When the IRS released the Code Section 409A document compliance correction guidance (IRS Notice 2010-6), some unexpected nuances were revealed, including one that caught many practitioners off guard – getting the timing of a release and payment of deferred compensation to work together.  The typical scenario goes like this:

Employment agreement or severance agreement provides for separation pay following an involuntary termination of employment.  Agreement specifies that payment is conditioned upon the terminated employee's execution of a waiver/release (and non-revocation).  Agreement specifies that payment will be made as soon as practicable following the lapse of the non-revocation period. 

Timing is key.  A "good" release for age discrimination purposes (OWBPA) requires, in part, that an individual have at least 21 days (45 days if a "group" termination is involved, remembering that a "group" can be just two individuals) to consider whether to sign the release, and then 7 days within which to revoke.

For Code Section 409A compliance, time of payment is also key.  IRS guidance clearly provides that an individual cannot direct the time of payment from one tax year to another tax year.  In the eyes of the IRS, for example, if severance payment provisions specify immediate payment following execution (and non-revocation) of a release, then the employee controls the timing and could, in the right circumstances, move payment from one tax year to the next. 

IRS document compliance correction guidance focuses on correction by way of amending the document to remove the ability of the employee to delay or accelerate the timing of the severance payment as a result of such employee's actions.  For example, a "corrected" severance payment provision could be drafted to provide that (i) payment is conditioned on execution of the waiver/release (and non-revocation within a set period) and (ii) payment will be made on a fixed date which is either 60 or 90 days following the occurrence of the termination of employment.  The amendment cannot otherwise change the time or form of payment.

This new stated "view" of the IRS makes it necessary to check the wording of all 409A agreements providing for a release as a condition of payment.  If the arrangement needs to be amended, such amendment must be made before the employee's separation from service and on or prior to December 31, 2010 in order to avoid a "non-compliant" 409A arrangement which can lead to unwanted current taxes, and a 20% additional tax.

We note that recently, Steven Tackney of the IRS was reported to have suggested that the IRS recognized that the interpretation of releases in the context of timing of payments presented problems for many agreements.  Whether the IRS will modify its position remains to be seen.