more 
of the payments provided that a payment may not be paid at any date 
before the later of January 1, 2020 or the date 12 months after the 
date of such election. As of December 31, 2010, the earliest date 
upon which Employee F may elect to have a payment made is January 1, 
2020. Because there is no reduction in the amount payable if a 
payment is accelerated, the earliest possible date of payment is the 
most valuable time and form of payment. Accordingly, for purposes of 
determining the total amount deferred for 2010, the amount is 
treated as payable as a single sum payment of $3,000 on January 1, 
2020.
    Example 5. Employee G is entitled to a single sum payment upon 
separation from service if Employee G separates from service before 
January 1, 2020 and a single life annuity if Employee G separates 
from service after December 31, 2019. As of December 31, 2010, 
Employee G has not separated from service. Under paragraph 
(b)(2)(vi)(A) of this section, the total amount deferred is 
determined based upon the amount that would be payable if Employee G 
separated from service on December 31, 2010. Accordingly, the single 
life annuity is not treated as an available time and form of 
payment, so that the amount is treated as payable as a single sum 
payment upon separation from service.
    Example 6. Employee H is entitled to a single sum payment of 
deferred compensation upon the earlier of January 1, 2020 or an 
unforeseeable emergency. Because the payment upon an unforeseeable 
emergency is disregarded, for purposes of determining the total 
amount deferred, the deferred amount is treated as payable only on 
January 1, 2020.

[[Page 74398]]

    Example 7. Employee I is entitled to a single sum payment of 
deferred compensation upon the earlier of January 1, 2020 or 
Employee I's involuntary separation from service. Under the facts 
and circumstances existing at the time the right to the payment was 
granted, if the deferred amount had been payable only upon Employee 
I's involuntary separation from service, the amount would have been 
subject to a substantial risk of forfeiture. Under paragraph 
(b)(2)(iv)(B) of this section, the right to a payment upon the 
Employee I's involuntary separation from service is disregarded, and 
the amount is treated as payable only on January 1, 2020.
    Example 8. Employee J is entitled to a single sum payment of 
deferred compensation upon the earlier of January 1, 2020 or 
Employee J's separation from service. As of December 31, 2010, 
Employee J has not separated from service. Under paragraph 
(b)(2)(vi)(A) of this section, the total amount deferred is 
determined based upon the amount that would be payable if Employee J 
separated from service on December 31, 2010 and therefore had the 
right to receive the payment on December 31, 2010. The total amount 
deferred for 2010 is the greater of the amount that would be payable 
on December 31, 2010 or the present value of the amount that would 
be payable on January 1, 2020.
    Example 9. Employee K is entitled to a single sum payment of 
deferred compensation upon the earlier of January 1, 2020 or the 
first day of the third month following Employee K's separation from 
service. As of December 31, 2010, Employee K has not separated from 
service. Under paragraph (b)(2)(vi)(A) of this section, the total 
amount deferred is determined based upon the amount that would be 
payable if Employee K separated from service on December 31, 2010, 
and therefore had a right to a payment on March 1, 2011. The total 
amount deferred for 2010 is the greater of the present value as of 
December 31, 2010 of the amount that would be payable on March 1, 
2011 or the present value as of December 31, 2010 of the amount that 
would be payable on January 1, 2020.
    Example 10. Employee L is entitled to a single sum payment of 
deferred compensation upon the earlier of January 1, 2020 or a 
separation from service that occurs on or before July 1, 2010. As of 
December 31, 2010, Employee L has not separated from service. For 
purposes of determining the total amount deferred, the right to be 
paid upon a separation from service on or before July 1, 2010 is 
ignored because it is no longer a possible payment trigger, and the 
amount is treated as payable only on January 1, 2020.
    Example 11. Employee M is entitled to a single sum payment of 
deferred compensation upon the earliest of the date Employee M dies, 
Employee M attains age 65, or a child of Employee M becomes a full-
time student at an accredited college or university (whether or not 
Employee M continues to be employed on such date). As of December 
31, 2010, Employee M has a 10-year-old child who is in the fifth 
grade. For purposes of determining the total amount deferred, the 
earliest time that the payment reasonably could be due upon Employee 
M's child entering a college or university is August 1, 2018. Thus, 
the total amount deferred for 2010 is the more valuable of the 
amount that would be payable on the Employee M's 65th birthday and 
the amount that would be payable on August 1, 2018. Because any 
additional value that would be payable upon Employee M's death is a 
death benefit excluded from the definition of deferred compensation 
under section 409A(d)(1)(B) and Sec.  1.409A-1(a)(5), that 
additional value, if any, is not required to be calculated.

