HR administrators, employers, employees, and even independent consultants are all well-advised to remember the approaching March 15th deadline for the distribution of annual bonuses and many other forms of compensation that were earned in 2020.
Ever-lurking tax traps wreaked on businesses and individuals by Section 409A of the Tax Code makes each year’s due date to meet 409A’s “short-term deferral” exemption a critical one. For calendar year employers and employees, this deadline is March 15. (Carmody note: employers with a different tax year may have additional time, but not less.)
To be clear, there is not a blanket requirement that all compensation earned in a prior year must be paid by March 15th (or a later end date of an employer’s short-term deferral window, in the case of a non-calendar year employer). But in order to exempt deferred compensation from Section 409A using the short-term deferral exemption, the prior year’s earned compensation must be paid by this date. Other exceptions may separately exempt certain deferred compensation from Section 409A, such as severance pay resulting from an involuntary termination, or qualifying equity compensation.
In addition, losing exemption from Section 409A does not mean that the law will automatically come after taxpayers in the manner famously referenced by Shakespeare. However, 409A imposes strict limits on the time and form of payment of deferred compensation, including general prohibitions on the acceleration and subsequent deferrals of compensation. In other words, if a deferred compensation arrangement does not qualify for an exemption from 409A, it has little room to maneuver.
Violations of Section 409A are harsh, particularly on employees. If a covered arrangement fails to comply, an employee or other service provider is treated as having received income the first tax year that the deferred compensation was no longer subject to a “substantial risk of forfeiture” (generally, when the compensation vests), regardless of whether payment has been made. In addition, a 20% excise tax is imposed on the employee, plus stepped-up interest for late tax payments, which may go back for several years. Employer withholding and reporting requirements are also triggered. In other words, not the ideal outcome for a deferred compensation program.
If you are an employer or individual with compensation that was earned in 2020 and due to be paid or received in 2021, remember to beware the Ides of March 15th, and plan ahead with legal counsel when necessary.