19234 Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9321] 

RIN 1545–BE79 

Application of Section 409A to 

Nonqualified Deferred Compensation 

Plans 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

regulations regarding the application of 

section 409A to nonqualified deferred 

compensation plans. The final 

regulations are necessary to clarify and 

explain the rules governing the 

application of section 409A to 

nonqualified deferred compensation 

plans. The regulations affect service 

providers receiving amounts of deferred 

compensation and the service recipients 

for whom the service providers provide 

services. 

FOR FURTHER INFORMATION CONTACT: 

Stephen Tackney, (202) 927–9639 (not a 

toll-free number). 

DATES: Effective Date: These regulations 

are effective April 17, 2007. 

Applicability Dates: For dates of 

applicability, see § 1.409A–6(b). 

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 unless certain requirements are 

met, amounts deferred under a 

nonqualified deferred compensation 

plan for all 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 a nonqualified deferred 

compensation plan, where such 

arrangements are located outside of the 

United States or are restricted to the 

provision of benefits in connection with 

a decline in the financial health of the 

sponsor. 

On December 20, 2004, the IRS issued 

Notice 2005–1 (published as modified 

on January 6, 2005, in 2005–1 CB 274), 

setting forth initial guidance with 

respect to the application of section 

409A, and supplying transition 

guidance pursuant to a statutory 

directive. A notice of proposed 

rulemaking (REG–158080–04, 2005–2 

CB 786 [70 FR 57930]) was published in 

the Federal Register on October 4, 2005. 

See § 601.601(a)(3). A public hearing 

was conducted on January 25, 2006. In 

addition, the IRS received written and 

electronic comments responding to the 

notice of proposed rulemaking. After 

consideration of all the comments, the 

proposed regulations are adopted as 

amended by this Treasury decision. The 

amendments are discussed in this 

preamble. 

The Treasury Department and the IRS 

have also issued six additional notices 

providing transition guidance with 

respect to section 409A: (1) Notice 

2005–94, 2005–2 CB 1208 (transition 

guidance with respect to 2005 reporting 

and withholding obligations); (2) Notice 

2006–4, 2006–3 IRB 307 (transition 

guidance with respect to certain 

outstanding stock rights); (3) Notice 

2006–33, 2006–15 IRB 754 (transition 

guidance with respect to the application 

of section 409A(b)); (4) Notice 2006–64, 

2006–29 IRB 88 (interim guidance 

regarding payments necessary to meet 

Federal conflict of interest 

requirements); (5) Notice 2006–79, 

2006–43 IRB 763 (additional transition 

relief); and (6) Notice 2006–100, 2006– 

51 IRB 1109 (transition guidance with 

respect to 2005 and 2006 reporting and 

withholding obligations). See 

§ 601.601(d)(2). For a discussion of the 

continued applicability of these notices, 

see the Effect on Other Documents 

section of this preamble. 

Explanation of Provisions and 

Summary of Comments 

I. Structure and Format of Regulations 

The final regulations generally adopt 

the structure and format of the proposed 

regulations. A table of contents has been 

included in the final regulations, as well 

as several additional sets of examples 

addressing various topics. 

II. Definition of Nonqualified Deferred 

Compensation Plan 

A. Excluded Plans 

The final regulations exclude the 

types of plans described in section 

409A(d)(1) from the definition of a 

nonqualified deferred compensation 

plan, as well as certain other 

arrangements that were also set forth in 

the proposed regulations. Accordingly, 

the final regulations generally provide 

that a nonqualified deferred 

compensation plan for purposes of 

section 409A does not include a 

qualified plan, a bona fide sick leave or 

vacation plan, a disability plan, a death 

benefit plan, or certain medical expense 

reimbursement arrangements. 

The final regulations clarify that the 

exemption from coverage under section 

409A for certain welfare plans does not 

apply to medical expense 

reimbursements that constitute taxable 

income to the service provider. The 

coverage exemption applies only to 

arrangements that provide benefits that 

are excludable from gross income under 

section 105 or section 106. 

Several commentators requested 

clarification of when a leave program 

will be treated as a bona fide sick leave 

or vacation leave plan for purposes of 

section 409A. Another commentator 

requested a clarification of the 

definition of a compensatory time plan. 

Because the definitions of these terms 

may raise issues and require 

coordination with the provisions of 

section 451, section 125, and, with 

respect to certain taxpayers, section 457, 

the final regulations do not address 

these issues. 

Notice 2005–1, Q&A–6 provides that, 

until further guidance, taxpayers whose 

participation in a nonqualified deferred 

compensation plan would be subject to 

section 457(f) may rely on the 

definitions of bona fide vacation leave, 

sick leave, compensatory time, 

disability pay, or death benefit plan 

applicable for purposes of section 457(f) 

as also being applicable for purposes of 

section 409A. Until further guidance, 

such taxpayers may continue to rely on 

such definitions for purposes of section 

409A. 

One commentator requested that a 

qualified employer plan for purposes of 

the exclusion from section 409A include 

certain plans covered by section 402(d) 

(certain plans with a foreign-situs trust 

treated as qualified plans with respect to 

the taxation of the participants and 

beneficiaries) and retirement plans 

described in section 1022(i)(2) of the 

Employee Retirement Income Security 

Act of 1974, as amended (certain Puerto 

Rican retirement plans). The final 

regulations adopt this suggestion. 

B. Section 457 Plans 

The final regulations provide that 

section 409A is not applicable to an 

eligible deferred compensation plan 

under section 457(b), but may be 

applicable to a deferred compensation 

plan that is subject to section 457(f). 

Commentators requested clarification of 

the application of the exception in the 

proposed regulations from the definition 

of deferred compensation referred to as 

the short-term deferral rule (described 

in section III.C.1 of this preamble) to a 

section 457(f) plan. As discussed below, 

a right to deferred compensation 


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generally refers to a legally binding right 

in one taxable year to compensation that 

is or may be payable in a subsequent 

taxable year. For purposes of 

determining the time of payment, the 

term ‘‘payment’’ generally refers to an 

actual or constructive payment of cash 

or property. However, the final 

regulations provide that for purposes of 

the short-term deferral rule, an amount 

is treated as paid when it is included in 

income under section 457(f) whether or 

not an actual or constructive payment 

occurs. Accordingly, where the income 

inclusion under section 457(f) stems 

from the lapse of a substantial risk of 

forfeiture that is also treated as a 

substantial risk of forfeiture for 

purposes of section 409A, the amount 

included in income will be considered 

a short-term deferral for purposes of 

section 409A. However, the right to 

earnings on amounts that have 

previously been included under section 

457(f) will be deferred compensation for 

purposes of section 409A unless the 

right to the earnings independently 

satisfies the requirements for an 

exclusion. 

C. Arrangements With Independent 

Contractors 

The final regulations provide that 

section 409A generally does not apply 

to an amount deferred under an 

arrangement between a service provider 

and an unrelated service recipient if 

during the service provider’s taxable 

year in which the service provider 

obtains a legally binding right to the 

deferred amount the service provider is 

actively engaged in the trade or business 

of providing services (other than as an 

employee or as a director of a 

corporation), and provides significant 

services to two or more service 

recipients to which the service provider 

is not related and that are not related to 

one another. 

The final regulations retain the safe 

harbor in the proposed regulations, 

under which a service provider is 

deemed to be providing significant 

services to two or more such service 

recipients for this purpose if the 

revenues generated from the services 

provided to any service recipient or 

group of related service recipients 

during such taxable year do not exceed 

70 percent of the total revenues 

generated by the service provider from 

the trade or business of providing such 

services. Commentators expressed 

concern that the safe harbor did not 

permit independent contractors to know 

in advance whether the arrangements 

under which an independent contractor 

deferred compensation during a taxable 

year would be subject to section 409A. 

Commentators requested certain lookback periods, including the ability to 

use averaging over the previous three to 

five years, or to satisfy the 70 percent 

threshold over a certain portion of the 

previous three to five years. The 

Treasury Department and the IRS are 

concerned that the suggested rules 

would allow service providers to engage 

in strategic behavior to ensure that 

activity in certain years would be 

exempt from section 409A. Accordingly, 

the final regulations adopt an additional 

safe harbor that provides that a service 

provider that has actually met the 70 

percent threshold in the three 

immediately previous years is deemed 

to meet the 70 percent threshold for the 

current year, but only if at the time the 

amount is deferred the service provider 

does not know or have reason to 

anticipate that the service provider will 

fail to meet the threshold in the current 

year. 

In response to comments, the final 

regulations provide that if an 

independent contractor qualifies for the 

safe harbor for exclusion from coverage 

under section 409A with respect to 

arrangements with unrelated service 

recipients, an arrangement between the 

independent contractor and a service 

recipient related to the independent 

contractor will not be subject to section 

409A if the arrangement, and the 

practices under the arrangement, are 

bona fide, arise in the ordinary course 

of business, and are substantially the 

same as the arrangements and practices 

(such as billing and collection practices) 

applicable to one or more unrelated 

service recipients to whom the 

independent contractor provides 

substantial services and that produce a 

majority of the total revenue that the 

independent contractor earns from the 

trade or business of providing such 

services during the year. 

The final regulations further clarify 

that if at the time the legally binding 

right to the payment arose, the 

arrangement was not subject to section 

409A because the service provider was 

an independent contractor that was 

eligible for this exclusion from coverage 

under section 409A, the amount 

deferred under the arrangement during 

that taxable year (and earnings credited 

to the deferred amount) will not become 

subject to section 409A in a later year 

if the service provider becomes an 

employee, independent contractor, or 

other type of service provider subject to 

the rules of section 409A. 

Commentators also requested that a 

service recipient be permitted to rely 

upon a representation of an 

independent contractor that the 

independent contractor meets the 

exclusion requirements, so that a service 

recipient will know whether it is subject 

to the reporting requirements with 

respect to amounts deferred subject to 

section 409A. The Treasury Department 

and the IRS are continuing to study this 

issue. 

D. Anti-Abuse Rule 

If a principal purpose of a plan is to 

achieve a result with respect to a 

deferral of compensation that is 

inconsistent with the purposes of 

section 409A, the Commissioner may 

treat the plan as a nonqualified deferred 

compensation plan for purposes of 

section 409A. 

III. Definition of Nonqualified Deferred 

Compensation Plan 

A. In General 

The final regulations provide that a 

nonqualified deferred compensation 

plan is a plan that provides for the 

deferral of compensation. The final 

regulations further provide that a plan 

generally provides for the deferral of 

compensation if, under its terms and the 

relevant facts and circumstances, a 

service provider has a legally binding 

right during a taxable year to 

compensation that, pursuant to its 

terms, is or may be payable to (or on 

behalf of) the service provider in a later 

year. For this purpose, an amount 

generally is payable at the time the 

service provider has a right to currently 

receive a transfer of cash or property, 

including a transfer of property 

includible in income under section 83, 

the economic benefit doctrine or section 

402(b). Accordingly, a taxable transfer of 

an annuity contract is treated as a 

payment for purposes of section 409A. 

The definition of deferral of 

compensation in the final regulations 

excludes the condition that the amount 

not be actually or constructively 

received and included in income during 

the taxable year, because that language 

might cause confusion with respect to 

the applicable rules governing deferral 

elections and the prohibition on the 

acceleration of payments. For example, 

if a service provider has made an 

irrevocable election to defer an amount 

of his or her salary to a future year, that 

amount is treated as deferred 

compensation regardless of whether the 

service recipient actually pays such 

amount to the service provider during 

the year in which the services are 

performed. Any early payment of the 

deferred compensation (or any right to 

receive such an early payment) 

generally would constitute an 

impermissible acceleration of the 

payment of the deferred amount. 


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For this purpose, a plan will be 

treated as providing for a payment to be 

made in a subsequent year whether the 

plan explicitly so provides (including 

through a service provider election) or 

the deferral condition is inherent in the 

terms of the contract. Where the parties 

have agreed that a payment will be 

made upon an event that could occur 

after the year in which the legally 

binding right to the payment arises, the 

plan generally will provide for a deferral 

of compensation (unless otherwise 

excluded under a specific exception, 

such as the short-term deferral rule). 

For example, if a plan provides a 

service provider a right to a payment 

upon separation from service, the plan 

generally will result in a deferral of 

compensation regardless of whether the 

service provider separates from service 

and receives the payment in the same 

year as the grant, because under the 

plan the payment is conditioned upon 

an event that may occur after the year 

in which the legally binding right to the 

payment arises. Similarly, if an 

arrangement such as a stock option or 

stock appreciation right not otherwise 

excluded from coverage under section 

409A provides a right to a payment for 

a term of years where the payment 

could be received during the short-term 

deferral period or a subsequent period 

but is not otherwise includible in 

income until paid, the arrangement will 

provide for deferred compensation even 

though the service provider could 

receive the payment during the shortterm deferral period (for example, by 

exercising the stock option or stock 

appreciation right). However, where a 

plan does not specify a payment date, 

payment event or term of years (or 

specifies a date or event certain to occur 

during the year in which the services 

are performed), the plan generally will 

not provide for the deferral of 

compensation if the service provider 

actually or constructively receives the 

payment within the short-term deferral 

period. 

The proposed regulations provided 

that earnings on deferred amounts are 

generally treated as deferred 

compensation for purposes of section 

409A. Under the final regulations, 

whether a deferred amount constitutes 

earnings on an amount deferred, or 

actual or notional income attributable to 

an amount deferred, is determined 

under the principles defining income 

attributable to the amount taken into 

account under § 31.3121(v)(2)–1(d)(2). 

A commentator requested clarification 

of whether a payment for a 

noncompetition agreement could be 

subject to section 409A. Because such a 

payment would occur in connection 

with the performance or 

nonperformance of services, and a 

covenant not to compete does not create 

a substantial risk of forfeiture for 

purposes of section 409A, a legally 

binding right obtained in one year to a 

payment in a subsequent year in 

connection with a noncompetition 

agreement generally would constitute 

deferred compensation. 

B. Legally Binding Right 

The regulations define deferral of 

compensation in the context of a legally 

binding right to a payment of 

compensation in a future taxable year. 

Commentators requested clarification of 

the standard that would be used to 

determine whether a service provider 

has a legally binding right. A legally 

binding right includes a contractual 

right that is enforceable under the 

applicable law or laws governing the 

contract. A legally binding right also 

includes an enforceable right created 

under other applicable law, such as a 

statute. 

One commentator suggested that no 

legally binding right exists where the 

payment is made only upon the 

realization of gain from a particular 

investment. For example, the 

commentator argued that a bonus 

payable based upon the amount that a 

service provider obtains in selling 

property should not be treated as 

granting the service provider a legally 

binding right to the payment until the 

property is sold. In such a situation, 

however, the requirement that the 

property be sold is a condition to the 

right to the payment, but the right to the 

payment is still a legally binding right. 

The service recipient could not simply 

revoke the promise, sell the property, 

and not pay the bonus. However, the 

condition that the property be sold 

before the service provider becomes 

entitled to payment may constitute a 

substantial risk of forfeiture, depending 

on the specific facts and circumstances. 

C. Short-Term Deferrals 

1. In General 

Subject to the modifications described 

in this section III.C of the preamble, the 

final regulations generally adopt the 

short-term deferral rule that was 

contained in the proposed regulations. 

Under the short-term deferral rule, a 

deferral of compensation does not occur 

for purposes of section 409A if the 

arrangement under which a payment is 

made does not provide for a deferred 

payment and the payment is made no 

later than the 15th day of the third 

month following the later of the end of 

the service provider’s taxable year or the 

end of the service recipient’s taxable 

year in which occurs the later of the 

time the legally binding right to the 

payment arises or the time such right 

first ceases to be subject to a substantial 

risk of forfeiture (subject to certain 

extensions for unforeseeable events). 

For this purpose, an arrangement 

provides for a deferred payment if it 

provides for a payment that will be 

made or completed after a date or an 

event that will or may occur later than 

the end of the 21⁄2 month period 

described in the preceding sentence, 

either because of an affirmative election 

on the part of the service provider or 

service recipient or a deferral condition 

inherent in the terms of the contract (for 

example, that the amount will be paid 

upon the service provider’s separation 

from service, which may occur in a 

future year). 

Several commentators requested that 

additional flexibility be provided to 

allow payments to be short-term 

deferrals. By analogy to the rules in the 

proposed regulations concerning when 

payments of deferred compensation 

amounts are considered timely for 

purposes of the payment date rules, the 

commentators suggested that payments 

should qualify as short-term deferrals if 

made by the end of the year after the 

year in which a substantial risk of 

forfeiture lapses, rather than by the 15th 

day of the third month of that year. The 

final regulations do not adopt this 

suggestion. The short-term deferral rule 

is based on the historical treatment of 

certain payments paid within a short 

period following the end of a taxable 

year as not constituting deferred 

compensation. See § 1.404(b)–1T, Q&A– 

2(b). That short period has been defined 

as ending on the 15th day of the third 

month following the end of the year, 

subject to certain extensions for 

unforeseeable events. Extending the 

payment date by which a short-term 

deferral could be paid would be 

inconsistent with this approach and the 

legislative history of section 409A (H.R. 

Conf. Rep. No. 108–755, at 735 (2004)), 

and accordingly is not adopted in the 

final regulations. However, the final 

regulations liberalize the standard under 

which a payment can be a short-term 

deferral even if it is delayed due to 

unforeseeable events. The proposed 

regulations provided generally that 

payment could be delayed if the 

payment would jeopardize the service 

recipient’s solvency and such 

insolvency was unforeseeable at the 

time the service provider obtained the 

right to the payment. By contrast, the 

final regulations provide generally that 

payment may be delayed where the 


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payment would jeopardize the ability of 

the service recipient to continue as a 

going concern. 

Commentators asked how the shortterm deferral rule applies to a series of 

payments scheduled to commence 

following the lapse of a substantial risk 

of forfeiture. The final regulations 

provide that the short-term deferral rule 

applies separately to each payment, 

applying the technical definition of 

‘‘payment’’ set out in the regulations, 

provided that the entire payment is 

made during the short-term deferral 

period. Accordingly, where a payment 

has been designated as a separate 

payment, it may qualify as a short-term 

deferral (and thus not deferred 

compensation) even where the service 

provider has a right to subsequent 

payments under the same arrangement. 

In contrast, where a payment has not 

been designated as a separate payment 

(such as, for example, a life annuity 

payment or a series of installment 

payments treated as a single payment), 

any initial payments in the series will 

not be treated as a short-term deferral 

even if paid within the short-term 

deferral period. For a discussion of the 

definition of payment, see § 1.409A–3. 

Commentators suggested that a right 

to a reimbursement be treated as 

potentially subject to the short-term 

deferral rule, arguing that the right to 

the reimbursement payment is subject to 

a substantial risk of forfeiture that the 

service provider will not incur the 

expense. Commentators argued that the 

short-term deferral rule then could 

apply if the reimbursement payment 

were made within a short period 

following the occurrence of the expense. 

Generally, the risk that a service 

provider will fail to incur a 

reimbursable expense will not qualify as 

a substantial risk of forfeiture, so the 

short-term deferral rule will not be 

applicable. However, the final 

regulations provide considerable 

additional flexibility with regard to 

structuring reimbursement 

arrangements to meet the requirements 

of section 409A. For a discussion of 

these provisions, see section VII.B.2 of 

this preamble. 