    (3) Account balance plans--(i) In general. For purposes of this 
section, if benefits are provided under a nonqualified deferred 
compensation plan that is described in Sec.  1.409A-1(c)(2)(i)(A) or 
(B) (an account balance plan), the present value of the amount payable 
equals the amount credited to the service provider's account as of the 
last day of the taxable year, including both the principal amount 
credited to the account, and any earnings or losses attributable to the 
principal amounts credited to the account through the last day of the 
taxable year. For purposes of this section, earnings or losses means 
any increase or decrease in the amount credited to a service provider's 
account that is attributable to amounts previously credited to the 
service provider's account, regardless of whether the plan denominates 
that increase or decrease as earnings or losses. For rules related to 
the crediting of earnings, see paragraph (b)(2)(iii) of this section. 
For rules relating to earnings based on an unreasonable interest rate 
or a rate of return based on an investment other than a single 
predetermined actual investment or a single reasonable interest rate, 
see paragraph (b)(3)(ii) of this section.
    (ii) Unreasonable rate of return--(A) Application. This paragraph 
(b)(3)(ii) applies to an account balance plan under which the amount of 
earnings or losses credited is not based on either a predetermined 
actual investment, within the meaning of Sec.  31.3121(v)(2)-
1(d)(2)(i)(B) of this chapter, or a rate of interest that is not higher 
than a reasonable rate of interest, within the meaning of Sec.  
31.3121(v)(2)-1(d)(2)(i)(C) of this chapter, as determined by the 
Commissioner.
    (B) Unreasonably high interest rate. If the earnings or losses to 
be credited under a plan are based on an unreasonably high rate of 
interest, the amount deferred under the plan is equal to the present 
value as of the end of the taxable year (using a reasonable interest 
rate) of the amount that will be credited to the service recipient's 
account using the unreasonably high rate for the entire period for 
which the unreasonably high interest will be credited under the plan, 
beginning with the last day of such taxable year and ending with the 
date the unreasonably high interest will no longer be credited 
(determined in accordance with the payment timing assumptions set forth 
in paragraph (b)(2)(vi) and (vii) of this section). If the service 
recipient fails to use a reasonable interest rate to determine the 
amount includible in income, AFR will be used. For purposes of this 
section, AFR means the appropriate applicable Federal rate (as defined 
pursuant to section 1274(d)) based on annual compounding, for the last 
month of the taxable year for which the amount includible in income is 
being determined. The period described in the first sentence of this 
paragraph (b)(3)(ii)(B) is used to determine the appropriate AFR 
(short-term, mid-term, or long-term). For purposes of this paragraph 
(b)(3)(ii)(B), an unreasonably high interest rate includes a fixed 
interest rate that exceeds an interest rate that is reasonable, within 
the meaning of Sec.  31.3121(v)(2)-1(d)(2)(i)(C) of this chapter.
    (C) Other rates of return. If the amount of earnings or losses 
credited is based on a rate of return that is not an unreasonably high 
interest rate, within the meaning of paragraph (b)(3)(ii)(B) of this 
section, but is also not a predetermined actual investment, within the 
meaning of Sec.  31.3121(v)(2)-1(d)(2)(i)(B) of this chapter or a rate 
of interest that is no more than a reasonable rate of interest, within 
the meaning of Sec.  31.3121(v)(2)-1(d)(2)(i)(C) of this chapter , the 
amount payable is a formula amount.
    (4) Reimbursement and in-kind benefit arrangements. For purposes of 
this section, if benefits for a service provider are provided under a 
nonqualified deferred compensation plan described in Sec.  1.409A-
1(c)(2)(i)(E) (a reimbursement arrangement), or under a nonqualified 
deferred compensation plan that would be described in Sec.  1.409A-
1(c)(2)(i)(E) except that the amounts, separately or in the aggregate, 
constitute a substantial portion of either the overall compensation 
earned by the service provider for performing services for the service 
recipient or the overall compensation received due to a separation from 
service, the arrangement is treated as providing for a formula amount 
to the extent that the expenses to be reimbursed are not explicitly 
identified to be a specific amount. Notwithstanding the foregoing, if 
the expenses eligible for reimbursement are limited, it is presumed 
that the limit reflects the reasonable amount of eligible expenses

[[Page 74399]]

