Deferred compensation payments are due to one of your former executives, but the former executive is nowhere to be found. You know that the IRS has strict timing rules for payments subject to Code Section 409A (but maybe not as strict as you think). The end of the tax year is approaching fast. What to do?
Missing participants can be a problem for benefit plan sponsors in a variety of contexts. Sponsors of qualified plans can turn to IRS and DOL guidance on what do to when a missing participant is owed required minimum distributions or the plan is being terminated and assets must be distributed.
For executive compensation arrangements subject to Section 409A, however, there is no clear guidance on how to handle missing participants. This presents a problem for employers when payments are due in one tax year, but the participant is not located until a later tax year, because it is unclear whether withholding and IRS reporting requirements must be fulfilled in the year the payment is due, even if no payment is actually made. And, Section 409A requires that deferred compensation may only be paid at prescribed times. If payments under a Section 409A plan are not being delivered because the participant can’t be located, there is a risk that when payments are finally made, they will be late and in violation of the Section 409A timing rules.
One option is for the employer to treat the participant as being in constructive receipt of the payments, and report the payments to the IRS as if they were distributed to the participant. This may create issues down the road, however, if the participant is never located and questions arise about what to do with the money that was treated as distributed.
Another solution is to suspend the payments until the participant is located and report the payments in the year they are distributed. In the absence of clear guidance, employers may be able to take this approach, so long as plan language, distribution forms, or administrative procedures require a participant to provide up-to-date contact information as a condition of payment, and the employer the makes a reasonable effort to locate the participant. Accordingly, we suggest that employers update their plan documents, distribution forms, or administrative procedures along those lines.
If a participant in a Section 409A plan goes missing, the employer should make reasonable efforts to locate the participant or an appropriate beneficiary by following the steps outlined in the DOL’s guidance on locating missing participants. The employer should maintain a record of the payment history, stale checks, and the efforts made to locate the participant. The search should be periodically renewed, but until the participant is found, the employer may suspend payments, relying on the provision in its plan requiring the participant to provide contact information prior to receiving payment.
Although following the steps outlined above should protect the employer from risks associated with failing to make or report the payments, this will not necessarily protect the participant from excise taxes for receiving a distribution outside the periods allowed under Section 409A. In fact, the regulations suggest that the opposite is true, and a participant that misses payments due to the participant’s failure to provide up-to-date contact information will be subject to the penalty and premium interest taxes if the payments violate the timing rules of Section 409A when the payments are eventually made.