2. Application to Event-Based Payments 

Some commentators asked whether 

any payments based on a legally binding 

right arising in the year of a separation 

from service are excluded from coverage 

under section 409A, if paid by the end 

of the relevant short-term deferral 

period. For example, where an 

employee had accrued benefits under a 

defined benefit supplemental executive 

retirement plan (SERP) during his career 

that was payable immediately upon a 

separation from service, including an 

amount accrued in the year of 

separation from service, commentators 

asked whether the payment of the 

portion of the benefits accrued in that 

final year is excluded from coverage 

under section 409A if paid by March 15 

of the year following the separation 

from service, because the amount is 

paid within a short period following the 

year the service provider obtains a 

vested legally binding right to the 

additional benefit accrual. (This 

generally would be of most concern to 

specified employees subject to the 

requirement of a six-month delay in 

payment following a separation from 

service.) 

The analysis that applies in this 

situation is similar to that applied to the 

general definition of deferral of 

compensation, discussed in section III.A 

of this preamble. The short-term deferral 

rule does not provide an exclusion from 

the requirements of section 409A for 

such current-year benefit accruals 

because the rule does not apply to 

amounts of compensation subject to a 

deferral election. For this purpose, an 

election to defer includes either an 

affirmative election on the part of the 

service provider or a deferral condition 

inherent in the terms of the contract. 

Where the parties have agreed that a 

payment will be made upon an event 

that does not necessarily coincide with 

the lapsing of the substantial risk of 

forfeiture, and could occur at a time 

beyond the short-term deferral period, 

the arrangement provides for a deferral 

election such that the short-term 

deferral rule does not apply. 

Accordingly, in this example, because 

the benefits accrued in the final year of 

the SERP could have been paid upon an 

event occurring after the short-term 

deferral period (if, for example, the 

individual had not separated from 

service until a later year), the payment 

of the benefit accrued in the final year 

is subject to section 409A and is not a 

short-term deferral, even if paid by 

March 15 of the year following the 

separation from service. 

Also, for example, if a plan that is not 

subject to section 457(f) provides that an 

amount is subject to a substantial risk of 

forfeiture until the completion of three 

years of service, and is payable upon a 

separation of service following the three 

years of service, the right to the amount 

is not a short-term deferral even if the 

service provider separates from service 

immediately after vesting in the right, 

because under the plan the payment is 

based upon an event other than the 

lapsing of the substantial risk of 

forfeiture and such event may occur in 

a year subsequent to the year in which 

the risk of forfeiture lapses. 

Conversely, where a plan specifies no 

payment date or payment event, or 

specifies only the date at which the 

substantial risk of forfeiture lapses, the 

plan may qualify for the short-term 

deferral rule if the payment is made 

within the applicable short-term 

deferral period. However, such a plan 

generally would violate section 409A if 

the payment were made after the shortterm deferral period. 

As discussed in this preamble with 

respect to the general definition of 

deferred compensation, to implement 

the statutory scheme, including the 

applicable reporting and form 

requirements, taxpayers generally must 

be able to determine whether an 

arrangement provides for a deferral of 

compensation at the time the service 

provider obtains a legally binding right 

to the compensation. Although a plan 

need not specify a payment date to be 

a short-term deferral that is excluded 

from coverage under section 409A, the 

short-term deferral exclusion does not 

apply if the payment event or date is 

specified and will or may occur after the 

end of the short-term deferral period. 

The preamble to the proposed 

regulations explained that where a plan 

requires that a payment be made on a 

date within the short-term deferral 

period, but the payment is made after 

the specified date and after the end of 

the short-term deferral period, the 

arrangement will be treated as a 

nonqualified deferred compensation 

plan, but the payment date will be 

treated as a specified date. Thus, under 

such an arrangement, if the service 

provider receives the payment after the 

specified date, but not later than the end 

of the year in which the specified date 

occurs, the payment generally will 

comply with section 409A. However, 

taxpayers should note that a provision 

requiring only that a payment be made 

on or before the end of the short-term 

deferral period may not qualify as a 

permissible specified date for this 

purpose, if under the facts and 

circumstances the payment could have 

been made in more than one taxable 

year. For a discussion of the application 

of the definition of a specified payment 

date to this type of plan, see section 

VII.B of this preamble. 

For a discussion of when rights to 

compensation upon a separation from 

service for good reason may be treated 

as rights to compensation upon an 

involuntary termination, and the 

potential application of the short-term 

deferral exception to these 

arrangements, see section III.J.3 of this 

preamble. 


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D. Stock Options and Stock 

Appreciation Rights 

1. In General 

Subject to the modifications described 

in this preamble, the final regulations 

adopt the provisions of the proposed 

regulations excluding from coverage 

under section 409A statutory stock 

options and certain other stock rights. 

Generally under the regulations, 

nondiscounted stock options and 

nondiscounted stock appreciation rights 

issued on service recipient stock that do 

not include any additional deferral 

feature are excluded from section 409A. 

2. Statutory Stock Options 

The final regulations adopt the 

exclusion from coverage under section 

409A for statutory stock options, 

including incentive stock options 

described in section 422 of the Code and 

options granted under an employee 

stock purchase plan described in section 

423 of the Code. This exclusion applies 

regardless of whether the statutory stock 

option would be excluded if the same 

option were not treated as a statutory 

stock option. For example, an employee 

stock purchase plan described in section 

423 offering a discounted purchase 

price is not a deferred compensation 

plan for purposes of section 409A. 

Commentators requested clarification, 

however, of the treatment of a statutory 

stock option that is modified, or 

otherwise becomes ineligible to be 

treated as a statutory stock option. The 

final regulations adopt the rule set forth 

in the proposed regulations, and 

provide that at the time of such 

modification or event, the modification 

or other event is treated as the grant of 

a new option, or causes the option to be 

treated as having had a deferral feature 

from the date of grant, as applicable, for 

purposes of section 409A only if such 

modification or other event would have 

been so treated had the option been a 

nonstatutory stock option immediately 

before such modification or other event. 

For example, where an incentive stock 

option is modified through an extension 

of the option’s term, the extended 

option will be treated as having had an 

additional deferral feature from the date 

of grant for section 409A purposes only 

if the same extension of a nonstatutory 

stock option would have resulted in 

such treatment. 

Commentators also requested that the 

exclusion from coverage under section 

409A for certain stock rights issued 

under plans meeting the requirements of 

section 423 (employee stock purchase 

plans) be extended to employee stock 

purchase plans offered by foreign 

employers that do not meet such 

requirements, where the shares are 

made available for purchase at a 

discount and substantially all of the 

participants are nonresident aliens. The 

legislative history does not provide a 

basis for extending the exception 

applicable to options meeting the 

requirements of section 423 to grants of 

discounted stock options not meeting 

the requirements of section 423. 

Accordingly, this suggestion is not 

adopted in the final regulations. 

3. Definition of Service Recipient Stock 

The final regulations adopt the 

requirement in the proposed regulations 

that for the exclusion for certain stock 

rights to apply, the stock right must 

relate to service recipient stock. 

Commentators criticized the definition 

of service recipient stock contained in 

the proposed regulations as too 

restrictive. Generally such criticisms 

centered on two different aspects of the 

definition of service recipient stock in 

the proposed regulations—the classes of 

stock that may qualify as service 

recipient stock, and the issuer or issuers 

whose stock may constitute service 

recipient stock, where the service 

recipient is comprised of more than one 

entity. 

a. Classes of Stock That May Qualify as 

Service Recipient Stock 

Commentators requested clarification 

and expansion of the classes of stock of 

a corporation that may constitute 

service recipient stock. Commentators 

generally focused on two issues. First, 

with respect to stock of a particular 

service recipient corporation, 

commentators requested that the stock 

right be permitted to relate to any class 

of common stock, regardless of whether 

another class of common stock of that 

corporation was publicly traded, and 

regardless of whether that class of 

common stock had the greatest aggregate 

value of all classes of common stock 

issued by that corporate entity. Subject 

to the restrictions governing certain 

preferences as to distributions, the final 

regulations generally provide that any 

class of common stock may be used, 

regardless of whether another class of 

common stock that could qualify as 

service recipient stock is publicly traded 

or has a higher aggregate value 

outstanding, and regardless of whether 

the class of stock is subject to 

transferability restrictions or buyback 

rights (provided such buyback rights 

reflect the fair market value of the stock 

at the time of purchase). 

Second, commentators suggested 

narrowing the types of preferences on a 

class of common stock that would 

prohibit that class from being treated as 

service recipient stock. One 

commentator requested that the classes 

of stock permitted as service recipient 

stock include any class of stock that is 

widely held by non-service recipients. 

While it may be unlikely that a widelyheld class of stock was created to 

facilitate an abusive avoidance of 

section 409A, it does not follow that 

service recipient stock rights issued on 

such stock necessarily would be 

consistent with the intended application 

of section 409A if, for example, holders 

of such class enjoyed preferences that 

would make such stock rights a suitable 

substitute for nonqualified deferred 

compensation. 

To be treated as service recipient 

stock under the final regulations, a class 

of stock must qualify as common stock 

under section 305 of the Code. 

Accordingly, the final regulations 

provide that stock that is not common 

stock under section 305 is not service 

recipient stock for purposes of section 

409A. However, the mere classification 

of a class of stock as common stock 

under section 305 is not sufficient for 

such stock to be treated as service 

recipient stock for purposes of section 

409A. The Treasury Department and the 

IRS are concerned that classes of stock 

that are common stock under section 

305 may provide preferences that could 

permit stock rights with respect to such 

stock to resemble traditional 

nonqualified deferred compensation, 

such that exclusion of such stock rights 

would permit the avoidance of section 

409A. 

Commentators suggested that a 

preference with respect to liquidation 

rights, without any other preferences 

such as a preferential right to dividends, 

should be permitted under the 

definition of service recipient stock. A 

holder of this class of stock would not 

be guaranteed any return, but rather 

would simply be guaranteed preferred 

distribution rights upon a complete 

liquidation of the service recipient. The 

final regulations generally adopt this 

suggestion. 

With respect to other preferential 

rights, commentators were unable to 

provide a workable standard under 

which permissible preferences could be 

distinguished from impermissible 

preferences. Accordingly, the final 

regulations do not treat any stock 

including such preferences as service 

recipient stock. However, the Treasury 

Department and the IRS continue to 

study this area, and the final regulations 

authorize the publication of other 

additional guidance, should a workable 

standard be developed. 


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b. Entities the Stock of Which May 

Qualify as Service Recipient Stock 

Commentators also requested an 

expansion of the class of entities the 

stock of which can qualify as service 

recipient stock where the service 

recipient is comprised of multiple 

entities. The Treasury Department and 

the IRS believe that the stock right 

exception under section 409A was 

intended to cover stock rights directly 

reflecting the enterprise value of the 

entity for which the service provider is 

providing services. Consistent with this 

approach, the final regulations provide 

that service recipient stock may include 

the stock of the corporation for which 

the service provider was providing 

services at the date of grant. In addition, 

the final regulations provide that service 

recipient stock may include stock of any 

corporation in a chain of organizations 

all of which have a controlling interest 

in another organization, beginning with 

the parent organization and ending with 

the organization for which the service 

provider was providing services at the 

date of grant of the stock right. Similarly 

to the proposed regulations, the final 

regulations provide that the term 

‘‘controlling interest’’ has the same 

meaning as provided in § 1.414(c)–

2(b)(2)(i), except that where that 

regulation requires at least an 80 percent 

interest, the final regulations generally 

require only a 50 percent interest. In 

addition, where the use of such stock 

with respect to the grant of a stock right 

to such service provider is based upon 

legitimate business criteria, the final 

regulations generally require only a 20 

percent interest. For purposes of 

determining ownership of an interest in 

an organization, the attribution rules of 

§ 1.414(c)–4 apply, and the exclusion 

rules of § 1.414(c)–3 also apply. For 

example, under the final regulations, 

with respect to an employee of a 

subsidiary corporation, the common 

stock of the ultimate parent corporation, 

or of a subsidiary corporation anywhere 

in the chain of corporate ownership 

between the subsidiary that employed 

the employee and the ultimate parent 

corporation (a higher tier subsidiary), 

could qualify as service recipient stock 

for purposes of determining whether a 

stock right issued to such employee 

with respect to such stock was excluded 

from coverage under section 409A, 

provided that the 50 percent or 20 

percent ownership standard, as 

applicable, was satisfied by each 

corporation in the chain. 

The proposed regulations contained 

many requirements for using an 

ownership level of less than 50 percent. 

Commentators requested several 

simplifications of these requirements. In 

response, the final regulations no longer 

require a formal election by any 

corporation. Rather, each individual 

grant of a stock right is analyzed to 

determine whether the stock qualifies as 

service recipient stock with respect to a 

service provider at the time the stock 

right is granted. If a corporation owns at 

least 50 percent of the stock of one 

corporation and owns less than 50 

percent of the stock of another 

corporation, and it intends to treat its 

stock as service recipient stock with 

respect to employees of both 

corporations, there is no requirement 

that a legitimate business criteria exist 

with respect to the issuance of stock 

rights on the parent corporation stock to 

service providers of the first such 

corporation. The legitimate business 

criteria standard applies only to stock 

rights issued to service providers of 

subsidiaries that are not majorityowned, because the test of legitimate 

business criteria relates to the actual 

issuance of a stock right to a particular 

service provider. Accordingly, a 

subsidiary may have more than one 

shareholder corporation the stock of 

which qualifies as service recipient 

stock with respect to a subsidiary 

employee such as, for example, where 

three entities each own a one-third 

interest in the subsidiary. However, 

with respect to each grant of a stock 

right on stock of a particular nonmajority shareholder corporation to a 

service provider of a particular 

subsidiary, there must exist legitimate 

business criteria for issuing such a stock 

right. Even if legitimate business criteria 

exist with respect to the issuance of a 

stock right on stock of a particular 

shareholder corporation to a particular 

service provider, legitimate business 

criteria may or may not exist with 

respect to the issuance of a stock right 

to the same service provider on stock of 

another shareholder corporation. 

The legitimate business criteria 

requirement is a facts and circumstances 

test, focusing generally on whether there 

is sufficient nexus between a particular 

service provider and the entity, the 

stock of which underlies the stock right 

granted to the service provider, for the 

grant to serve a legitimate non-tax 

business purpose. As provided in the 

preamble to the proposed regulations, if 

a corporation issued a stock right on its 

stock to a current employee of a joint 

venture in which the corporation was a 

venturer, and the employee was a 

former employee of the corporate 

venturer, generally the issuance would 

be based on legitimate business criteria. 

Similarly, if the corporate venturer 

issued such a right to an employee of 

the joint venture who it reasonably 

expected would become an employee of 

the corporate venturer in the future, 

generally the legitimate business criteria 

requirement would be met. By contrast, 

where an employee has no real nexus 

with a corporate venturer, such as 

generally happens when the corporate 

venturer is a passive investor in the 

service recipient, the use of the investor 

corporation stock as the stock 

underlying a stock right grant to that 

employee generally would not be based 

upon legitimate business criteria. 

Similarly, where a corporation holds 

only a minority interest in an entity that 

in turn holds a minority interest in the 

entity for which the employee performs 

services, such that the corporation holds 

only an insubstantial indirect interest in 

the entity receiving the services, 

legitimate business criteria generally 

would not exist for issuing a stock right 

on the corporation’s stock to the 

employee. 

The Treasury Department and the IRS 

remain concerned that the manipulation 

of the structure of a related group of 

corporations may be used to allow stock 

options or stock appreciation rights to 

mimic the characteristics of 

nonqualified deferred compensation, by 

compensating holders based on 

predictable amounts and investment 

returns unrelated to the enterprise value 

of an operating entity. Accordingly, the 

exception contained in the proposed 

regulations under which the stock of a 

corporation serving as investment 

vehicle is not considered service 

recipient stock has been retained. In 

addition, an anti-abuse rule has been 

added to address corporate structures, 

transactions, or stock right grants, a 

principal purpose of which is the 

avoidance of the application of section 

409A to an arrangement otherwise 

providing deferred compensation. These 

corporate structures, transactions, and 

stock right grants generally will occur 

where the structure, transaction, or 

grant is intended to provide enhanced 

security for the value of the stock right 

as a means of providing deferred 

compensation, rather than as 

compensation related to an increase in 

the true enterprise value of the service 

recipient. The regulations provide that if 

an entity becomes a member of a group 

of corporations or other entities treated 

as a single service recipient, and the 

primary source of income or value of 

such entity arises from the provision of 

management services to other members 

of the service recipient group, if any 

stock rights are issued with respect to 

such entity it is presumed that such 


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structure was established for purposes 

of avoiding the application of section 

409A. 

c. Equity Interests in Certain NonCorporate Entities 

The final regulations permit certain 

equity interests in a non-stock mutual 

company to be treated analogously to 

equity interests in a corporation. 

Commentators requested that the 

definition of service recipient stock be 

expanded to cover interests in 

cooperatives and interests in the value 

of an Indian tribal enterprise. The 

regulations do not include such 

interests in the definition of service 

recipient stock, but provide the IRS 

authority to provide guidance 

expanding the definition of service 

recipient stock. For a discussion of the 

application of the exclusion for certain 

stock rights to rights issued on equity 

interests in entities taxed as 

partnerships, see section III.G of this 

preamble. 

4. Valuation 

a. In General 

The final regulations provide that for 

the exclusion for stock rights to apply, 

the stock right must specify an exercise 

price of the stock right that may never 

be less than the fair market value of the 

underlying stock on the date the stock 

right is granted. For purposes of this 

discussion and the final regulations, the 

exercise price of a stock appreciation 

right refers to the base stock value from 

which the appreciation is measured for 

purposes of determining the 

compensation payable under the stock 

appreciation right (for example, a stock 

appreciation right providing for a 

payment of the excess of the fair market 

value of 100 shares over $100 would 

have a $1 per share exercise price). 

Several commentators expressed 

concerns regarding the determination of 

the fair market value of the underlying 

stock. Some commentators requested 

that the valuation rules applicable to 

incentive stock options be applied for 

purposes of the exclusion from section 

409A. Under those rules, if the stock 

option would otherwise fail to be an 

incentive stock option solely because 

the exercise price was less than the fair 

market value of the underlying stock as 

of the date of grant, generally the option 

is treated as an incentive stock option if 

the issuer attempted in good faith to set 

the exercise price at fair market value. 

See section 422(c)(1). The Treasury 

Department and the IRS believe that this 

is not the appropriate standard for 

determining whether stock rights are 

subject to section 409A. Incentive stock 

options are subject to strict limitations 

on the amount of such options that may 

be granted to a particular employee. See 

section 422(d). In contrast, there are no 

such limits applicable to nonstatutory 

stock options, and grants of 

nonstatutory stock options often far 

exceed the limitation applicable to 

incentive stock options. In addition, 

section 422(c)(1) explicitly provides for 

the good faith standard with respect to 

incentive stock options, while no such 

provisions exist within section 409A or 

its legislative history. 

Commentators requested clarification 

of the consistency standard with respect 

to the use of a valuation method. 

Specifically, commentators asked 

whether one valuation method could be 

used for purposes of establishing the 

exercise price while another method 

could be used for purposes of 

determining the fair market value of the 

stock at the time of the payment (for 

example, to determine the amount of 

payment in the case of a stock 

appreciation right or a stock option 

where the stock is subject to repurchase 

by the service recipient). The final 

regulations clarify that consistency is 

not required, provided that each 

valuation method used otherwise meets 

the requirements of the final 

regulations. Accordingly, a service 

recipient may use one valuation method 

for purposes of establishing an exercise 

price, but another valuation method for 

purposes of establishing the payment 

amount (in the case of a stock 

appreciation right) or the buyback 

amount (in the case of a stock option 

where the underlying stock is subject to 

a buyback arrangement). However, once 

an exercise price has been established, 

the exercise price may not be changed 

through the retroactive use of another 

valuation method. In addition, where 

after the date of grant, but before the 

date of exercise, of the stock right, the 

service recipient stock to which the 

stock right relates becomes readily 

tradable on an established securities 

market, the service recipient must use a 

valuation method for stock readily 

tradable on an established securities 

market for purposes of determining the 

payment amount (in the case of a stock 

appreciation right) or the buyback 

amount (in the case of a stock option 

where the underlying stock is subject to 

a buyback arrangement). 

b. Valuation—Stock Readily Tradable 

on an Established Securities Market 

The final regulations adopt the rules 

under the proposed regulations 

governing valuation of stock readily 

tradable on an established securities 

market, generally requiring that the 

valuation of such stock be based upon 

the contemporaneous prices established 

in the securities market, subject to the 

modifications discussed in this 

preamble. Some commentators 

requested additional guidance with 

respect to when a stock will be treated 

as readily tradable. The final regulations 

adopt the same standard as that set forth 

in § 1.280G–1, Q&A–6(e), that stock is 

treated as readily tradable if it is 

regularly quoted by brokers or dealers 

making a market in such stock. 