that the service provider will incur at the earliest possible date 
during the time period to which the limit applies, and for which the 
service provider will request reimbursement at the earliest possible 
date that the service provider may request reimbursement. This 
presumption may be rebutted only by demonstrating by clear and 
convincing evidence that it is unreasonable to assume that a service 
provider would incur such amount of expenses during the applicable time 
period. This presumption is not applicable to any reimbursement 
arrangement to which Sec.  1.409A-3(i)(1)(iv)(B) applies (certain 
medical reimbursement arrangements). In addition, this paragraph (b)(4) 
also applies to an arrangement providing a service provider a right to 
in-kind benefits from the service recipient, or a payment by the 
service recipient directly to the person providing the goods or 
services to the service provider.
    (5) Split-dollar life insurance arrangements. For purposes of this 
section, if benefits for a service provider are provided under a 
nonqualified deferred compensation plan described in Sec.  1.409A-
1(c)(2)(i)(F) (a split-dollar life insurance arrangement), the amount 
of the future payment to which the service provider is entitled is 
treated as the amount that would be includible in income under Sec.  
1.61-22 or Sec.  1.7872-15 (as applicable) or, if those regulations are 
not applicable, the amount that would be includible in income under any 
other applicable guidance. For this purpose, the payment timing 
assumptions set forth in paragraph (b)(2)(vi) and (vii) of this section 
generally apply. However, in the case of an arrangement subject to 
Sec.  1.7872-15, to the extent the assumptions set forth in paragraph 
(b)(2)(vi) and (vii) of this section conflict with the provisions of 
Sec.  1.7872-15, the provisions of Sec.  1.7872-15 apply, and the 
conflicting assumptions set forth in paragraph (b)(2)(vi) and (vii) of 
this section do not apply. In either case, for purposes of determining 
the total amount deferred under the plan for the taxable year, the 
benefits under the split-dollar life insurance arrangement are included 
only to the extent that the right to such benefits constitutes a right 
to deferred compensation under Sec.  1.409A-1(b).
    (6) Stock rights. If a stock right has not been exercised during 
the service recipient's taxable year, and remains outstanding as of the 
last day of the service provider's taxable year for which the total 
amount deferred is being calculated, the total amount deferred under 
the stock right for such taxable year is the excess of the fair market 
value of the underlying stock on the last day of the service provider's 
taxable year (determined in accordance with Sec.  1.409A-1(b)(5)(iv)) 
over the sum of the stock right's exercise price plus any amount paid 
for the stock right. If a stock right has been exercised during the 
service provider's taxable year, the payment amount for purposes of 
calculating the total amount deferred for the taxable year under the 
stock right is the excess of the fair market value of the underlying 
stock (as determined in accordance with Sec.  1.409A-1(b)(5)(iv)) on 
the date of exercise over the sum of the exercise price of the stock 
right and any amount paid for the stock right.
    (7) Anti-abuse provision. The Commissioner may disregard all or 
part of the rules of paragraphs (b)(2) through (b)(6) of this section 
or all or part of the plan's terms if the Commissioner determines based 
on all of the facts and circumstances that the plan terms have been 
established to eliminate or minimize the total amount deferred under 
the plan determined in accordance with the rules of paragraphs (b)(2) 
through (b)(6) of this section and if the rules of paragraphs (b)(2) 
through (b)(6) of this section were applied or such plan terms were 
given effect, the total amount deferred would not reasonably reflect 
the present value of the right. For example, if a plan provides that a 
deferred amount is payable upon a separation from service but also 
contains a provision that the amount will be forfeited upon a 
separation from service occurring on the last day of the service 
provider's taxable year (so that the application of paragraph 
(b)(2)(vii)(A) of this section treating the service provider as 
separating from service on the last day of the taxable year for 
purposes of determining the timing of the payment in calculating the 
total amount deferred would result in a zero amount deferred), the 
latter provision will be disregarded.
    (c) Additional 20 percent tax under section 409A(a)(1)(B)(i)(II). 
With respect to an amount required to be included in income under 
section 409A(a) for a taxable year, the amount is subject to an 
additional income tax equal to 20 percent of the amount required to be 
included in income under section 409A(a).
    (d) Premium interest tax under section 409A(a)(1)(B)(i)(I)--(1) In 
general. With respect to an amount required to be included in income 
under section 409A(a) for a taxable year, the amount is subject to an 
additional income tax equal to the amount of interest at the 
underpayment rate plus one percentage point on the underpayments that 
would have occurred had the deferred compensation been includible in 
the service provider's 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. The 
amount required to be allocated to determine the additional tax 
described in this paragraph (d) is the amount required to be included 
in income under section 409A(a) for the taxable year, regardless of 
whether additional amounts were deferred under the plan in previous 
years.
    (2) Identification of taxable year deferred amount was first 
deferred or vested--(i) Method of identification. The following method 
is applied for purposes of determining the taxable year or years in 
which an amount required to be included in income under section 409A(a) 
was first deferred and not subject to a substantial risk of forfeiture.
    (A) For each taxable year preceding the taxable year for which the 
deferred amount is includible in income (the current taxable year) in 
which the service provider had an amount deferred under the plan that 
was not subject to a substantial risk of forfeiture (vested), ending 
with the later of the first taxable year in which the service provider 
had no vested amount deferred or the first taxable year beginning after 
December 31, 2004, calculate the vested total amount deferred for such 
year. For each year, include any deferred amount that was previously 
included in income under paragraph (a)(3) of this section but has not 
been paid, but exclude any amount paid to (or on behalf of) the service 
provider during such taxable year.
    (B) Identify any payments made under the plan to (or on behalf of) 
the service provider for each taxable year identified in paragraph 
(d)(2)(i)(A) of this section.
    (C) Identify any deemed net investment losses or other net 
decreases in the amount deferred (other than as a result of a payment) 
applicable to amounts that are vested for the current taxable year and 
each preceding taxable year identified in paragraph (d)(2)(i)(A) of 
this section.
    (D) Starting with the first taxable year during which there was a 
payment identified under paragraph (d)(2)(i)(B) of this section or a 
loss identified under paragraph (d)(2)(i)(C) of this section (or both), 
subtract the total payments and loss for such taxable year from the 
amount determined under paragraph (d)(2)(i)(A) of this section for the 
earliest taxable year before such year in which there is such an 
amount, and from the amount determined under paragraph

[[Page 74400]]

(d)(2)(i)(A) of this section for each subsequent taxable year ending 
before the taxable year in which the payment was made or the loss 
incurred. Do not reduce any taxable year-end balance below zero.
    (E) Repeat this process for each subsequent taxable year during 
which there was a payment identified under paragraph (d)(2)(i)(B) of 
this section or a loss identified under paragraph (d)(2)(i)(C) of this 
section (or both).
    (F) For each taxable year identified in paragraph (d)(2)(i)(A) of 
this section, determine the excess (if any) of the remaining amount 
deferred for the taxable year over the remaining amount deferred for 
the previous taxable year. Treat the amount deferred in taxable years 
beginning before January 1, 2005 as zero.
    (G) Determine how much of the total amount deferred for the current 
taxable year was previously included in income in accordance with 
paragraph (a)(3) of this section.
    (H) Subtract the amount determined in paragraph (d)(2)(i)(G) of 
this section from the excess amount determined in paragraph 
(d)(2)(i)(F) of this section for the earliest taxable year in which 
there is any such excess amount, but do not reduce the balance below 
zero. If the amount determined in paragraph (d)(2)(i)(G) of this 
section exceeds the amount determined in paragraph (d)(2)(i)(F) of this 
section for that earliest taxable year, subtract the excess from the 
amount determined in paragraph (d)(2)(i)(F) of this section for the 
next succeeding taxable year, but do not reduce the balance below zero. 
Repeat this process until the excess has been reduced to zero. The 
balance remaining with respect to each taxable year identified in 
paragraph (d)(2)(i)(A) of this section is the portion of the amount 
includible in income under section 409A(a) in the current taxable year 
that was first deferred and vested in that taxable year.
    (ii) Examples. The following examples illustrate the provisions of 
paragraph (d)(2) of this section. In all of the following examples, the 
service provider is an individual taxpayer with a calendar year taxable 
year who elects to defer a portion of the bonus that would otherwise be 
payable to the service provider in each of Year 1 through Year 4. All 
amounts deferred are deferred under the same plan, and no amount 
deferred under the plan is ever subject to a substantial risk of 
forfeiture. The plan does not fail to meet the requirements of section 
409A(a) in any year prior to Year 4, and no amounts deferred under the 
plan are otherwise includible in income until Year 4, except for 
payments actually made to the service provider. The service provider 
had no amount deferred under the plan prior to Year 1. The plan fails 
to meet the requirements of section 409A(a) in Year 4. The examples 
read as follows:

    Example 1. 

----------------------------------------------------------------------------------------------------------------
                                                                 Year 1       Year 2       Year 3       Year 4
----------------------------------------------------------------------------------------------------------------
Opening Total Amount........................................            0          110          275          495
Bonus Deferral..............................................          100          150          200          250
Net Gains (Losses)..........................................           10           15           20           25
Payments....................................................            0            0            0            0
Closing Total Amount........................................          110          275          495          770
----------------------------------------------------------------------------------------------------------------

    (i) The amount required to be included in income under section 
409A is 770. To calculate the premium interest tax, the 770 must be 
allocated to the year or years in which the amount was first 
deferred and vested.
    (ii) Step A. Identification of vested total amount deferred 
excluding payments and including deferred amounts previously 
included in income.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
            110                      275                     495
------------------------------------------------------------------------

    (iii) Step B. Identification of any payments for each year other 
than Year 4.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
              0                        0                       0
------------------------------------------------------------------------

    (iv) Step C. Identification of any other decreases attributable 
to vested amounts.

------------------------------------------------------------------------
      Year 1             Year 2            Year 3            Year 4
------------------------------------------------------------------------
           0                  0                 0                 0
------------------------------------------------------------------------

    (v) Steps D and E. Subtraction of payments and decreases from 
amounts deferred.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
            110                      275                     495
             -0                       -0                      -0
------------------------------------------------------------------------
            110                      275                     495
------------------------------------------------------------------------

    (vi) Step F. Subtraction of previous year total from each year's 
total.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
            110                      275                     495
             -0                     -110                    -275
------------------------------------------------------------------------
            110                      165                     220
------------------------------------------------------------------------

    (vii) Because no amount was previously included in income, Step 
G does not apply. Accordingly, the 770 is allocated such that 110 is 
treated as first deferred and vested in Year 1, 165 in Year 2, 220 
in Year 3. The remainder (275) is treated as first deferred in Year 
4, but is not required to be allocated for purposes of the premium 
interest tax because there is no hypothetical underpayment for such 
year.
    Example 2. 