With respect to the rules governing 

the valuation of stock that is readily 

tradable on an established securities 

market, commentators generally focused 

on the provision of the proposed 

regulations permitting the use of an 

average selling price during a specified 

period that is within 30 days before or 

30 days after the date of grant. 

Specifically, comments concentrated on 

the requirement that the commitment to 

grant the stock right with an exercise 

price set using such an average selling 

price be irrevocable before the 

beginning of the specified period. 

Commentators questioned both the 

purpose of the requirement of the 

commitment to the valuation method, as 

well as the actions required to satisfy 

the rule if averaging were being used. 

The rule was intended to prohibit the 

use of an average price, set on a lookback basis, to ensure a discounted 

exercise price. For example, if a 

corporation decided to grant a stock 

option on July 1, and it could set the 

exercise price using an average selling 

price for any period falling within the 

prior 30 days without having had a prior 

commitment to a specific averaging 

period, the corporation could simply 

look for the lowest price that occurred 

during the prior June. Furthermore, if 

the corporation were not committed to 

grant the stock option on July 1, the 

corporation could wait until its stock 

price began to rise and then grant an 

option using the selling price on a given 

day during the previous 30 days to 

provide a particular discount. 

Accordingly, the final regulations 

require that the commitment to grant the 

stock right with an exercise price set 

using such an average selling price be 

irrevocable before the beginning of the 

specified period. To satisfy this 

requirement, the service recipient must 

designate the recipient of the stock 

option, the number of shares the stock 

option will permit the holder of the 

stock option to purchase, and the 

method for determining the exercise 

price including the period over which 

the averaging will occur, before the 

beginning of the specified averaging 

period. 


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One commentator stated that the 

requirement of an irrevocable 

commitment to the averaging period 

could not be met under French law, 

because French law requires that the 

stock option exercise price be set based 

on the average trading price over the 

preceding 20 days and the commitment 

to the grant before the beginning of the 

period may be viewed as violating that 

requirement. The final regulations 

provide that where applicable foreign 

law requires that the compensatory 

stock right granted by the issuer must be 

priced based upon a specific price 

averaging method and period, a stock 

right granted in accordance with such 

applicable foreign law will be treated as 

meeting the requirement, provided that 

the averaging period may not exceed 30 

days. 

c. Valuation—Stock Not Readily 

Tradable on an Established Securities 

Market 

i. In General 

The final regulations adopt the 

provisions in the proposed regulations 

relating to the valuation of stock not 

readily tradable on an established 

securities market, subject to the 

modifications discussed in this section 

III.C.4.c. Accordingly, a valuation of 

stock based upon a reasonable 

application of a reasonable valuation 

method is treated as reflecting the fair 

market value of the stock. To meet this 

standard, it is not necessary that a 

taxpayer demonstrate that the value was 

determined by an independent 

appraiser. Where the taxpayer can 

otherwise demonstrate that the 

valuation was determined by the 

reasonable application of a reasonable 

valuation method, the standard will be 

met. 

One commentator requested that the 

factors to be considered in determining 

the fair market value of the stock should 

be modified to include consideration of 

any recent equity sales made by the 

corporation in arm’s-length transactions. 

The final regulations adopt this 

suggestion. 

The final regulations continue to 

require that in the case of a stock right 

issued with respect to stock that was not 

publicly traded at the time the right was 

issued, but becomes publicly traded 

before the right is exercised, the stock 

value for purposes of calculating the 

payment amount (in the case of a stock 

appreciation right) or the buyback 

amount (in the case of a stock option 

where the underlying stock is subject to 

a buyback agreement) must be based 

upon the rules governing stock that is 

publicly traded. This does not mean that 

the initial exercise price determined 

under the rules governing stock that is 

not publicly traded must be reset. 

Rather, this means only that the value 

at the time of exercise used to determine 

the payment amount or the buyback 

amount must be determined under the 

rules governing stock that is publicly 

traded. For example, if a service 

provider holds an excluded stock 

appreciation right with an exercise price 

of $1 that was fixed based on a 

valuation of the closely-held corporate 

stock at the time of grant, and before 

exercise the stock becomes readily 

tradable on an established securities 

market, the amount payable upon 

exercise must be the excess of the value 

of the stock based on its trading price 

over the $1 exercise price. 

ii. Safe Harbor Presumptions 

The final regulations adopt a 

presumption in specified circumstances 

that, for purposes of section 409A, a 

valuation of stock reflects the fair 

market value of the stock, rebuttable 

only by a showing that the valuation is 

grossly unreasonable. The presumption 

applies where the valuation is based 

upon an independent appraisal, a 

generally applicable repurchase formula 

(applicable for both compensatory and 

noncompensatory purposes) that would 

be treated as fair market value under 

section 83, or, in the case of illiquid 

stock of a start-up corporation, a 

valuation by a qualified individual or 

individuals applied at a time that the 

corporation did not otherwise anticipate 

a change in control event or public 

offering of the stock. 

Many of the comments with respect to 

these presumptions related to the 

presumption applicable to illiquid stock 

of start-up corporations. As set forth in 

the proposed regulations, the start-up 

corporation presumption would not 

apply if the service recipient or service 

provider could reasonably anticipate, as 

of the time the valuation is applied, that 

the service recipient would undergo a 

change in control event or make a 

public offering of securities within the 

12 months following the event to which 

the valuation is applied. Commentators 

suggested that a 12-month period is too 

long, because changes occur so rapidly 

in the business world that it often is 

difficult or impossible to predict so far 

in advance whether such an event will 

occur. Commentators suggested that the 

service provider should retain the 

benefit of the presumption unless the 

issuing corporation entered into a 

definitive agreement or filed its 

registration statement with the 

Securities and Exchange Commission 

within a period of 15 or 30 days after 

issuing the stock right. 

The Treasury Department and the IRS 

believe that a 15-day or a 30-day period 

is too short. Although there is always a 

risk that a public offering will fail or 

that a corporate transaction will not 

occur, the Treasury Department and the 

IRS also believe that a person should 

reasonably be able to anticipate whether 

such a transaction will occur during a 

reasonable period before the transaction. 

Accordingly, the final regulations 

provide that the start-up corporation 

presumption will not apply if at the 

time the valuation is made, the service 

recipient or service provider may 

reasonably anticipate that the service 

recipient will undergo a change in 

control event in the next 90 days or an 

initial public offering within the next 

180 days. As under the proposed 

regulations, the rule in the final 

regulations is concerned with what the 

parties may reasonably anticipate at the 

time the stock right is issued. 

Other comments requested examples 

of persons with sufficient knowledge, 

experience, and skill in valuing illiquid 

stock of a start-up corporation. Because 

knowledge, skill, and training may be 

obtained in different ways, the final 

regulations do not provide specific 

examples. However, the regulations 

clarify that the standard to be applied is 

whether a reasonable individual, upon 

being apprised of such person’s relevant 

knowledge, experience, education, and 

training, would reasonably rely on the 

advice of such person with respect to 

valuation in deciding whether to accept 

an offer to purchase or sell the stock 

being valued. The final regulations also 

clarify that significant experience 

generally means at least five years of 

relevant experience in business 

valuation or appraisal, financial 

accounting, investment banking, private 

equity, secured lending, or other 

comparable experience in the line of 

business or industry in which the 

service recipient operates. 

With respect to the presumption 

based upon a generally applicable 

buyback formula, some commentators 

requested that the presumption apply 

where the formula is applicable to all 

compensatory stock transactions, but 

not also applicable to all 

noncompensatory stock transactions. 

The final regulations do not adopt this 

suggestion. However, the final 

regulations clarify that to meet the 

requirements of the presumption, the 

buyback formula is required to be 

applicable to compensatory and 

noncompensatory transactions with the 

issuer or a person owning 10 percent or 

more of the stock of the issuer, but is not 


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required to be applicable to transactions 

with other persons or transactions that 

are part of an arm’s length transaction 

constituting the sale of all or 

substantially all of the stock of the 

issuer to an unrelated purchaser. 

5. Modification of a Stock Right 

The final regulations continue to 

apply certain rules addressing 

modifications, extensions and renewals 

of stock rights. Although these rules in 

many respects resemble the rules 

applicable to statutory stock options, the 

rules are not intended to incorporate the 

rules applicable to statutory stock 

options except where explicitly 

provided. 

The final regulations generally retain 

the rules in the proposed regulations 

that generally treat extensions of the 

exercise period of a stock right as an 

additional deferral feature as of the date 

of grant of the right, with an exception 

for certain limited extensions following 

a separation from service. 

Commentators characterized these rules 

as unnecessarily restrictive. 

Specifically, commentators argued that 

the extension of a stock option upon the 

occurrence of a separation from service 

(often in connection with a program of 

layoffs) or a corporate transaction is a 

common practice, and that often these 

extensions cover periods longer than the 

limited period provided in the proposed 

regulations. In addition, commentators 

argued that the same substantive results 

could be obtained by specifying a longer 

term for the stock right and providing 

the service recipient the discretion to 

shorten the term, rather than providing 

discretion to extend a shorter term, and 

that the former approach would be 

permissible under the proposed 

regulations. In response, the final 

regulations provide that the extension of 

an option exercise period generally is 

not treated as an additional deferral 

feature or a modification of the stock 

option for section 409A purposes if the 

exercise period is not extended beyond 

the earlier of the original maximum 

term of the option or 10 years from the 

original date of grant of the stock right. 

Many commentators also requested 

that the extension of the exercise period 

of a stock right not be treated as an 

additional deferral feature for purposes 

of section 409A, where at the time of the 

extension the fair market value of the 

underlying stock does not exceed the 

exercise price (an ‘‘underwater’’ option). 

Because the issuance of an otherwise 

identical option with an exercise period 

ending after the end of the exercise 

period of the underwater option would 

be excluded from coverage under 

section 409A, the final regulations 

provide that such an extension does not 

constitute an additional deferral feature. 

The final regulations adopt the 

provisions in the proposed regulations 

regarding substitution or assumption of 

stock rights due to a corporate 

transaction, which are generally in 

accordance with the corresponding 

provisions governing incentive stock 

options. The final regulations clarify 

that the applicable corporate 

transactions for this purpose include 

only those transactions described in 

§ 1.424–1(a)(3). One commentator 

requested that the provision permitting 

substitutions of stock options be 

modified to reflect that a holder of a 

nonstatutory stock option is not 

required to be employed by the 

successor entity. The final regulations 

adopt this suggestion, so that a 

substituted nonstatutory stock option 

may be treated as a continuation of the 

initial option even where the holder of 

the option is not employed or otherwise 

providing services to the successor 

entity, provided the substitution 

otherwise meets the rules provided in 

the regulations. 

6. Other Stock Right Issues 

The final regulations adopt certain 

definitions from the regulations 

governing statutory stock options, 

modified as appropriate for purposes of 

applying the rules under section 409A. 

These include the time and date of grant 

of an option (§ 1.421–1(c)), and the 

definitions of option (§ 1.421–1(a)), 

stock (§ 1.421–1(d)), exercise price 

(§ 1.424–1(e)), exercise (§ 1.421–1(f)), 

and transfer (§ 1.421–1(g)). These 

definitions apply by analogy to stock 

appreciation rights. 

The final regulations adopt the rule 

that a right to a payment of accumulated 

dividend equivalents at the time of the 

exercise of a stock right generally will 

be treated as a reduction in the exercise 

price of the stock right, causing the 

stock right to be deferred compensation 

subject to the requirements of section 

409A. The final regulations provide that 

an arrangement to accumulate and pay 

dividend equivalents the payment of 

which is not contingent upon the 

exercise of a stock right may be treated 

as a separate arrangement for purposes 

of section 409A. Such an arrangement 

generally will be required to comply 

with section 409A (unless it 

independently qualifies for an exception 

from coverage under section 409A), but 

will not affect whether the related stock 

right qualifies for the exclusion from 

coverage under section 409A. The right 

to the dividend equivalents may be set 

forth within the stock right plan or the 

individual stock right grant, or in a 

separate document, as long as the 

payment of the dividend equivalents is 

not contingent upon the exercise of the 

stock right. 

Commentators also asked whether the 

exclusion of stock rights from coverage 

under section 409A would apply to 

tandem rights, meaning a stock right 

that combines a stock option right and 

a stock appreciation right, exercisable 

on an alternative basis. Similarly, 

commentators asked whether the 

substitution of a stock option for a stock 

appreciation right, or vice versa, where 

all the terms except the mode of 

payment upon exercise are similar, 

would be treated as a modification of a 

stock right. The application of section 

409A generally is not affected by the 

medium of a taxable payment (for 

example, cash or stock). Accordingly, 

whether a stock right is expressed as a 

tandem arrangement under which the 

exercise of one right terminates the 

other right, or there is a substitution of 

a stock appreciation right for a stock 

option identical in all respects except 

for the medium of payment, generally 

does not impact whether the 

arrangement is excluded from coverage 

under section 409A. 

Commentators requested further 

clarification of the application of section 

409A to stock option gain deferrals. The 

ability to defer gain upon the exercise or 

exchange (including a purported 

forfeiture) of a stock right is 

incompatible with the exclusion of 

certain stock rights from the 

requirements of section 409A because 

such exclusion is predicated on the 

option not having any additional 

deferral feature. Accordingly, if an 

arrangement provides for a potential to 

defer the payment of cash or property 

upon the exercise or exchange of a stock 

right beyond the year the right is 

exercised or beyond the original term of 

the stock right, the arrangement 

provides for a deferral feature and must 

comply with the requirements of section 

409A from the time the legally binding 

right granted by the award arises. 

Because a stock option with a deferral 

feature is subject to section 409A 

regardless of whether the deferral 

feature is actually utilized, an option 

that includes a provision permitting 

deferral of option gain generally will not 

satisfy the time and form of payment 

rules under section 409A if the service 

provider can exercise the option in more 

than one taxable year. If a deferral 

feature is added to a preexisting option, 

the option will be treated as having 

included a deferral feature as of the 

original date of grant, generally resulting 

in a violation of section 409A. 


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However, the final regulations 

provide that a stock right will not be 

treated as having a deferral feature 

where the service recipient delays a 

payment because the making of the 

payment would violate applicable 

Federal, state, local, or foreign law or 

jeopardize the ability of the service 

recipient to continue as a going concern. 

Although these provisions permit the 

delay for purposes of section 409A, no 

inference should be drawn as to the 

Federal tax consequences of such a 

delay under any other section of the 

Code or Federal tax doctrine such as 

section 83, section 451, the constructive 

receipt doctrine, or the economic benefit 

doctrine. 

Commentators requested that the 

definition of service recipient stock be 

expanded to include the stock of a 

corporation for which a service 

recipient provides substantial services, 

at least with respect to a service 

provider of the service recipient that is 

providing services to the corporation. 

The legislative history does not support 

such a broad interpretation of service 

recipient stock, and the final regulations 

do not adopt this suggestion. 

E. Restricted Property 

The final regulations provide, as did 

the proposed regulations, that a grant of 

restricted property generally will not 

constitute a deferral of compensation for 

purposes of section 409A. 

Commentators requested that the 

regulations clarify that a vested right to 

receive nonvested property in a future 

year does not constitute deferred 

compensation. Commentators argued 

that a right to receive nonvested 

property is not truly vested. For 

example, commentators argued that a 

right to receive restricted stock that will 

be subject to a substantial risk of 

forfeiture until the service provider 

completes three years of future services 

cannot be a vested right. The final 

regulations adopt this suggestion, so 

long as the risk of forfeiture to which 

the stock is subject constitutes a 

substantial risk of forfeiture for 

purposes of section 409A. 

Commentators specifically requested 

clarification of the circumstances under 

which a service provider may elect to be 

paid a bonus or other payment in the 

form of restricted stock, rather than 

cash. Generally an election between 

compensation alternatives, none of 

which provides for a deferral of 

compensation within the meaning of 

section 409A, will not cause the election 

to be subject to the section 409A timing 

restrictions. Thus, a choice between an 

award of restricted stock or stock 

options that are not subject to section 

409A will not be governed by the 

section 409A election timing rules. 

However, where any of the alternatives 

involves a deferral of compensation 

subject to section 409A, the election 

must comply with the provisions of 

section 409A. In addition, no inference 

should be drawn as to the Federal tax 

consequences of such an election 

provision under any other section of the 

Code or Federal tax doctrine such as 

section 83, section 451, the constructive 

receipt doctrine, or the economic benefit 

doctrine. 

F. Section 402(b) Trusts 

The final regulations continue to 

except from coverage under section 

409A transfers of a beneficial interest in 

a trust, or a transfer to or from a trust, 

to the extent such a transfer is subject 

to section 402(b). The final regulations 

further clarify that a right to 

compensation required to be included 

in income under section 402(b)(4)(A) 

(alternative taxation of highly 

compensated employees of a section 

402(b) trust that fails to meet the 

requirements of section 401(a)(26) or 

section 410(b)) also is not a deferral of 

compensation. However, a right to 

receive a benefit formulated as a right to 

a future contribution to a section 402(b) 

trust is similar to a right to receive 

property in a future taxable year, and 

generally would constitute deferred 

compensation. 

G. Arrangements Between Partnerships 

and Partners 

The proposed regulations did not 

address the application of section 409A 

to arrangements between partnerships 

and partners, and these final regulations 

also do not address such arrangements. 

The statute and the legislative history of 

section 409A do not specifically address 

arrangements between partnerships and 

partners providing services to a 

partnership and do not explicitly 

exclude such arrangements from the 

application of section 409A. 

Commentators raised a number of 

issues, relating both to the scope of the 

arrangements subject to section 409A 

and the coordination of the provisions 

of subchapter K and section 409A with 

respect to those arrangements that are 

subject to section 409A. The Treasury 

Department and the IRS are continuing 

to analyze the issues raised in this area. 

Notice 2005–1, Q&A–7 provides interim 

guidance regarding the application of 

section 409A to arrangements between 

partnerships and partners. Until further 

guidance is issued, taxpayers may 

continue to rely on Notice 2005–1, 

Q&A–7 and section II.E. of the preamble 

to the proposed regulations. 

Notice 2005–1, Q&A–7 provided that 

until further guidance is issued for 

purposes of section 409A, taxpayers 

may treat the issuance of a partnership 

interest (including a profits interest) or 

an option to purchase a partnership 

interest, granted in connection with the 

performance of services under the same 

principles that govern the issuance of 

stock. For this purpose, taxpayers may 

apply the principles applicable to stock 

options or stock appreciation rights 

under these final regulations, as 

effective and applicable, to equivalent 

rights with respect to partnership 

interests. 