----------------------------------------------------------------------------------------------------------------
                                                                 Year 1       Year 2       Year 3       Year 4
----------------------------------------------------------------------------------------------------------------
Opening Total Amount........................................            0          110          235          365
Bonus Deferral..............................................          100          150          200          250
Net Gains (Losses)..........................................           10         (25)         (30)           25
Payments....................................................            0            0         (40)         (50)
Closing Total Amount........................................          110          235          365          590
----------------------------------------------------------------------------------------------------------------

    (i) The amount that is includible in income under section 
409A(a) for Year 4 is the closing total amount (590), plus the 
amounts paid during Year 4 that were includible in income (50) or 
640. To calculate the premium interest tax, the 640 must be 
allocated to the year or years in which the amount was first 
deferred and vested.
    (ii) Step A. Identification of vested total amount deferred 
excluding payments and including deferred amounts previously 
included in income.

[[Page 74401]]



------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
            110                      235                     365
------------------------------------------------------------------------

    (iii) Step B. Identification of any payments for each year other 
than Year 4.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
              0                        0                    (40)
------------------------------------------------------------------------

    (iv) Step C. Identification of any other decreases attributable 
to vested amounts.

------------------------------------------------------------------------
      Year 1             Year 2            Year 3            Year 4
------------------------------------------------------------------------
           0               (25)              (30)                 0
------------------------------------------------------------------------

    (v) Steps D and E. Subtraction of payments and decreases from 
amounts deferred.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
            110                      235                     365
   -25 (Year 2)             -40 (Year 3)          ......................
   -40 (Year 3)             -30 (Year 3)          ......................
   -30 (Year 3)          .......................  ......................
------------------------------------------------------------------------
             15                      165                     365
------------------------------------------------------------------------

    (vi) Step F. Subtraction of previous year total from each year's 
total.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
             15                      165                     365
             -0                      -15                    -165
------------------------------------------------------------------------
             15                      150                     200
------------------------------------------------------------------------

    (vii) Because no amount was previously included in income, Step 
G does not apply. Accordingly, the 640 is allocated such that 15 is 
treated as first deferred and vested in Year 1, 150 in Year 2, and 
200 in Year 3. The remaining amount includible in income under 
section 409A for Year 4 (275) is treated as first deferred in Year 
4, but is not required to be allocated for purposes of the premium 
interest tax because there is no hypothetical underpayment for Year 
4.
    Example 3. (i) The facts are the same as in Example 2 except 125 
was previously included in income under paragraph (a)(3) of this 
section. Accordingly, of the 590 closing total amount for Year 4 
plus the 50 payment during Year 4, or 640, only 515 (640 - 125) must 
be included in income under section 409A(a). To calculate the 
premium interest tax, the 125 must be allocated to the year or years 
in which such amount was first deferred.
    (ii) Step G. Allocation of amounts previously included in 
income.

------------------------------------------------------------------------
         Year 1                   Year 2                  Year 3
------------------------------------------------------------------------
             15                      150                     200
            -15                     -110                      -0
------------------------------------------------------------------------
              0                       40                     200
------------------------------------------------------------------------

    (iii) Accordingly, for purposes of calculating the premium 
interest tax, the 125 previously included in income is allocated so 
that of the 515 includible in income under section 409A(a), 0 is 
treated as first deferred and vested in Year 1, 40 in Year 2, and 
200 in Year 3.