Taxpayers also may continue to rely 

upon the explanation in the preamble to 

the proposed regulations regarding the 

application of section 409A to 

guaranteed payments for services 

described in section 707(c). As stated in 

that preamble, until further guidance is 

issued, section 409A will apply to 

guaranteed payments described in 

section 707(c) (and rights to receive 

such guaranteed payments in the 

future), only in cases where the 

guaranteed payment is for services and 

the partner providing services does not 

include the payment in income by the 

15th day of the third month following 

the end of the taxable year of the partner 

in which the partner obtained a legally 

binding right to the guaranteed payment 

or, if later, the taxable year in which the 

right to the guaranteed payment is first 

no longer subject to a substantial risk of 

forfeiture. 

Commentators raised issues 

concerning the application of the 

provision in Notice 2005–1, Q&A–7 

stating that until further guidance is 

issued, taxpayers may treat 

arrangements providing for payments 

subject to section 736 (payments to a 

retiring partner or a deceased partner’s 

successor in interest) as not being 

subject to section 409A, except that an 

arrangement providing for payments 

that qualify as payments to a partner 

under section 1402(a)(10) is subject to 

section 409A. Section 1402(a)(10) 

provides for an exception from the SelfEmployment Contributions Act (SECA) 

tax for payments to a retired partner, 

provided that certain conditions are 

met. Specifically, the payments must be 

made pursuant to a written plan of the 

partnership, must be on account of the 

partner’s retirement and must continue 

at least until the partner’s death. In 

addition, to qualify for the exception, 

the partner must not have rendered 

services during the partnership’s taxable 

year ending within or with the partner’s 

taxable year in which the amounts were 

received, as of the close of the 

partnership’s taxable year no obligation 


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must exist from the other partners to 

such retired partner except with respect 

to retirement payments under such 

plan, and before the end of the 

partnership’s taxable year such retired 

partner’s share, if any, of the capital of 

the partnership must have been paid to 

him in full. 

Commentators questioned the 

appropriateness of the inclusion of such 

arrangements under section 409A, 

because neither the statute nor the 

legislative history refers to section 

1402(a)(10). However, the Treasury 

Department and the IRS believe it is 

appropriate for such arrangements to be 

subject to section 409A because such 

arrangements are purposefully created 

to provide deferred compensation, and 

do not raise issues regarding the 

coordination of the provisions of section 

409A with the provisions of section 736, 

specifically the rules governing the 

classification of payments to a retired 

partner under section 736(a) (payments 

considered as distributive share or 

guaranteed payments) and section 

736(b) (payments for interest in 

partnership). 

However, further clarification and 

relief is provided concerning the 

application of the deferral election 

timing rules to these payments. Until 

further guidance is issued, for purposes 

of section 409A, taxpayers may treat the 

legally binding right to the payments 

excludible from SECA tax under section 

1402(a)(10) as arising on the last day of 

the partner’s taxable year before the 

partner’s first taxable year in which 

such payments are excludible from 

SECA tax under section 1402(a)(10), and 

the services for which the payments are 

compensation as performed in the 

partner’s first taxable year in which 

such payments are excludible from 

SECA tax under section 1402(a)(10). 

Accordingly, for purposes of section 

409A, the time and form of payment of 

such amounts generally may be 

established, including through an 

election to defer by the partner, on or 

before the final day of the partner’s 

taxable year immediately preceding the 

partner’s first taxable year in which 

such payments are excludible from 

SECA tax under section 1402(a)(10). 

However, this interim relief does not 

apply a second time where an amount 

paid under an arrangement in one year 

has been excluded from SECA tax under 

section 1402(a)(10), and an amount paid 

in a subsequent year has not been 

excluded from SECA tax under section 

1402(a)(10) because, for example, the 

partner performed services in that 

subsequent year. 

H. Foreign Plans 

1. Plans Covered by an Applicable 

Treaty 

The proposed regulations provided an 

exclusion from the definition of a 

nonqualified deferred compensation 

plan for any scheme, trust, or 

arrangement maintained with respect to 

an individual where contributions made 

by or on behalf of such individual to 

such scheme, trust or arrangement are 

excludable for Federal income tax 

purposes under an applicable income 

tax treaty. The final regulations retain 

that exclusion and clarify that the 

exclusion applies to the extent 

contributions made by or on behalf of 

such individual to such scheme, trust, 

arrangement or plan, or credited 

allocations, accrued benefits, or 

earnings or other amounts constituting 

income, of such individual under such 

scheme, trust, arrangement or plan, are 

excludable by such individual for 

Federal income tax purposes pursuant 

to any bilateral income tax convention 

to which the United States is a party. 

2. Exclusion for Benefits Earned Under 

a Broad-Based Foreign Retirement Plan 

The proposed regulations contained 

an exclusion from coverage under 

section 409A for amounts deferred 

under a broad-based foreign retirement 

plan, subject to certain conditions, 

including that the service provider not 

be eligible to participate in a qualified 

employer plan, and that if the person is 

a U.S. citizen or lawful permanent 

resident, the exception only applies to 

nonelective deferrals of foreign earned 

income (as defined in section 911(b)(1)) 

that do not exceed the limits under 

section 415(b) and (c) that would be 

applicable if the plan were a qualified 

plan. Deferrals by participants that are 

nonresident aliens are not subject to the 

limitation based on section 415. The 

final regulations adopt this provision, 

subject to certain modifications. 

Many of the commentators requested 

expansion of the exclusion for broadbased foreign retirement plans. One 

commentator requested that the 

exclusion apply to U.S. citizens working 

in the United States for a foreign 

employer. The Treasury Department and 

the IRS do not believe such an 

exception is justified. However, the 

exception for U.S. citizens or lawful 

permanent residents has been expanded 

to cover nonelective deferrals of foreign 

earned income as defined in section 

911(b)(1) without regard to section 

911(b)(1)(B)(iv) and without regard to 

the requirement that the income be 

attributable to services performed 

during the period described in section 

911(d)(1)(A) or (B). Accordingly, the 

exception may now cover certain 

participation by a U.S. citizen or lawful 

permanent resident who works overseas 

during only part of a year, and therefore 

is not a bona fide resident of a foreign 

country for an uninterrupted period that 

includes an entire taxable year, or is not 

present in the foreign country at least 

330 full days during a period of 12 

consecutive months. 

The regulations have also been 

modified to address nonqualified 

deferred compensation plans covering 

bona fide residents of a U.S. possession. 

Under the regulations a bona fide 

resident of a possession who 

participates in a broad-based foreign 

retirement plan is not subject to section 

409A with respect to participation in 

such plan. In addition, a plan 

substantially all of the participants in 

which are bona fide residents of a 

possession is eligible to be treated as a 

broad-based foreign retirement plan, so 

that U.S. citizens and resident aliens 

(other than bona fide residents of a 

possession) who participate in such a 

plan may be eligible for the more 

limited exclusion for participation in a 

broad-based foreign retirement plan. 

Another commentator requested that 

the exclusion apply to a plan that 

otherwise meets the requirements for 

the exclusion, regardless of whether the 

plan is sponsored by a foreign or U.S. 

employer. This suggestion has been 

adopted in the final regulations. 

Other commentators requested further 

clarification and revision of certain of 

the requirements to qualify for the 

exclusion. One commentator requested 

a safe harbor treating any plan granted 

favorable tax treatment under the laws 

of a foreign jurisdiction as qualifying for 

the exclusion. The Treasury Department 

and the IRS believe this standard is both 

too broad and not administrable, and 

this suggestion has not been adopted in 

the final regulations. 

Another commentator requested that 

the regulations provide a safe harbor 

percentage for determining whether 

substantially all of a foreign plan’s 

participants are nonresident aliens. The 

final regulations do not adopt such a 

provision. However, the final 

regulations clarify that in determining 

whether substantially all of a foreign 

plan’s participants are nonresident 

aliens or bona fide residents of a 

possession, only active participants are 

considered. For this purpose, active 

participants include individuals who, 

under the terms of the plan and without 

further amendment or action by the plan 

sponsor, are eligible to make or receive 

contributions or accrue benefits under 


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the plan (even if the individual has 

elected not to participate in the plan). 

A similar standard applies to the 

requirement that the individual not be 

eligible to participate in a qualified 

employer plan. The final regulations 

provide that a service provider will be 

treated as eligible to participate in a 

qualified employer plan if, under the 

plan’s terms and without further 

amendment or action by the plan 

sponsor, the service provider is eligible 

to make or receive contributions or 

accrue benefits under the plan (even if 

the service provider has elected not to 

participate in the plan). 

The final regulations also clarify that 

the exclusion for United States citizens 

and lawful permanent residents applies 

to nonelective deferrals even if elective 

deferrals are permitted under the same 

plan, provided that the amounts 

deferred through nonelective deferrals 

and earnings on such amounts are 

distinguishable from amounts deferred 

through elective deferrals and earnings 

on such amounts, such as through the 

use of separate accounts. 

3. Tax Equalization Payments 

The proposed regulations excluded 

from coverage under section 409A 

certain arrangements, referred to as tax 

equalization arrangements, that provide 

for payments intended to compensate 

the service provider for the excess of 

taxes actually imposed by a foreign 

jurisdiction on the compensation paid 

over the taxes that would be imposed if 

the compensation were subject solely to 

United States Federal income tax, 

subject to certain requirements. The 

final regulations adopt these provisions, 

subject to modifications. Based upon the 

comments received, the final regulations 

generally expand the exclusion in two 

respects. First, the final regulations 

extend the tax equalization payments 

exception to cover reimbursements of 

U.S. taxes that exceed foreign taxes. 

Second, the final regulations provide 

that the payment must be made by the 

end of the second taxable year of the 

service provider following the latest of 

the deadline for filing a U.S. Federal tax 

return or the deadline for filing foreign 

tax returns (or if a foreign return is not 

required to be filed, the due date for 

foreign tax payments) reflecting the 

compensation for which the tax 

equalization payment is provided. 

Commentators also asked how such 

reimbursement agreements could 

address the potential for an audit or 

other tax controversy, both in the U.S. 

and abroad. The same issue arises with 

respect to tax gross-up payments in 

general. For a discussion of the 

treatment of the right to such payments, 

see section VII.B.4 of this preamble. 

4. Certain Limited Deferrals by 

Nonresident Aliens 

The proposed regulations provided an 

exception for amounts deferred by a 

nonresident alien under a foreign plan 

maintained by a foreign service 

recipient, to the extent the amounts 

deferred during the year did not exceed 

$10,000. The final regulations adopt this 

provision, subject to the modifications 

described in this preamble. In response 

to comments, the final regulations 

clarify that the exception applies to 

amounts deferred in that taxable year up 

to the specified limit, regardless of 

whether additional amounts are 

deferred. In making this modification, 

the exclusion provision has been moved 

from the section providing a definition 

of nonqualified deferred compensation 

plan (§ 1.409A–1(a)) to the section 

providing a definition of an amount 

deferred (§ 1.409A–1(b)). In addition, 

the final regulations clarify that this 

exception applies to earnings on 

amounts deferred that were subject to 

the exception, provided that the 

taxpayer can identify both the deferred 

amounts excepted and the applicable 

earnings. Finally, in response to 

comments requesting that the limit be 

increased and indexed, the final 

regulations increase the limit for the 

small deferral exception to the limit 

provided for elective deferrals under 

section 402(g). 

The small deferral exception is 

intended to provide relief to service 

providers that are not U.S. citizens or 

lawful permanent residents, are 

participating in a foreign plan, and 

perform services in the U.S. for which 

they are compensated. In such cases, the 

nonresident alien may inadvertently 

defer a relatively small amount of 

compensation that would otherwise be 

subject to U.S. Federal income tax. This 

may occur where the service provider 

defers the compensation that the service 

provider would otherwise have been 

paid for a brief period of service in the 

United States, or where the service 

provider receives service or 

compensation credit for a brief period of 

service in the United States under a 

benefit formula of a nonqualified 

deferred compensation plan. 

Some commentators requested that 

the exemption be extended to cover all 

amounts deferred by nonresident aliens 

under foreign plans to the extent the 

nonresident alien provides only 

temporary services in the U.S. Where 

the compensation earned by such a 

nonresident alien would be subject to 

U.S. income tax if paid when earned, 

the Treasury Department and the IRS do 

not believe that such a broad exception 

is warranted. 

5. Other Foreign Plans 

The final regulations adopt the 

exclusion in the proposed regulations 

for deferrals of amounts that would be 

excluded as foreign earned income 

under section 911 if the amounts had 

been paid out when earned. The final 

regulations clarify that the amount is 

limited to an amount equal to or less 

than the difference between the 

maximum section 911 exclusion for the 

year and the amount actually excluded 

for the year. Commentators requested 

that the exception for the deferral of 

amounts that would be excluded under 

section 911 be relaxed, so that U.S. 

expatriates who return for periods 

longer than 30 days or who earn 

compensation for services performed in 

the U.S. that is not excluded as foreign 

earned income, may also take advantage 

of the exception. This exception was not 

intended to address such plans. Rather, 

the provision was intended to provide 

relief from the section 409A 

requirements for U.S. expatriates who 

intend to work full-time outside the U.S. 

for compensation that is less than the 

exclusion amount under section 911, 

because it would severely disadvantage 

such workers to expect them to request 

that their potential foreign employers 

modify standard plans to accommodate 

them, or to expect such workers to 

otherwise be able to determine how to 

avoid or comply with section 409A. 

Commentators pointed out, however, 

that earnings on deferred amounts, 

including increases in amounts deferred 

under a nonaccount balance plan solely 

due to the passage of time, may not be 

treated as earned income under section 

911 and argued that, nonetheless, such 

amounts should not lower the amount 

otherwise available to be deferred under 

the exception. The final regulations 

generally provide that rights to earnings 

credited on amounts that qualify for this 

exception are also excepted from 

coverage under section 409A, provided 

that the earnings satisfy the definition of 

earnings in § 1.409A–1(o). 

I. Indemnification Arrangements 

The final regulations generally 

provide that the right to the payment of 

contingent amounts pursuant to a 

service recipient’s indemnification for 

expenses incurred as a result of a legal 

claim for damages related to the service 

provider’s performance as a service 

provider, to the extent permissible 

under applicable law, will not be treated 

as the right to deferred compensation. 

Similarly, a right to liability insurance 


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coverage providing for such payments 

in the event of such a suit also will not 

be treated as providing for a deferral of 

compensation. 

J. Separation Pay Plans 

1. In General 

The final regulations generally adopt 

the provisions addressing separation 

pay plans set forth in the proposed 

regulations, subject to certain 

modifications. The final regulations 

clarify that separation pay refers only to 

compensation to which the service 

provider’s right is conditioned upon a 

separation from service (including a 

separation from service due to death or 

disability) and not to compensation the 

service provider could receive without 

separating from service (such as an 

amount also payable upon a change in 

control, as a result of an unforeseeable 

emergency, or on a date certain). For 

example, the right to a gross-up 

payment for taxes payable due to the 

application of section 280G will 

constitute separation pay if a separation 

from service is required to obtain the 

payment. The final regulations also 

clarify that a separation pay plan for 

purposes of section 409A, including for 

purposes of the plan aggregation rules, 

refers only to plans providing for 

payments of amounts of deferred 

compensation (disregarding the 

exceptions from the definition of 

deferred compensation for certain types 

of separation pay) where one of the 

conditions to the right to the payment 

is a separation from service. A right to 

a payment upon a separation from 

service that is not deferred 

compensation does not become subject 

to section 409A under the plan 

aggregation rule. For example, the 

accelerated vesting due to a separation 

from service of stock options excluded 

from coverage under section 409A 

would not constitute a separation pay 

plan or otherwise become subject to 

section 409A under the plan aggregation 

rules. 

The final regulations generally retain 

and supplement the various exceptions 

from the definition of deferred 

compensation for certain types of 

separation pay, providing exceptions for 

(1) certain bona fide collectively 

bargained arrangements, (2) certain 

arrangements providing separation pay 

due solely to an involuntary separation 

from service or participation in a 

window program in limited amounts 

and for a limited period of time, (3) 

certain foreign separation pay 

arrangements, (4) certain reimbursement 

arrangements providing for expense 

reimbursements or in-kind benefits for a 

limited period of time following a 

separation from service, and (5) certain 

rights to limited amounts of separation 

pay. These exceptions from coverage 

under section 409A for specified 

separation pay plans may be used in 

combination. For example, the rights of 

an employee to the maximum amount 

available under the exception for 

separation payments made solely due to 

involuntary separation from service or 

participation in a window program, to 

reimbursements for reasonable moving 

expenses and outplacement expenses 

that meet the requirement for exclusion 

from coverage under section 409A, and 

to rights to payments that do not exceed 

the limit on elective deferrals under 

section 402(g) and accordingly qualify 

for the limited payment exception, may 

all be excluded from coverage under 

section 409A due to application of the 

various exceptions. 

The final regulations continue to 

provide that any amount, or entitlement 

to any amount, that acts as a substitute 

for, or replacement of, amounts deferred 

under a separate nonqualified deferred 

compensation plan constitutes a 

payment of deferred compensation or 

deferral of compensation under the 

separate nonqualified deferred 

compensation plan. Commentators 

asked how this would apply where the 

service provider would otherwise forfeit 

a payment upon separation from service 

but a payment is made anyway, in 

whole or in part. 

The regulations provide that if a 

separation from service is voluntary, it 

is presumed that the payment results 

from an acceleration of vesting followed 

by a payment of the deferred 

compensation that is subject to section 

409A. Accordingly, any change in the 

payment schedule to accelerate or defer 

the payments would be subject to the 

rules of section 409A. The presumption 

that a right to a payment is not a new 

right, but is instead a right substituted 

for an existing nonvested right, may be 

rebutted by demonstrating that the 

service provider’s right to the payment 

after the separation from service would 

have existed regardless of the forfeiture 

of the nonvested right. Factors 

indicating that a right would have 

existed regardless of the forfeiture 

include that the amount to which the 

service provider obtains a right is 

materially less than the present value of 

the forfeited amount multiplied by a 

fraction, the numerator of which is the 

period of service the service provider 

actually completed, and the 

denominator of which is the full period 

of service the service provider would 

have been required to complete to 

receive the full amount of the payment. 

Another factor is that the payment 

consists of a type of payment 

customarily made to service providers 

who separate from service with that 

service recipient and do not forfeit 

nonvested rights to deferred 

compensation (for example, a payment 

of accrued but unused leave or a 

payment for a release of potential 

claims). 

2. Separation Pay Due Solely to 

Involuntary Separation From Service or 

Participation in a Window Program 

The final regulations generally 

continue the exception from coverage 

under section 409A in the proposed 

regulations for rights to payments 

available only upon an involuntary 

separation from service or participation 

in a window program, payable no later 

than the end of the second taxable year 

of the service provider following the 

year of the separation from service, and 

limited to an amount that is generally 

the lesser of two times the service 

provider’s annual compensation or two 

times the limit on compensation set 

forth in section 401(a)(17). This 

exception only applies where the 

payment is available solely due to an 

involuntary separation from service of 

the service provider, or the service 

provider’s participation in a window 

program, and not to a plan providing for 

a payment upon a voluntary separation 

from service or other event. For a 

discussion of when a separation from 

service for good reason may be treated 

as an involuntary separation from 

service, see section III.J.3 of this 

preamble. 

Commentators requested that the 

exclusion continue to apply to 

payments up to the limit, even where 

the entire amount of the separation 

payments exceeds the limit. The final 

regulations adopt this rule. Accordingly, 

where a service provider is entitled to 

a payment that qualifies for the 

exception except that it exceeds the 

limit, only the excess over the limit will 

be subject to section 409A. The right to 

the payment up to the applicable limit 

will not be subject to section 409A, 

including the requirement that the 

payment be delayed for six months in 

the case of a specified employee, 

provided that such limited payment is 

otherwise required to be made, and is 

made, no later than the end of the 

second taxable year following the 

service provider’s taxable year in which 

the separation from service occurs. 