    (3) Calculation of hypothetical underpayment for the taxable year 
during which a deferred amount was first deferred and vested--(i) 
Calculation method. The hypothetical underpayment for a taxable year is 
determined by treating as an additional cash payment of compensation to 
the service provider for such taxable year, the amount determined 
pursuant to paragraph (d)(2) of this section to be the portion of the 
amount includible in income under section 409A(a) that was first 
deferred and vested during such taxable year. The hypothetical 
underpayment is calculated based on the service provider's taxable 
income, credits, filing status, and other tax information for the year, 
based on the service provider's original return filed for such year, as 
adjusted by any examination for such year or any amended return the 
service provider filed for such year that was accepted by the 
Commissioner. The hypothetical underpayment must reflect the effect 
that such additional compensation would have had on the service 
provider's Federal income tax liability 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 amount includible in income under section 409A(a) was 
first deferred and vested in the subsequent year), any changes to the 
service provider's Federal income tax liability for the subsequent year 
that would have occurred if the portion of the amount that was first 
deferred and vested during the previous taxable year had been included 
in the service provider's income for the previous year must be taken 
into account. Assumptions not based on the service provider's taxable 
income, credits, filing status, and other tax information for the year, 
based on the service provider's original return for such year, as 
adjusted by any examination for such year or any amended return the 
service provider filed for such year that was accepted by the 
Commissioner, may not be applied. For example, the service provider may 
not assume that some of the additional compensation would have been 
deferred under the terms of a qualified plan. If the service provider's 
Federal income tax liability for the taxable year in which an amount 
required to be included in income under section 409A(a) was first 
deferred and vested is adjusted (for example, by an amended return or 
IRS examination), and the adjustment affects the amount of the 
hypothetical underpayment, the service provider must recalculate the 
hypothetical underpayment and adjust the amount of premium interest tax 
due with respect to such inclusion in income under section 409A(a), as 
appropriate.
    (ii) Examples. The following examples illustrate the provisions of 
paragraph (d)(3)(i) of this section. In all of the following examples, 
Employee N is an individual taxpayer with a calendar year taxable year. 
For the year 2020, Employee N has a total amount deferred of $100,000 
which is includible in income under section 409A(a). For purposes of 
determining the premium interest tax, assume that $30,000 was first 
deferred and vested in 2018, $35,000 was first deferred and vested in 
2019, and $35,000 was first deferred and vested in 2020. The first year 
that Employee N had a vested deferred amount under the plan was 2018. 
The examples read as follows:

    Example 1. For the taxable years 2018 and 2019, Employee N has 
no carryover losses or other items a change in which could affect 
the adjusted gross income for a subsequent taxable year. Employee N 
determines the hypothetical underpayment for 2018 by assuming an 
additional cash compensation payment of $30,000 for 2018, and 
determining the hypothetical underpayment of Federal income tax that 
would result. Employee N determines the hypothetical underpayment 
for 2019 by assuming an additional cash compensation payment of 
$35,000 in 2019, and determining the hypothetical underpayment of 
Federal income tax for 2019 that would result. There is no 
hypothetical underpayment with respect to hypothetical income in 
2020 because the tax payment would not have been due until 2021. 
Therefore, Employee N is not required to determine a hypothetical 
underpayment for 2020.
    Example 2. The facts are the same as in Example 1, except that 
in 2018, Employee N had an excess charitable contribution the 
deduction of which was not permitted under section 170(b), and which 
was carried over to subsequent taxable years under section 170(d). 
For purposes of determining the hypothetical underpayment for 2018, 
Employee N uses the charitable contribution deduction that otherwise 
would have been available if the $30,000 compensation payment had 
actually been made. Employee N must then calculate the hypothetical 
underpayment for all subsequent years in a manner that eliminates 
the portion of any carryovers of excess contributions under section 
170(d) related to the charitable contribution in 2018 that would not 
have been available in such subsequent years as a result of having 
been deducted in 2018.
    Example 3. The facts are the same as in Example 2, except that 
in 2021 the IRS

[[Page 74402]]

examines Employee N's 2018 return and determines that Employee N had 
$20,000 in unreported income for that year. In addition to paying 
the tax deficiency owed for 2018, Employee N must redetermine the 
hypothetical underpayment for 2018 and recalculate the premium 
interest tax owed for 2020.

    (4) Calculation of hypothetical premium underpayment interest--(i) 
Calculation method. The amount of hypothetical premium underpayment 
interest is determined for any taxable year by applying the applicable 
rate of interest under section 6621 plus one percentage point to 
determine the underpayment interest under section 6601 that would be 
due for such underpayment as of the last day of the taxable year for 
which the amount deferred is includible in income under section 
409A(a). The amount of additional income tax under paragraph (d)(2) of 
this section with respect to an amount required to be included in 
income under section 409A(a) is the sum of all of the hypothetical 
premium underpayment interest for all years in which there was 
determined a hypothetical underpayment.
    (ii) Examples. The following examples illustrate the provisions of 
this paragraph (d)(4). In each of these examples, the service provider 
is an individual taxpayer with a calendar year taxable year. At all 
times the total amount deferred under the nonqualified deferred 
compensation plan is not subject to a substantial risk of forfeiture. 
The examples read as follows:

    Example 1. Employee O has a total amount deferred under a 
nonqualified deferred compensation plan for 2010 of $100,000. The 
entire deferred amount was first deferred in 2006. For purposes of 
calculating the hypothetical premium underpayment interest tax, 
Employee O first must determine the hypothetical underpayment for 
taxable years 2006 through 2009 under the rules of paragraph (d)(3) 
of this section. Then Employee O must determine the underpayment 
interest under section 6601 that would have accrued, calculated 
using the applicable underpayment interest rate under section 6621 
increased by one percentage point, applied through December 31, 
2010. That amount is the premium interest tax that is due for 2010.
    Example 2. Employee P has a total amount deferred under a 
nonqualified deferred compensation plan for 2010 of $100,000. 
$60,000 of that deferred amount was first deferred in 2006. $30,000 
of that amount was first deferred in 2008. $10,000 of that amount 
was first deferred in 2010. For purposes of calculating the 
hypothetical premium underpayment interest tax, Employee P first 
must determine the hypothetical underpayment for taxable years 2006 
through 2009 under the rules of paragraph (d)(3) of this section 
applying $60,000 of hypothetical additional compensation for 2006, 
and applying $30,000 of hypothetical additional compensation for 
2008. The $10,000 of hypothetical additional compensation in 2010 
would not result in a hypothetical underpayment because the Federal 
income tax applicable to that hypothetical additional compensation 
would not yet be due. Second, Employee P must determine the 
underpayment interest under section 6601 that would have accrued, 
calculated using the applicable underpayment interest rate under 
section 6621 increased by one percentage point, applied through 
December 31, 2010, for both the hypothetical underpayment occurring 
in 2006 and the hypothetical underpayment occurring in 2008. The sum 
of those two amounts is the premium interest tax that is due for 
2010.

    (e) Amounts includible in income under section 409A(b) [Reserved].
    (f) Application of amounts included in income under section 409A to 
payments of amounts deferred--(1) In general. 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 
this chapter or any other rule of law later than the time provided in 
this section. An amount included in income under section 409A that has 
neither been paid in the taxable year the amount was included in income 
under section 409A nor served as the basis for a deduction under 
paragraph (g) of this section is allocated to the first payment of an 
amount deferred under the plan in any year subsequent to the year the 
amount was included in income under section 409A. To the extent the 
amount included in income under section 409A exceeds such payment, the 
excess is allocated to the next payment of an amount deferred under the 
plan. This process is repeated until the entire amount included in 
income under section 409A has been paid or the service provider has 
become entitled to a deduction under paragraph (g) of this section.
    (2) Application of the plan aggregation rules. The plan aggregation 
rules of Sec.  1.409A-1(c)(2) apply to the allocation of amounts 
previously included in income under section 409A to payments made under 
the plan. Accordingly, references to an amount deferred under a plan, 
or a payment of an amount deferred under a plan, refer to an amount 
deferred or a payment made under all arrangements in which a service 
provider participates that together are treated as a single plan under 
Sec.  1.409A-1(c)(2).
    (3) Examples. The following examples illustrate the provisions of 
this section. In each of these examples, the service provider is an 
individual taxpayer with a calendar year taxable year. Each service 
provider has a total amount deferred under a nonqualified deferred 
compensation plan of $0 for 2010, a total amount deferred under the 
plan of $100,000 for 2011, a total amount deferred under the plan of 
$250,000 for 2012, and a total amount deferred under the plan of 
$400,000 for 2013. At all times the total amount deferred under the 
plan is not subject to a substantial risk of forfeiture. During 2011, 
the plan fails to comply with section 409A(a) and each service provider 
includes $100,000 in income under section 409A. Except as otherwise 
provided in the following examples, the service provider does not 
receive any payments of amounts deferred under the plan. The examples 
read as follows:

    Example 1. During 2012, Employee Q receives a $10,000 payment 
under the plan. During 2013, Employee Q receives a $150,000 payment 
under the plan. For 2012, $10,000 of the $100,000 included in income 
under section 409A(a) is allocated under paragraph (f)(1) of this 
section to the $10,000 payment, so that no amount is includible in 
gross income as a result of such payment and Employee Q retains 
$90,000 of amounts previously included in income under the plan to 
allocate to future plan payments. For 2013, the remaining $90,000 
included in income under section 409A(a) is allocated to the 
$150,000 payment, so that only $60,000 is includible in income as a 
result of such payment.
    Example 2. During 2012, Employee R receives a $10,000 payment 
under the plan. During 2014, Employee R receives a $50,000 payment, 
equaling the entire amount deferred under the plan. For 2012, 
$10,000 of the $100,000 previously included in income is allocated 
pursuant to paragraph (f)(1) of this section to the $10,000 payment, 
so that no amount is includible in gross income as a result of such 
payment. For 2014, $50,000 of the $90,000 remaining amount 
previously included in income is allocated pursuant to paragraph 
(f)(1) of this section to the $50,000 payment, so that no amount is 
includible in gross income as a result of such payment. Provided 
that the requirements of paragraph (g) of this section are otherwise 
met, Employee R is entitled to a deduction for 2014 equal to the 
remaining amount ($40,000) that was previously included in income 
under section 409A(a) that has not been allocated to a payment under 
the plan.