The final regulations clarify that for 

purposes of applying the section 

401(a)(17) limit, the statutory limit 

applicable for the year of the separation 

from service occurs applies. The final 


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regulations also clarify that for purposes 

of determining the service provider’s 

annual rate of pay for the taxable year 

preceding the taxable year in which the 

separation from service occurs, an 

annual rate of pay based upon the 

service provider’s taxable year 

immediately preceding the service 

provider’s taxable year in which the 

separation from service occurs is used, 

adjusted for any increase during the 

year that was expected to continue 

indefinitely if the service provider had 

not separated from service. One 

commentator requested that the limit be 

set at twice the amount of compensation 

set forth under section 401(a)(17), 

regardless of the service provider’s 

actual income. This suggestion has not 

been adopted in the final regulations. 

3. Definition of Involuntary Separation 

From Service 

The proposed regulations provided an 

exclusion from coverage under section 

409A that applied only to certain 

amounts paid solely because of an 

actual involuntary separation from 

service or participation in a window 

program. Many comments asked how to 

determine whether a separation from 

service is involuntary for this purpose. 

The final regulations contain a 

definition of involuntary separation 

from service and also apply this 

definition for purposes of the definition 

of a substantial risk of forfeiture, 

pursuant to which a payment that will 

not be made unless the service provider 

experiences an involuntary separation 

from service is subject to a substantial 

risk of forfeiture for purposes of section 

409A. (See section V of this preamble.) 

The final regulations provide that 

whether a separation from service is 

involuntary is determined based on all 

the facts and circumstances. For this 

purpose, any characterization of the 

separation from service as voluntary or 

involuntary by the service provider and 

the service recipient in the 

documentation relating to the separation 

from service is rebuttably presumed to 

properly characterize the nature of the 

separation from service. For example, if 

a separation from service is 

characterized as voluntary, the 

presumption may be rebutted by 

demonstrating that absent the voluntary 

separation from service the service 

recipient would have terminated the 

service provider’s services, and that the 

service provider had knowledge that the 

service provider would be so 

terminated. 

Commentators requested that a 

separation from service for good reason 

be treated as an involuntary separation 

from service. The final regulations 

provide that where the right to a 

payment is contingent upon a voluntary 

separation from service following an 

occurrence that constitutes good reason 

for the service provider to terminate his 

or her services, the right may be treated 

as payable only upon an involuntary 

separation from service where the good 

reason condition is such that the service 

provider’s separation from service 

effectively is an involuntary separation 

for purposes of section 409A. To be 

treated as an involuntary separation for 

purposes of section 409A, the avoidance 

of the requirements of section 409A 

must not be a purpose of the inclusion 

of any good reason condition in the plan 

or of the actions by the service recipient 

in connection with the satisfaction of a 

condition. In addition, such good reason 

condition must require actions taken by 

the service recipient resulting in a 

material negative change in the 

employment relationship, such as a 

material negative change in the duties to 

be performed, the conditions under 

which such duties are to be performed, 

or the compensation to be received. 

Additional factors that may be relevant 

to whether a purported separation from 

service for good reason is the result of 

a bona fide good reason condition not 

having as a principal purpose the 

avoidance of section 409A include the 

extent to which the payments upon a 

separation from service for good reason 

are in the same amount and are made 

at the same time and in the same form 

as payments available upon an actual 

involuntary separation from service, and 

whether the service provider is required 

to give the service recipient notice of the 

existence of the good reason condition 

and a reasonable opportunity to remedy 

the condition. Where a good reason 

condition is sufficient to be treated for 

purposes of section 409A as a condition 

requiring an involuntary separation 

from service, an amount payable on 

account of a separation from service for 

good reason will be treated the same as 

an amount payable on account of an 

actual involuntary separation from 

service. 

The final regulations also provide a 

safe harbor under which a provision for 

a payment upon a voluntary separation 

from service for good reason will be 

treated for purposes of section 409A as 

providing for a payment upon an actual 

involuntary separation from service. 

Those conditions include that the 

amount be payable only if the service 

provider separates from service within a 

limited period of time not to exceed one 

year following the initial existence of 

the good reason condition, and that the 

amount, time and form of payment upon 

a voluntary separation from service for 

good reason be identical to the amount, 

time and form of payment upon an 

involuntary separation from service. In 

addition, the service provider must be 

required to provide notice of the 

existence of the good reason condition 

within a period not to exceed 90 days 

of its initial existence, and the service 

recipient must be provided a period of 

at least 30 days during which it may 

remedy the good reason condition. For 

these purposes, a good reason condition 

may consist of one or more of the 

following conditions arising without the 

consent of the service provider: (1) A 

material diminution in the service 

provider’s base compensation; (2) a 

material diminution in the service 

provider’s authority, duties, or 

responsibilities; (3) a material 

diminution in the authority, duties, or 

responsibilities of the supervisor to 

whom the service provider is required 

to report, including a requirement that 

a service provider report to a corporate 

officer or employee instead of reporting 

directly to the board of directors of a 

corporation (or similar entity with 

respect to an entity other than a 

corporation); (4) a material diminution 

in the budget over which the service 

provider retains authority; (5) a material 

change in geographic location at which 

the service provider must perform the 

services; or (6) any other action or 

inaction that constitutes a material 

breach of the terms of an applicable 

employment agreement. 

4. Collectively Bargained Plans 

Commentators requested an exception 

from coverage under section 409A to 

address certain plans providing for 

payments upon a voluntary separation 

from service, in the context of a 

collective bargaining agreement 

covering services performed for 

multiple employers. The Treasury 

Department and the IRS believe these 

issues are better addressed in the 

definition of separation from service. 

See section VII.C.2.b of this preamble. 

5. Treatment as a Separate Plan 

For purposes of the plan aggregation 

rules, the final regulations provide for 

separate treatment of plans providing 

for separation pay solely due to an 

involuntary separation from service or 

participation in a window program. 

This exception is intended to apply only 

where the amounts are payable solely 

due to an involuntary separation from 

service or participation in a window 

program, and not where the amounts 

may also become payable for some other 

reason, even where such payments 

actually are made due to an involuntary 


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separation from service or participation 

in a window program. Accordingly, any 

amount that would be paid as a result 

of a voluntary separation from service 

will not be included in this category. An 

arrangement that does not provide for 

deferred compensation will not be 

aggregated with a deferred 

compensation plan under this rule, 

merely because the arrangement not 

providing for deferred compensation 

accelerates vesting or payment upon an 

involuntary separation from service (for 

example, the acceleration of the vesting 

of a stock option or stock appreciation 

right that is excluded from coverage 

under section 409A). 

6. Reimbursement and Fringe Benefit 

Plans 

a. In General 

The proposed regulations provided 

that certain plans under which a service 

recipient reimburses certain types of 

expenses (for example, reasonable 

moving expenses or reasonable 

outplacement expenses directly related 

to a termination of the service provider’s 

services) actually incurred by a service 

provider (including certain in-kind 

benefits provided to the service 

provider) following a separation from 

service are not nonqualified deferred 

compensation plans for purposes of 

section 409A, if such reimbursements 

are available only for expenses incurred, 

and the reimbursements are made 

during a limited period (generally not 

after the second taxable year of the 

service provider following the 

separation from service). 

In response to questions from 

commentators, the final regulations 

clarify that a right to a benefit that is 

excludible from income will not be 

treated as a deferral of compensation for 

purposes of section 409A. Accordingly, 

for example, an arrangement to provide 

health coverage excludible from income 

under section 105 generally would not 

be subject to section 409A. 

Many commentators requested 

increased flexibility to provide for 

reimbursement arrangements upon a 

separation from service, including 

certain requests to exempt broad 

categories of such arrangements, such as 

the continuation of any plan in which 

the service provider participated while 

performing services. The Treasury 

Department and the IRS believe that an 

exemption from coverage under section 

409A is not appropriate in such 

circumstances, because such plans may 

provide for rights to significant amounts 

of deferred compensation over lengthy 

periods of time. However, the final 

regulations extend the limited period 

during which taxable reimbursements of 

medical expenses may be provided, to 

cover the period during which the 

service provider would be entitled (or 

would, but for such arrangement, be 

entitled) to continuation coverage under 

a group health plan of the service 

recipient under section 4980B (COBRA) 

if the service provider elected such 

coverage and paid the applicable 

premiums. In addition, the final 

regulations contain several provisions 

governing reimbursement plans 

(including plans providing in-kind 

benefits) that constitute nonqualified 

deferred compensation plans for 

purposes of section 409A, so that 

taxpayers will be able to design such 

arrangements to comply with the 

payment timing requirements of section 

409A. For a discussion of these 

provisions, see section VII.B.2 of this 

preamble. 

b. Specific Exceptions for PostSeparation Reimbursement Plans 

The final regulations continue to 

exclude from coverage under section 

409A the reimbursement of certain 

expenses such as reasonable 

outplacement expenses and reasonable 

moving expenses for a limited period of 

time due to a separation from service, 

whether the separation from service is 

voluntary or involuntary. The final 

regulations, like the proposed 

regulations, require that the eligible 

expense must be incurred by the service 

provider no later than the end of the 

second year following the year in which 

the separation from service occurs. In 

response to questions from 

commentators, the final regulations 

clarify that the exception applies to the 

qualifying reimbursements available 

during the limited period of time, even 

if the plan extends beyond the limited 

period of time. 

Several commentators requested that 

the limited period of time refer solely to 

the time the expense is incurred, and 

not the time the expense is reimbursed, 

to reflect the need for time to process 

the reimbursement request. Although 

the final regulations do not adopt this 

suggestion, the final regulations extend 

the period during which a service 

provider can receive a reimbursement 

payment by providing that such 

payments must be made not later than 

the end of the third year following the 

separation from service. This extension 

applies only to reimbursements of 

expenses incurred by the service 

provider. Where the service recipient 

provides in-kind benefits (as defined in 

the regulations), or the service recipient 

pays a third party to provide in-kind 

benefits, such benefits must be provided 

by the end of the second year following 

the separation from service. 

Commentators also requested that the 

final regulations clarify the treatment of 

rights to a reimbursement of any loss 

incurred due to a sale of a residence. 

The regulations clarify that for this 

purpose, reasonable moving expenses 

include the reimbursement of an 

amount related to a loss incurred due to 

a sale of a primary residence, provided 

that the reimbursement does not exceed 

the loss actually incurred. 

7. Limited Payments of Separation Pay 

The final regulations provide that, if 

not otherwise excluded, a taxpayer may 

treat a right or rights under a separation 

pay plan to a payment or payments of 

an aggregate amount not to exceed the 

applicable dollar amount under section 

402(g)(1)(B) for the year of the 

separation from service as not providing 

for a deferral of compensation. 

Commentators raised questions 

concerning the calculation of the 

excluded amount, and requested an 

increase in the amount. The limited 

payment exception is intended to avoid 

the application of section 409A to 

incidental benefits often provided upon 

a separation from service, where the 

parties may not realize that the benefits 

are nonqualified deferred compensation. 

The exception is not intended to 

address extended or significant benefits. 

Accordingly, the final regulations do not 

substantially increase the amount of the 

exclusion. However, to permit the 

excluded amount to automatically 

reflect cost-of-living increases, the 

maximum exclusion now equals the 

maximum amount of an elective deferral 

permitted under section 402(g) for the 

year of the separation from service. 

The aggregate amount refers to the 

aggregate amount of payments to which 

the service provider has a right or rights. 

The exclusion may be applied to any 

type of separation pay plan, but may 

apply only once with respect to 

amounts paid by a service recipient to 

a service provider. So, for example, if a 

service provider treats a right to a 

payment of separation pay equal to the 

applicable limit under section 402(g) in 

the first year following a separation 

from service as an excluded right, the 

right to the amount is not treated as a 

deferral of compensation regardless of 

when the amount is actually paid 

(though other provisions of the Code 

and the constructive receipt doctrine 

continue to apply). However, once the 

right is treated as excluded, the service 

provider may not treat any other right 

with respect to the service recipient, 

such as an additional right to a payment 

equal to the applicable limit under 


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section 402(g) in the second year 

following the separation from service, as 

excluded under this exception. 

K. Non-Taxable Benefits 

The final regulations clarify that a 

legally binding right to receive a 

nontaxable benefit does not provide for 

a deferral of compensation for purposes 

of section 409A, unless the service 

provider has received the right in 

exchange for, or has the right to 

exchange the right for, an amount that 

will be includible in income (other than 

due to participation in a cafeteria plan 

described in section 125). In addition, 

because such benefits do not provide for 

a deferral of compensation, the plan 

aggregation rules will not result in 

taxation of other benefit plans merely 

because the terms of such nontaxable 

benefit arrangements would not comply 

with section 409A if the arrangement 

were covered by section 409A. For a 

discussion of the requirements for a 

taxable reimbursement plan to satisfy 

the payment timing requirements of 

section 409A, see section VII.B.2. of this 

preamble. 

L. Legal Settlements 

Commentators requested clarification 

of the application of section 409A to 

amounts paid pursuant to litigation 

between the service provider and 

service recipient, including both court 

awards and bona fide settlements, and 

including amounts characterized as 

wages or otherwise treated as replacing 

compensation. The Treasury 

Department and the IRS believe that 

section 409A was not intended to 

govern settlements or awards resolving 

bona fide legal claims based on 

wrongful termination, employment 

discrimination, the Fair Labor Standards 

Act, or worker’s compensation statutes, 

regardless of whether such claims arise 

under Federal, state, local, or foreign 

laws, even where settlements or awards 

pursuant to such claims are treated as 

compensation for Federal tax purposes. 

The final regulations generally treat 

such arrangements as not providing for 

deferred compensation for purposes of 

section 409A. In addition, the final 

regulations generally provide that 

section 409A does not apply to the 

payment of, or reimbursement for, 

attorney’s fees incurred in connection 

with the enforcement of such a claim. 

However, the exception covers only 

rights arising from the bona fide claim, 

and is not intended to allow such 

settlements or awards to act as 

substitutes for, or to allow for the 

restructuring of, preexisting deferred 

compensation subject to section 409A. 

For example, a change to the timing of 

the payment of a pre-existing amount of 

deferred compensation as part of such a 

settlement would be subject to the rules 

governing accelerated payments and 

subsequent deferral elections. In 

addition, the payment of an amount 

upon the execution of a waiver of any 

or all of such claims does not 

necessarily indicate that the amounts 

are paid as an award or settlement of an 

actual bona fide claim. Rather, to qualify 

for the exception under this provision, 

the amounts must be paid with respect 

to an actual bona fide claim for damages 

under the applicable law. For a 

discussion of the treatment of 

settlements of bona fide disputes 

regarding the right to preexisting 

deferred compensation subject to 

section 409A, see section VIII.G of this 

preamble. 

M. Split-Dollar Life Insurance 

Arrangements 

Some commentators requested that 

split-dollar life insurance arrangements 

be excluded from coverage under 

section 409A. Split-dollar life insurance 

arrangements are often used as a method 

of providing deferred compensation and 

there is no indication in the statute or 

legislative history of any legislative 

intent that such arrangements be 

excluded from coverage under section 

409A. In addition, like a promise to 

transfer property in the future, a 

promise to transfer an economic benefit 

in the future may provide for deferred 

compensation. Accordingly, a splitdollar life insurance arrangement may 

provide for deferred compensation, and 

whether a split-dollar life insurance 

arrangement provides for deferred 

compensation must be determined 

through application of the general rules 

defining deferred compensation and a 

nonqualified deferred compensation 

plan. In response to requests for 

additional guidance, the Treasury 

Department and the IRS anticipate 

issuing a notice addressing the 

application of section 409A to splitdollar life insurance arrangements. 

Commentators raised issues 

concerning the interplay between the 

modifications that may be needed to 

satisfy the requirements of section 409A 

and the effective date rules applicable to 

split-dollar life insurance arrangements 

under § 1.61–22(j). Commentators 

pointed out that the modifications 

necessary to meet the requirements of 

section 409A and these regulations may 

cause the arrangement to be treated as 

a new arrangement under § 1.61–22(j) 

and requested relief. The notice will 

also address this issue. 

N. Educational Benefits 

Commentators requested an exclusion 

from coverage under section 409A for 

promises to provide future taxable 

educational benefits to service 

providers. These benefits typically 

would be provided as an inducement to 

provide a period of services. 

Commentators expressed concern that 

the amount and timing of the payment 

of such benefits would be difficult to 

ascertain, because the amount and 

timing of the payments would depend 

upon the service provider’s decisions 

with respect to further education. The 

final regulations generally provide an 

exception from coverage under section 

409A for rights to educational benefits, 

where the benefits consist solely of 

educational assistance (as defined for 

purposes of section 127(c)) provided 

solely for the education of the service 

provider. 

IV. Definition of Plan 

A. Plan Aggregation Rules 

The proposed regulations generally 

provided that all amounts deferred with 

respect to a service provider under all 

plans of a service recipient falling 

within a particular category would be 

treated as deferred under a single plan. 

The enumerated categories included 

amounts deferred under account 

balance plans, amounts deferred under 

nonaccount balance plans, amounts 

deferred under separation pay plans 

providing payments due solely to an 

involuntary termination or participation 

in a window program, and amounts 

deferred under any other plan. The final 

regulations adopt these provisions, 

subject to certain modifications 

described in this preamble. 

The final regulations provide that the 

bifurcation rules applicable to plans 

under § 31.3121(v)(2)–1(c)(1)(iii)(B), 

which are permissive for purposes of 

the application of section 3121(v)(2), 

must be applied for purposes of the plan 

aggregation rules under section 409A. 

Accordingly, a portion of a nonqualified 

deferred compensation plan is a 

separate account balance plan if that 

portion otherwise qualifies as an 

account balance plan and the amount 

payable to service providers under that 

portion is determined independently of 

the amount payable under the other 

portion of the plan. 

The final regulations also provide 

additional categories of plans for 

purposes of the aggregation rules. One 

category covers split-dollar life 

insurance arrangements. Another 

category is comprised of reimbursement 

plans, providing for the reimbursement 

of expenses incurred or the provision of 


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in-kind benefits (as defined in the 

regulations), to the extent the right to 

such benefits or reimbursements, 

separately or in the aggregate, does not 

constitute a substantial portion of 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. Stock rights 

that constitute nonqualified deferred 

compensation for purposes of section 

409A also comprise a separate category. 

The final regulations further provide 

for account balance plans to be 

subdivided into a category for elective 

plans and a category for nonelective 

plans. Plans will only be subdivided in 

this manner to the extent the amounts 

deferred under an elective deferral 

arrangement (and earnings on such 

amounts) may be separately identified. 

For this purpose, a right to a match on 

an elective deferral will not be treated 

as an elective deferral arrangement. 

In an additional category, any 

amounts deferred under a foreign plan 

may be treated as deferred under a 

separate plan from any amounts 

deferred under a domestic plan, 

provided that the deferrals under the 

plan are deferrals of amounts that would 

be treated as modified foreign earned 

income (meaning foreign earned income 

as defined under section 911(b)(1) 

without regard to section 

911(b)(1)(B)(iv) and without regard to 

the requirement that the income be 

attributable to services performed 

during the period described in section 

911(d)(1)(A) or (B)) if paid to the service 

provider at the time the amount is first 

deferred, and provided further that the 

foreign plan is not substantially 

identical to a domestic plan in which 

the service provider participates. For 

this purpose, a foreign plan is a plan 

that the service recipient provides 

primarily to nonresident aliens or 

resident aliens classified as resident 

aliens solely under section 

7701(b)(1)(A)(ii) (and not section 

7701(b)(1)(A)(i)). 

B. Written Plan Requirement 

Commentators requested clarification 

and simplification of the provisions 

required to be included in writing in 

plan documents to comply with section 

409A. As a general rule, the final 

regulations provide that to satisfy the 

requirement that a plan be in writing, 

the document or documents constituting 

the plan must specify, at the time an 

amount is deferred, the amount to 

which the service provider has a right 

to be paid (or, in the case of an amount 

determinable under an objective, 

nondiscretionary formula, the terms of 

such formula), and the payment 

schedule or payment triggering events 

that will result in a payment of the 

amount. 

A plan must provide for the sixmonth delay requirement applicable to 

payments to specified employees upon 

a separation from service no later than 

the time the provision may become 

applicable to a separation from service 

of the specified employee. Accordingly, 

the plan must contain the provision by 

the time at which the employee 

becomes a specified employee (either 

because the stock of a component of the 

service recipient becomes publicly 

traded, or because the specified 

employee effective date has been 

reached for a list of specified employees 

that includes the employee). A 

provision applicable to a plan 

sponsored by a service recipient or a 

plan in which a specified employee 

participates is effective with respect to 

a specified employee only to the extent 

the provision is binding on the 

employee. 

With respect to a deferral election, 

whether an initial or subsequent 

deferral election, the plan must specify 

no later than the time by which that 

election is required to be irrevocable the 

conditions under which that election 

may be made. With respect to permitted 

accelerations of a payment, the plan 

need not specify the conditions under 

which the accelerated payment will be 

made except as explicitly required in 

these regulations. However, the taxpayer 

must demonstrate that the acceleration 

of the payment complies with the 

requirements of section 409A and these 

regulations. 

Commentators also requested 

clarification regarding whether the 

requirement that a plan be in writing 

also means that the plan must be 

contained in a single document. For 

purposes of this rule, the plan consists 

of all documents that together define the 

service provider’s rights to the 

compensation. Accordingly, the terms of 

a plan document may be contained in 

more than one document including, for 

example, a deferral election document. 

Commentators asked whether a 

savings clause would be sufficient to 

ensure compliance with section 409A, 

where the savings clause provides that 

each provision of the plan will be 

interpreted to be consistent with the 

requirements of section 409A and that 

any provision of the plan that does not 

satisfy such requirements will be of no 

force or effect. The final regulations 

provide that for purposes of determining 

the terms of a plan, general provisions 

of the plan that purport to nullify 

noncompliant plan terms, or to supply 

required specific plan terms, are 

disregarded. Accordingly, if a plan 

contains terms that do not meet the 

requirements of section 409A and these 

regulations, or fails to contain a plan 

term necessary to meet the requirements 

of section 409A and these regulations, 

the plan will violate the requirements of 

section 409A and these regulations 

regardless of whether the plan contains 

such a savings clause. 

Several commentators requested that 

the Treasury Department and the IRS 

publish model amendments. Due to the 

complex and varied universe of deferred 

compensation plans, the Treasury 

Department and the IRS do not believe 

that it is feasible to publish model 

amendments at this time. 

V. Definition of Substantial Risk of 

Forfeiture 

A. In General 

The final regulations generally adopt 

the definition of substantial risk of 

forfeiture set forth in the proposed 

regulations. Several commentators 

requested that the definition of 

substantial risk of forfeiture be the same 

as the definition of substantial risk of 

forfeiture in § 1.83–3(c). However, the 

definition of substantial risk of 

forfeiture for purposes of compensatory 

transfers of property under section 83 

reflects different policy concerns from 

those involved in section 409A, and 

there are also practical differences 

between transfers of restricted property 

and promises to pay deferred 

compensation. This is reflected in the 

provisions of section 409A(e)(5), 

directing the Secretary of the Treasury 

Department to issue regulations 

disregarding a substantial risk of 

forfeiture in cases where necessary to 

carry out the purposes of section 409A. 

Accordingly, the final regulations do not 

adopt this suggestion. 

A right to an amount deferred may be 

subject to the satisfaction of two or more 

different conditions that each 

independently would be a substantial 

risk of forfeiture. In that case, the 

substantial risk of forfeiture generally 

would continue until all of such 

conditions had been met. Alternatively, 

a right to an amount deferred may be 

subject to the satisfaction of any of two 

or more different conditions that each 

independently would constitute a 

substantial risk of forfeiture. In that 

case, the substantial risk of forfeiture 

generally would lapse as soon as one of 

the conditions had been met. 

The final regulations explicitly 

provide that a payment conditioned on 

an involuntary separation from service 

without cause may be treated as subject 


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to a substantial risk of forfeiture if there 

is a substantial risk that the service 

provider will not be involuntarily 

separated from service without cause. 

Many of the comments relating to the 

definition of a substantial risk of 

forfeiture requested also that a benefit 

available only upon a separation from 

service for good reason be treated as 

subject to a substantial risk of forfeiture. 

Under the definition of an involuntary 

separation from service provided in the 

final regulations, the right to a payment 

upon a separation for service for good 

reason may, in certain circumstances, be 

treated as a right to a payment upon an 

involuntary separation from service. For 

a discussion of the definition of an 

involuntary separation from service, see 

section III.J.3 of this preamble. 

Commentators requested that a 

requirement that an employee sign a 

release of claims to receive a benefit be 

treated as a substantial risk of forfeiture. 

Generally, conditions under the 

discretionary control of the service 

provider (other than the decision 

whether or not to continue providing 

services) are not treated as creating a 

substantial risk of forfeiture. 

Accordingly, the final regulations do not 

adopt this suggestion. 

One commentator suggested that any 

right to a payment be treated as subject 

to a substantial risk of forfeiture until 

the amount of the payment is readily 

determinable, at least where the 

payment could be zero. The Treasury 

Department and the IRS do not believe 

that this standard is appropriate. 

B. Election Between Vested and 

Nonvested Rights 

The final regulations provide that an 

amount will not be considered subject 

to a substantial risk of forfeiture after 

the date or time at which the recipient 

otherwise could have elected to receive 

the amount of compensation, unless the 

present value of the amount purportedly 

subject to a substantial risk of forfeiture 

(disregarding, in calculating the present 

value, the risk of forfeiture) is materially 

greater than the present value of the 

vested amount the recipient otherwise 

could have elected to receive. For 

example, if a service provider can elect 

to receive, in lieu of a payment of 

current compensation, a bonus based 

upon a formula that would otherwise 

subject the bonus to a substantial risk of 

forfeiture, the bonus will be subject to 

a substantial risk of forfeiture for 

purposes of section 409A only if the 

present value of the amount of the 

bonus (disregarding the risk of 

forfeiture) is materially greater than the 

present value of the current 

compensation amount. 

Some commentators asked whether 

this exception addressed the extension 

of a substantial risk of forfeiture as part 

of the negotiated extension of an 

employment contract. Commentators 

argued that rights a service provider 

obtains under a new or extended 

employment contract could be viewed 

as a right to an amount materially 

greater than the amount the service 

provider otherwise could have received. 

The final regulations clarify that for 

purposes of this rule, compensation the 

service provider would receive for 

continuing to perform services 

regardless of whether the service 

provider elected to receive the vested 

payment is not taken into account for 

purposes of determining whether the 

present value of the right to the 

nonvested payment is materially greater. 

VI. Initial Deferral Election Rules 

A. In General 

The final regulations adopt the 

provisions contained in the proposed 

regulations relating to initial deferral 

elections, subject to the modifications 

described in this preamble. 

The proposed regulations generally 

provided that in a nonelective plan, a 

service recipient may designate the time 

and form of payment on or before the 

date the service provider obtains a 

legally binding right to the payment. 

Commentators requested clarification of 

how the service recipient’s discretion to 

designate a time and form of payment 

related to the requirement in the 

proposed regulations that a service 

provider’s deferral election be 

irrevocable by the applicable deadline. 

Specifically, commentators requested 

that a deferral election by a service 

provider be treated as irrevocable, even 

if during the period during which the 

service recipient could have set the time 

and form of payment (that is, through 

the date the service recipient grants the 

service provider a legally binding right 

to the payment), the service recipient 

retains the right to override the service 

provider’s deferral election and provide 

for deferral of a lesser or greater amount. 

The final regulations do not adopt this 

suggestion. If a service provider may 

make an initial deferral election, 

including an election as to the time and 

form of payment, the election must be 

irrevocable as of the date required under 

the rules governing such service 

provider elections. Accordingly, a plan 

may not provide for such an override, 

unless such override cannot occur after 

the deadline by which the service 

provider’s election must be effective. 

Many commentators requested a 

clarification of the rules with respect to 

a deferral of a discretionary bonus, 

where the legally binding right to the 

bonus does not arise until a year 

subsequent to the year in which services 

are performed. For example, an 

employer announces in 2010 that it will 

be awarding discretionary bonuses for 

services performed in 2011, and will 

decide which employees will receive 

bonuses and in what amounts at the 

beginning of 2012. Section 409A(a)(4) 

generally provides that compensation 

for services performed during a taxable 

year may be deferred at the service 

provider’s election only if the election 

to defer such compensation is made not 

later than the close of the taxable year 

preceding the year in which the services 

are rendered. Accordingly, even where 

the bonus is discretionary such that the 

legally binding right to the bonus does 

not arise until after the period of 

services for which the bonus is paid has 

begun, a service provider’s deferral 

election must occur before the year in 

which the period of services begins 

absent some other applicable exception 

(such as, for example, the deferral 

election rules related to performancebased compensation). The 

determination of the period of services 

for which compensation is earned is 

based on all the facts and 

circumstances, but may include periods 

of service before the date the service 

provider obtains a legally binding right 

to the compensation. Although not 

necessarily determinative, one of the 

factors taken into account in that 

determination is a designation by the 

service recipient of the period of 

services for which the compensation is 

earned. 

B. Nonelective Deferrals 

Commentators pointed out that under 

the proposed regulations, a service 

recipient might be required to designate 

a time and form of payment with respect 

to a nonelective deferral at an earlier 

date than the service provider would 

have to make such a designation if an 

election had been provided to the 

service provider. Commentators 

requested that the service recipient be 

provided the same flexibility as the 

service provider in such cases. The final 

regulations generally adopt this 

suggestion, so that if the service 

provider has no election as to the time 

and form of payment of an amount of 

deferred compensation, the service 

recipient may set the time and form of 

payment on any date on or before the 

later of the latest date the service 

provider would have been permitted 

under these regulations to elect such 

time and form of payment if an election 

had been provided to the service 


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provider, or the date the service 

recipient grants the legally binding right 

to the compensation. So, for example, 

where compensation is performancebased compensation, and the service 

recipient retains the discretion to 

establish the time and form of the 

payment, the plan generally could 

permit the service recipient to establish 

the time and form of the payment on or 

before the date six months before the 

end of the relevant performance period. 

C. Performance-Based Compensation 

The final regulations generally adopt 

the definition of performance-based 

compensation contained in the 

proposed regulations, subject to the 

modifications described in this 

preamble. The final regulations clarify 

that where a portion of an award would 

qualify as performance-based 

compensation if the portion were the 

sole amount available under the plan, 

that portion of the award will not fail to 

qualify as performance-based 

compensation merely because another 

portion of the award does not qualify as 

performance-based compensation, if the 

portion that would qualify as 

performance-based compensation is 

designated separately or otherwise 

separately identifiable under the terms 

of the plan and each portion is 

determined independently of the other. 

Commentators asked whether in order 

to use the deferral rules regarding 

performance-based compensation, a 

service provider must be required to 

perform services during the entire 

performance period, or from the date the 

performance criteria are set through the 

end of the performance period. 

Commentators argued that because a 

payment cannot be substantially certain 

to be made at the time of the deferral 

election under the deferral election 

rules applicable to performance-based 

compensation, a service provider’s 

ability to manipulate the timing of 

income inclusion under a performancebased compensation arrangement is 

limited. The final regulations require 

only that the service provider provide 

services from the later of the date the 

performance period starts or the date the 

performance criteria are established 

through the date the initial deferral 

election is made. 

Commentators suggested that a 

provision in a plan for automatic 

payment to occur upon death, disability, 

or a change in control event (as defined 

for purposes of section 409A) should 

not result in a failure of the arrangement 

to qualify as performance-based 

compensation. The final regulations 

adopt this suggestion, provided that 

where such an event occurs before a 

deferral election has been made, the 

right to the payment will no longer be 

treated as performance-based 

compensation so that a deferral election 

may not be effective unless made in 

accordance with another applicable 

deferral election rule. 

In response to comments, the 

requirement that a deferral election 

under the rule applicable to 

performance-based compensation be 

made before the compensation has 

become substantially certain to be paid 

has been modified, and now requires 

that the election be made before the 

amount is readily ascertainable. Where 

the right to a specified amount is subject 

to a performance requirement being met 

(for example, a right to a payment of 

$10,000 if a certain profit level is 

attained), the amount is treated as 

readily ascertainable when it is 

substantially certain that the 

performance requirement will be met. 

With respect to the right to an amount 

of compensation that varies based upon 

the level of performance, the payment, 

or any portion of the payment, is treated 

as readily ascertainable to the extent the 

amount or the payment is calculable 

and the performance requirement is 

substantially certain to be met. For this 

purpose, a right to a payment is 

bifurcated between the amount that is 

readily ascertainable and the amount 

that is not readily ascertainable. 

Accordingly, any minimum amount that 

is calculable and for which the 

performance requirement entitling the 

service provider to the payment is 

substantially certain to be met generally 

will be treated as readily ascertainable. 

For example, a service recipient 

agrees to pay $100 for every additional 

widget meeting certain quality 

requirements that is produced in a 

calendar year in excess of 100 widgets. 

At the end of the six months, 125 

widgets have been produced and no 

election to defer has been made. As of 

that date, the performance-based 

compensation with respect to which an 

election to defer can be made does not 

include the $2500 ((125–100) multiplied 

by $100) that is calculable and for 

which the performance requirement is 

substantially certain to be met. In 

addition, the performance-based 

compensation does not include any 

additional amount that the service 

provider is substantially certain to earn 

based on the number of additional 

widgets that the service provider is 

substantially certain to produce before 

the end of the year. However, the 

payment is bifurcated so that any 

additional amount that is not 

substantially certain to be paid may be 

treated as performance-based 

compensation such that an election to 

defer such compensation may be made. 

Commentators requested clarification 

of the circumstances under which 

compensation, the amount of which is 

determined by reference to the value of 

service recipient stock, may qualify as 

performance-based compensation. The 

fair market value of stock at any given 

time generally incorporates the market’s 

perception of the probability that the 

stock will increase or decrease in value. 

Accordingly, compensation payable for 

a service period that is equal to the 

value of a predetermined number of 

shares of stock, and is variable only to 

the extent that the value of such shares 

appreciates or depreciates, generally 

will not be performance-based 

compensation. However, if the right to 

such compensation is subject to a 

performance-based vesting requirement, 

such compensation may be 

performance-based compensation. Also, 

the attainment of a prescribed value for 

the service recipient (or a portion 

thereof), or a share of stock of the 

service recipient, may be used as a 

performance-based criterion, if it is a 

condition for receiving the 

compensation and the other 

requirements are met. 

D. Initial Eligibility 

Section 409A(a)(4)(B)(ii) provides that 

in the case of the first year in which a 

service provider becomes eligible to 

participate in the plan, an initial 

deferral election may be made within 30 

days after the date the service provider 

becomes eligible to participate in the 

plan, with respect to compensation for 

services to be performed subsequent to 

the election. The final regulations adopt 

the provisions implementing the initial 

eligibility deferral election rules set 

forth in the proposed regulations, 

subject to the following modifications. 

Many of the commentators on the 

initial eligibility deferral election rule 

expressed concerns about the 

application of the plan aggregation 

rules. The proposed regulations 

provided that the plan aggregation rules 

would apply in determining whether a 

service provider was newly eligible for 

a plan, so that if a service provider was 

already participating in an arrangement 

that is required to be aggregated with 

the arrangement for which the service 

provider is initially eligible, the service 

provider would not be able to take 

advantage of the initial eligibility 

deferral election rule. Some 

commentators requested that the plan 

aggregation rules not apply for this 

purpose. However, the Treasury 

Department and the IRS believe that 

such a rule would result in the potential 


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for the adoption of serial plans as a 

means to claim repeated initial 

eligibility and the ability thereby to 

make late deferral elections. In addition, 

such a rule would require difficult 

determinations of whether one plan was 

sufficiently dissimilar from another plan 

to qualify as a separate plan. 

Other commentators requested that 

the plan aggregation rules apply, but 

that plans allowing elections between 

current and deferred compensation, or 

the part of a plan allowing such 

elections, be treated separately from 

nonelective plans or nonelective 

benefits in each category. The final 

regulations generally adopt this rule 

through the modifications to the plan 

aggregation rules described in section 

IV.A of this preamble. 

Other comments focused on the 

application of the initial eligibility 

deferral election rule in the case of a 

rehire or a change in position within a 

service recipient. Commentators pointed 

out that under the standard in the 

proposed regulations, if an employee 

had not received a distribution after the 

initial termination of employment, or 

had transferred to a position not 

participating in the plan without 

receiving a distribution and then 

transferred back to a position 

participating in the plan, the rehired or 

returning employee would still retain 

the right to benefits under the plan and 

thus would not be able to use the initial 

eligibility deferral election rules. The 

final regulations provide that the initial 

eligibility deferral election rules are 

applicable to a service provider 

provided that the service provider has 

not been an active participant in the 

plan (applying the plan aggregation 

rules) for at least 24 months. For this 

purpose, a service provider is an active 

participant in the plan if, under the 

plan’s terms and without further 

amendment or action by the plan 

sponsor, the service provider is eligible 

to accrue benefits under the plan (even 

if the service provider has elected not to 

participate in the plan), other than 

earnings on amounts previously 

deferred. 

Commentators requested relief with 

respect to the timing rules for initial 

elections establishing the time and 

schedule of payments under nonelective 

excess benefit plans. Commentators 

noted that under such plans, a service 

provider often automatically becomes a 

participant when the service provider’s 

benefits under the qualified plan 

become limited under the rules 

governing qualified plans. Because 

determining whether a service provider 

is a participant requires calculations, 

commentators observed that both the 

service provider and the service 

recipient may be unaware that the 

service provider has become a 

participant in the plan for some time 

after the service provider actually first 

becomes eligible. The final regulations 

generally provide that with respect to a 

nonelective excess benefit plan, a 

service provider is treated as initially 

eligible to participate in the plan as of 

the first day of the service provider’s 

taxable year immediately following the 

first year the service provider accrues a 

benefit under such plan, so that an 

initial deferral election with respect to 

the time and form of payment may be 

effective for benefits accrued under the 

plan based on services performed 

during the taxable year immediately 

preceding the year in which the election 

is made. This rule may only be used 

once with respect to a service provider’s 

participation in a plan. 

E. Initial Deferral Elections With 

Respect to Certain Forfeitable Rights 

The proposed regulations provided a 

rule for initial deferral elections with 

respect to certain forfeitable rights, 

generally intended to address ad hoc 

awards. Under the rule in the proposed 

regulations, if a legally binding right to 

a payment in a subsequent year is 

subject to a forfeiture condition 

requiring the service provider’s 

continued services for a period of at 

least 12 months from the date the 

service provider obtains the legally 

binding right, an election to defer such 

compensation may be made on or before 

the 30th day after the service provider 

obtains the legally binding right to the 

compensation, provided that the 

election is made at least 12 months in 

advance of the earliest date at which the 

forfeiture condition could lapse. The 

final regulations retain this rule, subject 

to the modifications described in this 

preamble. 