    (g) Forfeiture or other permanent loss of right to deferred 
compensation--(1) Availability of deduction to the service provider. If 
a service provider has included a deferred amount in income under 
section 409A, but has not actually received payment of such deferred 
amount or otherwise allocated the amount included in income under 
paragraph (f) of this section, the service provider is entitled to a 
deduction for the taxable year in which the right to that amount of 
deferred compensation is permanently forfeited under the plan's terms 
or the right to the payment of the

[[Page 74403]]

amount is otherwise permanently lost. The deduction to which the 
service provider is entitled equals the deferred amount included in 
income under section 409A in a previous year, less any portion of such 
deferred amount previously included in income under section 409A that 
was allocated under paragraph (f) of this section to amounts paid under 
the plan, including any deferred amount paid in the year the right to 
any remaining deferred compensation is permanently forfeited or 
otherwise lost. For this purpose, a mere diminution in the deferred 
amount under the plan due to deemed investment loss, actuarial 
reduction, or other decrease in the amount deferred is not treated as a 
permanent forfeiture or loss of the right if the service provider 
retains the right to an amount deferred under the plan (whether or not 
such right is subject to a substantial risk of forfeiture as defined in 
Sec.  1.409A-1(d)). In addition, a deferred amount is not treated as 
permanently forfeited or otherwise lost if the obligation to make the 
payment of such deferred amount is substituted for another deferred 
amount or obligation to make a payment in a future year. However, a 
deferred amount is treated as permanently lost if the service 
provider's right to receive the payment of the deferred amount becomes 
wholly worthless during the taxable year. Whether the right to the 
payment of a deferred amount has become wholly worthless is determined 
based on all the facts and circumstances existing as of the last day of 
the relevant service provider taxable year.
    (2) Application of the plan aggregation rules. For purposes of 
determining whether the right to a deferred amount is permanently 
forfeited or otherwise lost, the plan aggregation rules of Sec.  
1.409A-1(c) apply. Accordingly, if the right to an identified deferred 
amount under a plan is permanently forfeited or otherwise lost, but an 
additional amount remains deferred under the plan, the service provider 
is not entitled to a deduction.
    (3) Examples. The following examples illustrate the provisions of 
this paragraph (g). In each example, the service provider is an 
individual taxpayer who has a calendar year taxable year and the 
service recipient does not experience bankruptcy at any time or 
otherwise discharge any obligation to make a payment of a deferred 
amount, except as expressly provided in the example. The examples read 
as follows:

    Example 1. For 2010, Employee S has a total amount deferred 
under an elective account balance plan of $1,000,000. The plan fails 
to meet the requirements of section 409A(a) during 2010 and Employee 
S includes $1,000,000 in income under section 409A(a) for the year 
2010. In 2011, Employee S experiences investment losses but no 
payments before July 1, 2011, such that Employee S's account balance 
under the plan is $500,000. On July 1, 2011, Employee S separates 
from service and receives a $500,000 payment equal to the entire 
amount deferred under the plan, and retains no other right to 
deferred compensation under the plan (including all arrangements 
aggregated with the arrangement under which the payment was made). 
For 2011, Employee S is entitled to deduct $500,000 (which is the 
amount Employee S previously included in income under section 
409A(a) ($1,000,000) less the amount actually received by Employee S 
($500,000)).
    Example 2. For 2010, Employee T has a total amount deferred 
under an elective account balance plan of $1,000,000. The plan fails 
to meet the requirements of section 409A(a) for 2010 and Employee T 
includes $1,000,000 in income under section 409A(a) for 2010. For 
2011, Employee T has a total amount deferred under the plan of 
$500,000, due solely to the deemed investment losses attributable to 
Employee T's account balance (with no payments being made during 
2011). Because Employee T retains the right to an amount deferred 
under the plan, Employee T is not entitled to a deduction for 2011 
as a result of the deemed investment losses.
    Example 3. For 2010, Employee U has a total amount deferred 
under an elective account balance plan of $1,000,000. The elective 
account balance plan consists of one arrangement providing for 
salary deferrals with an amount deferred for 2010 of $600,000, and 
another arrangement providing for bonus deferrals with an amount 
deferred for 2010 of $400,000. The plan fails to meet the 
requirements of section 409A(a) during 2010 and Employee U includes 
$1,000,000 in income under section 409A(a) for 2010. On July 1, 
2011, Employee U's account balance attributable to the salary 
deferral arrangement is $500,000, the reduction of which is due 
solely to deemed investment losses in 2011 and not any payments. On 
July 1, 2011, Employee U is paid the $500,000 equaling the entire 
account balance attributable to the salary deferral arrangement. On 
December 31, 2011, Employee U has an account balance attributable to 
the bonus deferral arrangement equal to $300,000. Because Employee U 
retains an amount deferred under the elective account balance plan, 
Employee U is not entitled to a deduction for 2011 as a result of 
the deemed investment losses.

    (h) Effective/applicability date. The rules of this section apply 
to taxable years ending on or after the date of publication of the 
Treasury decision adopting these rules as final regulation in the 
Federal Register.

 Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E8-28894 Filed 12-5-08; 8:45 am]
BILLING CODE 4830-01-P