Commentators suggested that the 

requirement of at least a 12-month 

service period following the deferral 

election during which the right could be 

forfeited due to a separation from 

service be shortened to 11 months, 

because the combination of the 30-day 

election period plus the 12-month 

service period requirement generally 

resulted in a requirement of at least a 

13-month performance period. The 

requirement of a 12-month service 

period after an election is made ensures 

that the election occurs while at least an 

entire year (12 months) of services is 

still required. This conforms in many 

respects to the general rule that the 

deferral election must be made in the 

year before the year in which the 

services are performed. Any shorter 

period would permit service providers 

to make deferral elections in the same 

taxable year in which all of the services 

are performed. The Treasury 

Department and the IRS do not believe 

that such a rule is consistent with the 

legislative intent. 

The final regulations also provide that 

this rule is available even if the right to 

the compensation may vest earlier than 

12 months following the election due to 

the service provider’s death or 

disability, or due to a change in control 

event (as defined for purposes of section 

409A) with respect to the service 

recipient. However, if death, disability, 

or a change in control event occurs and 

the condition lapses before the end of 

such 12-month period, a deferral 

election may be given effect only if the 

deferral election is permitted under the 

regulations without regard to this rule. 

F. Initial Deferral Election With Respect 

to Fiscal Year Compensation 

The final regulations retain the initial 

deferral election rule with respect to 

fiscal year compensation that was in the 

proposed regulations. The final 

regulations clarify that the rule with 

respect to the deferral of fiscal year 

compensation is based upon the service 

recipient’s taxable year, regardless of 

whether the service recipient’s taxable 

year is the calendar year or some other 

period. Accordingly, where a service 

recipient with a calendar year taxable 

year is providing fiscal year 

compensation to a service provider 

based upon a calendar year, a service 

provider with a non-calendar year 

taxable year generally could take 

advantage of the rule to defer such fiscal 

year compensation on or before the 

December 31 preceding the calendar 

year upon which the fiscal year 

compensation is based. 

G. Initial Deferral Elections With 

Respect to Commissions 

The final regulations continue to 

provide a special deferral election rule 

with respect to commission payments. 

These rules are intended to address 

concerns that, for many commission 

arrangements, it is difficult to determine 

when the services related to a particular 

commission payment began, so that it is 

difficult to apply the general rule that 

requires that a deferral election be made 

before the year in which any services 

are performed. This rule is not intended 

to address whether, absent such a 

deferral election, a particular 

commission arrangement would result 

in deferred compensation. Whether a 

commission arrangement otherwise 

provides for deferred compensation 

must be determined through the 


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application of the general rules defining 

deferred compensation. However, where 

a commission arrangement requires that 

the service provider be providing 

services at the time of the payment to be 

entitled to the payment, the commission 

is paid in the normal course, and 

neither the service provider nor the 

service recipient has a right to specify 

a payment date, the arrangement 

generally will not provide for the 

deferral of compensation. 

The final regulations generally adopt 

the deferral election rule set forth in the 

proposed regulations treating the 

services related to a commission 

payment as performed in the year in 

which the customer remits payment to 

the service recipient. For this purpose, 

the proposed regulations provided that 

commissions include only 

compensation contingent upon the 

service recipient receiving payment 

from an unrelated customer for the 

product or services provided. 

Commentators asked that this rule be 

extended to cover arrangements under 

which the service recipient paid the 

commission based upon consummation 

of a transaction, regardless of whether 

the customer paid the service recipient 

for the service or good purchased from 

the service recipient. For example, 

commentators stated that in some 

industries the service recipient pays a 

salesperson commissions based on the 

amount of sales recorded, even though 

the customer is not obligated to pay the 

service recipient until a later date. The 

final regulations generally adopt this 

suggestion by permitting the taxable 

year in which the sale occurs to be 

substituted for the year in which the 

customer remits payment. However, to 

avoid manipulation of the deferral 

election timing rules, the taxable year of 

the sale may be used only if it is applied 

consistently to all similarly situated 

service providers. 

Commentators also asked that this 

rule be extended to commissions earned 

due to the increase in value, or 

maintenance of overall value, of a pool 

of assets or accounts. In response, the 

final regulations provide that, for 

purposes of the initial deferral election 

rules, the services with respect to 

investment commission compensation 

are deemed to be performed over the 12 

months immediately preceding the date 

as of which the overall value of the 

assets or asset accounts is determined 

for purposes of the calculation of the 

investment commission compensation. 

For this purpose, investment 

commission compensation means 

compensation earned by a service 

provider if a substantial portion of the 

services provided by such service 

provider to a service recipient consists 

of sales of financial products or the 

provision of other direct customer 

services to an unrelated customer with 

respect to customer assets or customer 

asset accounts. For this purpose, 

amounts will only be treated as 

investment commission compensation if 

the customer retains the right to 

terminate the customer relationship and 

transfer or withdraw the assets or asset 

accounts without undue delay (which 

may be subject to a reasonable notice 

period), the compensation paid by the 

service recipient to the service provider 

consists of a portion of the value of the 

overall assets or asset account balance, 

an amount substantially all of which is 

calculated by reference to the increase 

in the value of the overall assets or 

account balance during a specified 

period, or both, and the value of the 

overall assets or account balance and 

investment commission compensation 

is determined at least annually. 

Commentators also requested that the 

exception for commissions be expanded 

to address arrangements involving 

customers related to either the service 

provider or the service recipient. The 

Treasury Department and the IRS are 

concerned that where arrangements 

involve related parties, there is the 

potential for manipulation of the timing 

of the payment and the commission, but 

also understand that many of such 

arrangements may not involve abuse. 

Therefore, the final regulations provide 

that the special rules with respect to 

commissions apply to arrangements 

involving a customer related to the 

service provider or the service recipient 

provided that substantial sales or 

substantial services occur between the 

service recipient and a significant 

number of unrelated customers, and the 

sales or service arrangement and the 

commission arrangement with respect to 

a customer related to either the service 

recipient or the service provider are 

bona fide and arise in the ordinary 

course of business, and both the terms 

and practices are substantially the same 

as the terms and practices applicable to 

customers to whom the service provider 

and service recipient are not related, 

and to whom, either individually or in 

the aggregate, the service recipient has 

made substantial sales or provided 

substantial services. 

H. Involuntary and Voluntary 

Separations From Service 

The final regulations provide that 

with respect to separation pay paid 

upon an actual involuntary separation 

from service, where the service provider 

had no prior right to such separation 

pay, and where the separation pay is the 

subject of bona fide, arm’s length 

negotiations, the initial deferral election 

may be made at any time before the 

service provider obtains a legally 

binding right to the payment. The final 

regulations expand this rule to include 

voluntary separations from service as 

well as involuntary separations, as long 

as all of the other conditions in the 

previous sentence are met. The 

exception addresses both a choice 

between a current and a deferred 

payment, and the establishment of the 

time and form of payment of deferred 

compensation. 

The exception is intended to address 

legally binding rights to deferred 

compensation arising as part of the 

process of separating from service and 

not based upon previously existing 

legally binding rights. The exception is 

intended to alleviate concern that where 

such rights are expressed or calculated 

based on prior compensation or service, 

any election by the service provider as 

to the timing of the payment during the 

negotiation process could be viewed as 

a late initial deferral election made 

during or after the year in which the 

services were performed, and to avoid 

the potential for the plan aggregation 

rules to eliminate the ability to make an 

initial eligibility deferral election. The 

Treasury Department and the IRS have 

become aware that certain taxpayers 

have attempted to apply this provision 

to existing deferred compensation plans, 

believing that the exception allows new 

elections provided that the separation 

pay was the subject of bona fide 

negotiations. This application is 

inconsistent with the explicit provision 

of the proposed regulations and these 

final regulations. The provision does not 

address preexisting legally binding 

rights to deferred compensation, 

including legally binding rights that are 

subject to a substantial risk of forfeiture. 

Any change in the time and form of 

payments under those arrangements 

would be required to meet the rules 

governing subsequent deferral elections 

and accelerated payments (including 

any applicable relief provided during 

the transition period). For a discussion 

of the treatment of benefits forfeitable 

upon the separation from service, see 

section III.J.1 of this preamble. 

I. Elections To Annualize Recurring 

Part-Year Compensation 

Commentators asked how the deferral 

election rules would apply to an 

election by certain employees providing 

services over less than a 12-month 

period to receive payments for services 

on an annualized basis. For example, 

teachers performing services during a 

school year running from September of 


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one year through June of the next year 

often are provided an election to receive 

the compensation on an annualized 

basis over 12 months instead of during 

only the school year. This raises issues 

under the general initial deferral 

election rules under section 409A 

because the teacher is permitted to elect 

after the beginning of the calendar year 

to defer some of the compensation that 

would be paid in September through 

December of that year to a period in the 

subsequent year. 

The final regulations provide that 

with respect to recurring part-year 

compensation, an election to defer all or 

a portion of the compensation to be 

earned during a particular period of 

service may be made at any time before 

the period of service begins, provided 

that no amounts are deferred under the 

election to a date after the last day of the 

13th month following the first day of the 

performance period. For this purpose, 

recurring part-year compensation is 

defined as compensation paid for 

services rendered in a capacity that the 

service recipient reasonably anticipates 

will continue in subsequent years on 

similar terms and conditions, and will 

require services to be provided over 

successive service periods of less than 

12 months, each of which begins in one 

taxable year of the service provider and 

ends in the next such taxable year. For 

example, a teacher earning 

compensation from September 15 of one 

year through June 30 of the subsequent 

year could elect to defer compensation 

earned during such period on any date 

on or before September 15 of the first 

year, provided that no amount deferred 

in accordance with this rule is deferred 

beyond October 31 of the following 

year. This exception may be applied to 

a particular amount of compensation 

only once, so that an amount deferred 

under this exception may not be 

deferred a second time through 

treatment of the amount as earned in a 

subsequent service period. 

J. USERRA 

The final regulations provide that the 

initial deferral election rules are deemed 

satisfied to the extent that a deferral 

election provided to a service provider 

is necessary to satisfy the requirements 

of the Uniformed Services Employment 

and Reemployment Rights Act of 1994, 

as amended, 38 U.S.C. 4301–4334. 

Similar relief has been provided with 

respect to changes in the time and form 

of payment and accelerations of 

payments. 

VII. Time and Form of Payment 

A. In General 

The final regulations clarify that 

except as explicitly provided otherwise, 

a single time and form of payment must 

be designated with respect to each 

payment that is payable upon a payment 

event. For example, a plan must 

designate how an amount will be paid 

upon a change in control event, and 

generally cannot provide one time and 

form of payment upon a particular type 

of change in control event, and another 

time and form of payment upon another 

type of change in control event. The 

final regulations retain the rule, 

however, that permits a plan to provide 

for a different time and form of 

payment, depending upon whether the 

permissible payment event occurs 

before or after a specified date. In 

addition, the final regulations also 

provide for a limited ability to designate 

different times and forms of payment 

based upon the conditions under which 

a service provider’s separation from 

service occurs. See section VII.C.5. of 

this preamble for a discussion of 

payments upon a separation from 

service. 

The proposed regulations provide that 

for purposes of applying the payment 

rules, a payment will be treated as made 

on a fixed date or on a fixed schedule 

if the payment or payments are made by 

the end of the calendar year in which a 

specified fixed payment date, or due 

date of a payment under a fixed 

schedule, occurs or, if later, the 15th 

day of the third month following such 

fixed date or due date. The final 

regulations clarify that the same 

flexibility applies to making a payment 

on account of a payment event. So, for 

example, where a payment is scheduled 

to be made upon the death of a service 

provider whose taxable year is the 

calendar year, the payment is timely if 

made on or before the later of December 

31 of the calendar year in which the 

death occurs, or the 15th day of the 

third month following the date of death. 

If the service provider’s taxable year is 

not the calendar year, the final 

regulations specify that the service 

provider’s taxable year is used for 

purposes of this rule. 

Commentators also requested that 

where a payment is scheduled to be 

made on a fixed date, a service recipient 

be permitted to pay at any preceding 

date within the same calendar year. 

Commentators argued that if the 

regulations permitted a payment to be 

made later within the same calendar 

year because the amount would be 

reflected on the same income tax return 

in the case of an individual service 

provider, then the same rationale should 

permit payments to be made earlier in 

the same calendar year. Because the 

adoption of this provision would 

conflict with the administration of the 

rules governing subsequent deferrals, 

the final regulations do not adopt this 

suggestion. 

The subsequent deferral rules require 

that any election to extend the deferral 

period must not be effective for at least 

one year after the date the payment is 

due. If a payment due on a specified 

date during a calendar year could 

always be made on January 1 or any 

subsequent date during the calendar 

year, then the one-year waiting period 

would have to begin to run on the 

previous January 1, regardless of the 

actual payment date the plan specified. 

For example, if a plan specified 

December 31 as the payment date, but 

the payment could be made on January 

1, then any subsequent deferral election 

would need to be made on or before 

January 1 of the preceding calendar 

year, making the deadline for a 

subsequent deferral election almost two 

years before the actual specified 

payment date. Such a rule would 

unduly burden service providers who 

cannot actually receive a payment 

before the date specified in the plan. 

However, to lower the potential for 

unintentional violations, the final 

regulations provide that a payment will 

be deemed made at the scheduled time 

of payment if made not earlier than 30 

days before the scheduled date, 

provided that the service provider is not 

permitted, directly or indirectly, to 

designate the taxable year of the 

payment. 

In addition, the final regulations 

continue to provide that a plan may 

designate an entire taxable year of the 

service provider, rather than a specific 

date, as the specified date of payment. 

If a plan provides only for the taxable 

year of payment, the payment may be 

made at any time during such year. For 

purposes of the subsequent deferral 

rules, the payment will be treated as 

scheduled to be paid on the first day of 

the service provider’s taxable year. 

Commentators also requested 

clarification of the treatment of 

deadlines for payment, where the plan 

does not designate a specific payment 

date or taxable year of the service 

provider. For example, commentators 

asked whether a provision requiring 

payment as soon as administratively 

feasible but in no event later than the 

15th day of the third month following 

the end of the year would be treated as 

having a fixed date of payment. The 

final regulations provide that such a 

provision will be a specified payment 


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date only if the period during which 

such payment may be made is restricted 

either to a specified taxable year of the 

service provider or a period of not more 

than 90 days and the service provider is 

not provided an election as to the 

taxable year of the payment. If a specific 

payment date is not established, the first 

possible date on which a payment could 

be made under the plan is the specified 

payment date for purposes of the rules 

relating to subsequent deferral elections. 

For example, a payment scheduled to be 

made at any time on or after January 1, 

2008, and on or before July 1, 2008, to 

a service provider whose taxable year is 

the calendar year will be deemed to 

have a fixed payment date. For purposes 

of the subsequent deferral rules, January 

1, 2008, is the specified payment date. 

By contrast, a payment scheduled to 

be made to such a service provider at 

any time on or before July 1, 2008, 

would not be deemed to have a fixed 

payment date, because the payment 

could be made before January 1, 2008. 

In addition, a payment scheduled to be 

made to a service provider, for example, 

within 180 days of a separation from 

service generally will not provide for a 

specified time and form of payment 

under the final regulations, because it 

specifies neither the taxable year of the 

service provider in which the payment 

must be made following the separation 

from service, nor a period of 90 days or 

less following the separation from 

service in which the payment must be 

made. Because such a payment schedule 

would not provide an objective payment 

date based upon the separation from 

service event, the payment also would 

not be eligible for the relief provided for 

payments made by the later of the end 

of the taxable year of the service 

provider or the 15th day of the third 

month following the specified payment 

date. However, a plan provision 

providing that the payment will be 

made within 90 days of a separation 

from service generally will be treated as 

a specified payment date, and for 

purposes of the subsequent deferral 

rules the date of the separation from 

service will be treated as the scheduled 

payment date. 

B. Specified Time or Fixed Schedule of 

Payments 

1. In General 

The final regulations generally adopt 

the rules defining a specified time or 

fixed schedule of payments, including 

the ability to designate a service 

provider’s taxable year as the year of 

payment rather than a specific date. For 

example, a plan provision providing for 

payment within the service provider’s 

taxable year that includes December 31, 

2008, would be treated as a fixed date 

of payment. 

2. Reimbursement and In-Kind Benefit 

Plans 

Many commentators requested 

additional guidance regarding ways in 

which rights to taxable reimbursements 

or in-kind benefits might be structured 

to meet the definition of a fixed 

schedule of payments. In response, the 

final regulations provide that a right to 

reimbursements or in-kind benefits will 

meet the requirement of a fixed time 

and form of payment if certain 

requirements are satisfied. For this 

purpose, a reimbursement plan must 

provide for the reimbursement of 

expenses incurred during an objectively 

prescribed period (including a period 

beginning or ending based upon a 

service provider’s death), where the 

amount of reimbursable expenses 

incurred or in-kind benefits available in 

one taxable year of the service provider 

cannot affect the amount of 

reimbursable expenses or in-kind 

benefits available in a different taxable 

year. In addition, the reimbursement 

payment must be made by no later than 

the end of the service provider’s taxable 

year following the taxable year in which 

the expense is incurred. Such 

reimbursement or in-kind benefit rights 

may not be subject to liquidation or 

exchange for another benefit. 

For example, a right to a 

reimbursement of membership fees 

incurred for each of three specified and 

consecutive calendar years by a former 

employee, where the former employee is 

entitled to reimbursement of the 

expenses incurred each year without 

regard to the expenses incurred in a 

different year, and where the former 

employee cannot exchange the right for 

cash or any other benefit, generally will 

be treated as providing for a fixed time 

and form of payment if the plan requires 

that the reimbursement payment be 

made by no later than the end of the 

calendar year following the year in 

which the expense is incurred. In 

contrast, a right to reimbursement of 

membership fees of up to $30,000 over 

three years would not meet the 

requirement of a fixed time and form of 

payment, because the extent to which 

the former employee incurred the 

expense in the first year would affect 

the amount available for reimbursement 

in a subsequent year. 

This rule applies similarly to the 

provision of in-kind benefits, such as a 

right to use a corporate vehicle or 

aircraft. The final regulations also 

provide a special rule for arrangements 

reimbursing medical expenses to permit 

certain aggregate limits on the benefits 

provided, such as lifetime maximums. 

3. Payment Schedules With Fixed or 

Formula Payment Limitations 

Commentators asked whether 

payment schedules with fixed or 

objective formula limitations on the 

amount that may be paid during any 

particular period would meet the 

requirement of a fixed schedule or time 

and form of payment. Where the fixed 

or formula limitation is established on 

or before the date the time and form of 

payment is otherwise required to be set, 

the fixed or formula limitation is based 

on a fixed or nondiscretionary, 

objectively determinable formula 

limitation on the amount that may be 

paid in a particular period where all the 

factors relevant to the determination of 

such limit are beyond the control of the 

service provider and not subject to any 

exercise of discretion by the service 

recipient, and the plan specifies the 

time and form of payment of any 

additional amount due in excess of the 

fixed or formula limitation amount, the 

schedule will be deemed to be a fixed 

schedule of payments because it is not 

subject to manipulation. However, a 

change in the limits or a change in the 

allocation method for the payment of 

the unpaid excess amounts that will be 

paid after the original due dates due to 

application of the limit may constitute 

a subsequent deferral election or the 

acceleration of a payment. Similarly, 

where the total amount payable under a 

plan with multiple participants is 

limited, the time and form of payment 

requirement may be met if the plan 

specifies, from the date the time and 

form of payment is otherwise required 

to be set, the following: (1) A fixed or 

nondiscretionary, objectively 

determinable limit on the amount that 

may be paid in a particular period such 

that none of the factors relevant to the 

determination of such limit is in the 

control of the service provider or subject 

to the exercise of any discretion by the 

service recipient; (2) where there is an 

overall limitation on the aggregate 

amount that may be paid to a group of 

service providers during a specified 

period, a nondiscretionary, objectively 

determinable method to allocate the 

payments that can be made in 

accordance with the limitation among 

the service providers participating in 

the plan over which neither the service 

recipient nor any service provider 

retains control or discretion; and (3) the 

time and form of payment of any 

amount that will be paid after its 

original due date because of the formula 

limitation. 


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For example, a plan may provide that 

all payments to all participants under 

the plan in a given year may not exceed 

$1 million, provided that the plan must 

provide an objective, nondiscretionary 

method of currently allocating the $1 

million of payments if the amounts 

otherwise payable exceed $1 million 

(such as proportionately to each 

participant based on the amount 

otherwise payable to such participant 

absent the limit), and specifies the time 

and form of payment of any amount not 

paid currently because of the limitation 

(such as at the earliest time possible 

without exceeding the applicable 

limitation for any subsequent year). 

However, a change in the limits or a 

change in the allocation method may 

constitute a subsequent deferral election 

or an acceleration of a payment. 

Commentators also asked whether the 

same analysis would apply where the 

limit on a payment is calculated 

pursuant to a formula related to 

business performance, such as a 

specified percentage of cash flow for the 

period. A payment schedule may be 

conditioned on a formula limitation if 

the formula limitation is specified at the 

time the schedule of payments is 

otherwise required to be set, the 

limitation is nondiscretionary and 

objectively determinable based on the 

business performance of the service 

recipient, and the service provider 

retains no control over the 

determination or application of the 

formula limitation. For this purpose, a 

formula limitation based on profits or 

other indicia of general business 

performance is not treated as 

discretionary or in the control of the 

service recipient. Thus, a plan providing 

that the maximum payment during a 

year will equal no more than a set 

percentage of the service recipient’s 

cash flow for the previous year generally 

would meet the requirement of a fixed 

time and form of payment. However, a 

change in the formula limitation may 

constitute a subsequent deferral election 

or an acceleration of a payment. For a 

discussion of schedules of payments 

based upon the timing of payments 

received by the service recipient, see 

section VII.B.6 of this preamble. 

4. Tax Gross-Up Payments 

Commentators requested clarification 

of how section 409A applies to a right 

to a tax gross-up payment that provides 

the service provider with the right to a 

payment of taxes otherwise payable by 

the service provider as well as any 

additional taxes resulting from the 

service recipient’s payment of the taxes. 

The final regulations provide that a right 

to a tax gross-up payment is a right to 

deferred compensation that satisfies the 

requirement of a fixed time and form of 

payment if the plan provides that the 

tax gross up payment will be made, and 

the payment is made, by the end of the 

service provider’s taxable year next 

following the service provider’s taxable 

year in which the related taxes are 

remitted to the taxing authority. 

In addition, the final regulations 

provide that a right to the 

reimbursement of expenses incurred 

due to a tax audit or litigation, whether 

Federal, state, local, or foreign, satisfies 

the requirement of a fixed time and form 

of payment if the right to the 

reimbursement provides that payment 

will be made, and the payment is made, 

by the later of the end of the service 

provider’s taxable year next following 

the year in which the taxes that are the 

subject of the audit or litigation are 

remitted to the taxing authority, or, if no 

taxes are to be remitted, the end of the 

service provider’s taxable year next 

following the year in which the audit or 

litigation is completed. Nothing in the 

provisions relating to tax gross-up 

payments modifies the application of 

section 409A to any underlying 

compensation arrangement that results 

in the taxes that are subject to the tax 

gross-up arrangement. 

5. Payment Schedules Based on 

Payments to the Service Recipient 

Commentators requested guidance on 

payment schedules contingent on the 

receipt of certain payments by the 

service recipient. For example, 

commentators requested clarification 

whether a plan requiring an annual 

payment equal to a percentage of certain 

accounts receivable collected during the 

prior 12-month period would qualify as 

a fixed time and form of payment. The 

ability to schedule payments based 

upon the time the service recipient 

receives a customer’s payment raises 

issues regarding the ability to, in effect, 

create an impermissible event-based 

payment through characterizing the 

payment as a schedule (for example, a 

payment ‘‘schedule’’ that pays an 

amount every year if a specified 

transaction occurs in that year actually 

pays based on whether and when the 

transaction occurs, which is not a 

permissible payment event under 

section 409A). In addition, these 

arrangements raise issues regarding the 

ability of the service recipient (or 

service provider) to control the timing of 

the payment of deferred compensation 

through an ability to influence the 

timing of the payment by the customer. 

Accordingly, the final regulations 

generally provide that a schedule based 

upon the timing of payments to the 

service recipient is not a fixed schedule 

of payments. However, the final 

regulations also provide certain 

parameters under which such a plan 

may qualify as having a fixed time and 

form of payment. First, if the service 

recipient is comprised of more than one 

entity, the payments must be due from 

a person that is not one of such entities 

(for example, not a payment due from a 

subsidiary corporation to a parent 

corporation). Second, the payments 

must stem from bona fide and routine 

transactions in the ordinary course of 

business of the service recipient, and 

the service provider must not at the time 

such payments are due retain effective 

control over the service recipient, the 

person from whom the payments to the 

service recipient are due, or the 

collection of the payments. Third, the 

payment schedule must provide for a 

nondiscretionary, objective method of 

identifying the customer payments to 

the service recipient from which the 

amount of the payment is determined, 

and a nondiscretionary, objective 

schedule under which payments of the 

nonqualified deferred compensation 

will be made (for example, a payment 

every March 1 of 10 percent of the 

accounts receivable collected during the 

previous calendar year). Finally, the 

sales to which the payment relates must 

be of a type that the service recipient is 

in the trade or business of making and 

makes frequently, and either all such 

sales must be taken into account or 

there must be a legitimate, nontax 

business purpose for limiting the sales 

taken into account. 

C. Separation From Service 

1. In General 

The final regulations generally adopt 

the provisions in the proposed 

regulations defining the circumstances 

under which a separation from service 

is deemed to occur, subject to the 

modifications described in this 

preamble. Some commentators 

requested that the parties to a 

nonqualified deferred compensation 

plan be permitted to define when a 

separation from service occurs, at least 

if they apply the definition consistently. 

The Treasury Department and IRS 

believe that a definition of separation 

from service that is objectively 

determinable, nondiscretionary and 

predictable, and not subject to 

negotiations between the parties is 

necessary to properly implement the 

legislative intent behind section 409A. 

The definitions of separation from 

service suggested by the commentators 

do not meet this standard. For example, 

a plan that defines separation from 


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service as the date a service provider is 

removed from a payroll would leave to 

the parties the discretion to determine a 

payment date by an action that may 

have little practical significance, 

especially when compared to the effect 

on the service provider’s deferred 

compensation amounts. The Treasury 

Department and the IRS continue to 

believe that the definition of separation 

from service should be based upon an 

objective determination of whether the 

service provider continues to provide 

significant services to the service 

recipient. 

2. Employees 

a. In General 

The proposed regulations provided 

that an employee separated from service 

with the employer if the employee died, 

retired, or otherwise had a termination 

of employment with the employer. 

Whether a termination of employment 

had occurred would be determined 

based on the facts and circumstances. 

The proposed regulations provided that 

where the facts and circumstances 

indicated that the employer and the 

employee did not intend for the 

employee to provide more than 

insignificant future services, the 

employee would be treated as having a 

separation from service. For this 

purpose, an employer and employee 

would not be presumed to have 

intended only insignificant services be 

provided if the employee continued 

providing services at a rate equal to at 

least 20 percent of the rate of the 

previous three years. Where an 

employee continued providing services 

in another capacity (for example, as an 

independent contractor), the employee 

would be deemed not to have a 

separation from service if the service 

provider continued providing services 

at a rate equal to at least 50 percent of 

the services provided during the 

previous three years. Different rules 

were provided for service providers who 

were not employees. 

Commentators criticized this standard 

in various respects. The proposed 

regulations applied one presumption 

where an employee continued providing 

services as an independent contractor, 

and another where an employee 

continued providing services as an 

employee. Commentators asked why the 

same presumptions did not apply 

regardless of whether the employee 

purports to continue service (or separate 

from service) as an employee or 

purports to continue service (or separate 

from service) as an independent 

contractor. Commentators also 

suggested that the presumptions should 

be based on the intent of the employer 

and employee at the time of the 

purported separation from service (or 

purported continuation of services), 

rather than the actual subsequent 

conduct. Commentators also argued that 

the employer and employee could be 

found to have violated section 409A 

based on subsequent actual conduct, 

even where the parties had a bona fide 

belief that a separation from service had 

or had not occurred, but circumstances 

changed. 

In response to these comments, the 

final regulations provide a simplified 

standard, applicable whether an 

employee continues to provide services 

as an employee or as an independent 

contractor. The general standard for 

determining whether the employee has 

terminated employment is based on 

whether the facts and circumstances 

indicate that the service recipient and 

employee reasonably anticipated either 

that no further services would be 

performed after a certain date or that the 

level of bona fide services the employee 

would perform after such date (whether 

as an employee or as an independent 

contractor) would permanently decrease 

to no more than 20 percent of the 

average level of bona fide services 

performed over the immediately 

preceding 36-month period (or the full 

period in which the employee provided 

services to the employer (whether as an 

employee or as an independent 

contractor) if the employee has been 

providing services for less than 36 

months). For this purpose, periods 

during which the employee is on an 

unpaid bona fide leave of absence are 

disregarded (including for purposes of 

determining the relevant 36-month 

period), and periods during which the 

employee is on a paid bona fide leave 

of absence are treated as periods during 

which the employee provided services 

at the level at which the employee 

would have been required to perform 

services to receive the compensation if 

not on a bona fide leave of absence. 

Facts and circumstances to be 

considered in determining whether the 

employee and employer reasonably 

anticipated that the service provider’s 

future services would be permanently 

reduced to less than 20 percent of the 

average level of bona fide service 

provided during the previous 36-month 

period include, but are not limited to, 

whether the employee continues to be 

treated as an employee for other 

purposes (such as continuation of salary 

and participation in employee benefit 

programs), whether similarly situated 

service providers have been treated 

consistently, and whether the employee 

is eligible to perform services for, and 

realistically available to perform 

services for, other employers in the 

same line of business. 

To assist in applying this standard, 

certain rebuttable presumptions are 

provided. An employee generally will 

be presumed to have separated from 

service where the level of bona fide 

services performed (whether as an 

employee or an independent contractor) 

changes to a level equal to 20 percent 

or less of the average level of services 

provided during the previous 36 months 

(whether as an employee or an 

independent contractor). An employee 

will be presumed not to have separated 

from service where the level of bona 

fide services rendered continues at a 

level that is 50 percent or more of the 

average level of services provided 

during the previous 36 months. No 

presumption applies to a change to a 

level of services between 20 percent and 

50 percent of the average level of 

services provided during the previous 

36 months. For purposes of the 

presumption, the entire period during 

which the employee has provided 

services to the employer is substituted 

for 36 months if the employee has been 

providing services to the employer for 

less than 36 months, and periods during 

which the employee is on a bona fide 

leave of absence are treated in the same 

manner as such periods are treated for 

the general rule. 

The presumptions are rebuttable, by 

demonstrating that the employer and 

the employee reasonably anticipated 

that as of a certain date the level of bona 

fide services would be reduced 

permanently to a level less than or equal 

to 20 percent of the average level of 

services provided during the 

immediately preceding 36-month period 

or full period in which the employee 

has provided services if the employee 

has been providing services to the 

employer for a period of less than 36 

months (or that the level of bona fide 

services would not be so reduced). For 

example, an employee may demonstrate 

that the service recipient and employee 

anticipated that the employee would 

cease providing services, but that 

(subsequent to the original cessation of 

services) business circumstances such 

as termination of the employee’s 

replacement caused the employee to 

return to employment. Although the 

employee’s return to employment may 

cause the employee to be presumed to 

have continued in employment because 

the rehired employee is providing 

services at a rate equal to the rate at 

which he was providing services before 

the termination of employment, the 

facts and circumstances in this case 


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would demonstrate that at the time the 

employee terminated employment, the 

employee and the service recipient 

reasonably anticipated that the 

employee would not provide any 

services in the future. 

Similarly, where the loss of a business 

client of the employer results in a 

permanent reduction in the level of 

bona fide services performed by the 

employee of more than 80 percent, so 

that the employee would be presumed 

to have separated from service, the 

taxpayer may rebut the presumption 

that a separation from service occurred 

by showing that the employer and 

employee reasonably anticipated that 

the level of services would not be so 

reduced. The separation from service 

would then be deemed to occur at the 

time that the employer and employee 

reasonably anticipated that such 

reduction would continue. 

Commentators requested additional 

flexibility to treat certain employees as 

having experienced a separation from 

service, even where the employee 

continues to provide services in a 

reduced capacity. This is often referred 

to as a phased retirement, in which an 

employee obtains retirement benefits 

despite continuing to provide services 

on a part-time or reduced basis. The 

Treasury Department and the IRS 

believe that providing flexibility to alter 

the definition of a separation from 

service after an amount has been 

deferred is inconsistent with the statute 

and legislative intent, and could be 

subject to manipulation. 

However, the final regulations permit 

certain flexibility for a plan to define a 

separation from service as including a 

change to a reduced level of bona fide 

services, if the definition is specified no 

later than the time and form of payment 

are elected or otherwise specified. 

Specifically, the final regulations 

provide that rather than treating a 

separation from service as requiring an 

anticipated permanent reduction in the 

level of bona fide services to 20 percent 

or less of the average level of bona fide 

services provided in the immediately 

preceding 36 months, a plan may treat 

another level of anticipated permanent 

reduction in the level of bona fide 

services as a separation from service, 

provided that the level of permanent 

reduction required must be set forth in 

the plan as a specific percentage, and 

the anticipated permanently reduced 

level of bona fide services must be 

greater than 20 percent but less than 50 

percent of the average level of bona fide 

services provided in the immediately 

preceding 36 months. The plan must 

specify the definition of separation from 

service on or before the date at which 

a separation from service is designated 

as a time of payment of an amount 

deferred, and once designated, any 

change to the definition of separation 

from service with respect to such 

amount deferred will be subject to the 

rules regarding subsequent deferrals and 

the acceleration of payments. 

For example, on or before the time at 

which a plan must designate a time and 

form of payment for a deferred amount, 

the plan may specify that a separation 

from service will be deemed to occur at 

any time that the employee and 

employer reasonably anticipate that the 

bona fide level of services the employee 

will perform (whether as an employee 

or an independent contractor) will be 

permanently reduced to a level that is 

less than 50 percent of the average level 

of bona fide services the employee 

performed during the immediately 

preceding 36 months (or the entire 

period the employee has provided 

services if the employee has been 

providing services to the employer less 

than 36 months). 

b. Identification of the Service Recipient 

Commentators requested that the 

definition of the term service recipient 

be expanded for purposes of 

determining whether a separation from 

service has occurred. The final 

regulations generally adopt this 

suggestion, so that for purposes of 

determining whether a service provider 

has separated from service with an 

employer or other service recipient, the 

service recipient is defined as including 

all entities that would be treated as part 

of the group of entities comprising the 

service recipient under section 414(b) 

and (c) and the accompanying 

regulations, but substituting a 50 

percent ownership level for the 80 

percent ownership level in section 

414(b) and (c) and the accompanying 

regulations. A plan may specify that a 

higher or lower percentage ownership 

level will be used, provided that the 

ownership level may not be higher than 

80 percent or lower than 20 percent, and 

provided further that an ownership 

level of less than 50 percent may be 

used only where such use is based on 

legitimate business criteria. As 

discussed, the plan must specify the 

percentage on or before the date at 

which a separation from service is 

designated as a time of payment of the 

amount deferred, and where a plan 

changes the definition of separation 

from service with respect to amounts 

previously deferred, such a change will 

be subject to the rules governing 

changes to the time and form of 

payment, including the anti-acceleration 

provisions. 

Commentators also requested special 

treatment with respect to the 

identification of the service recipient in 

instances where an amount is deferred 

pursuant to a bona fide collective 

bargaining agreement covering service 

with multiple employers, and the 

employee may be expected to perform 

services covered by the bona fide 

collective bargaining agreement for a 

number of different employers. 

Specifically, commentators expressed 

concern that an employee not be treated 

as having separated from service when 

a particular period of service with an 

employer is completed, if the employee 

has made herself available to perform 

services covered by the bona fide 

collective bargaining agreement for 

another employer. The final regulations 

generally provide that where the 

amount is deferred pursuant to a plan 

provided under a bona fide collective 

bargaining agreement covering services 

with multiple employers, and where 

service providers may reasonably 

anticipate providing services for more 

than one of the participating employers, 

the plan may define a separation from 

service in a manner that treats the 

service provider as not having separated 

from service when the service provider 

stops performing services for one 

employer covered by the agreement and 

provides services for another employer 

covered by the agreement. The final 

regulations also provide that the plan 

may not treat a service provider as 

having separated from service during 

periods where the service provider is 

not providing services but has made 

herself available to perform services for 

a participating employer, provided that 

the definition requires that the service 

provider be deemed to have separated 

from service no later than the end of any 

12-month period in which the service 

provider has not provided services 

covered by the bona fide collective 

bargaining agreement to any employer. 

c. Bona Fide Leave 

Many of the comments with respect to 

the definition of separation from service 

for an employee concerned the 

treatment of bona fide leaves of absence. 

For purposes of determining whether a 

service provider has separated from 

service (and not for purposes of 

determining whether a vacation or sick 

leave plan is a bona fide vacation or sick 

leave plan), a bona fide leave of absence 

refers to a leave of absence where there 

is a reasonable expectation the service 

provider will return to service with the 

service recipient. The final regulations 

provide that an employment 

relationship is treated as continuing 

while the individual is on sick leave, or 


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other bona fide leave of absence, if the 

period of such leave does not exceed six 

months, or if longer, so long as the 

individual retains a right to 

reemployment with the service recipient 

under an applicable statute or by 

contract. For example, where a tenured 

professor takes a leave of absence, but 

the professor retains a right to 

reemployment with the university as 

part of the professor’s tenured status, 

the professor will not be deemed to have 

terminated from employment merely 

due to the leave of absence from the 

university. If the period of leave exceeds 

six months and the individual does not 

retain a right to reemployment under an 

applicable statute or by contract, the 

employment relationship is deemed to 

terminate on the first date immediately 

following such six-month period. 

However, the final regulations modify 

the provisions in the proposed 

regulations with respect to disability 

leave. With respect to disability leave, 

the employment relationship will be 

treated as continuing for a period of up 

to 29 months, unless otherwise 

terminated by the employer or the 

employee, regardless of whether the 

employee retains a contractual right to 

reemployment. For this purpose, 

disability leave refers to leave due to the 

employee’s inability to perform the 

duties of his or her position of 

employment or any substantially similar 

position of employment by reason of 

any medically determinable physical or 

mental impairment that can be expected 

to result in death or can be expected to 

last for a continuous period of not less 

than six months. 

d. Salary Continuation Programs and 

Terminal Leave 

Commentators requested that salary 

continuation programs be permitted to 

delay the occurrence of a separation 

from service, where an employee 

continues to receive salary and benefits 

and is otherwise treated as an employee, 

although not required to perform any 

further meaningful services. Some 

commentators also requested this 

treatment for terminal leave, or leave 

intended to bridge a service provider to 

a separation from service date that 

would permit continuation of benefits 

or accrual of additional benefits under, 

for example, a qualified plan. The 

Treasury Department and the IRS 

believe that these types of actions are 

subject to manipulation and should not 

delay the time when a service provider 

is treated as having separated from 

service for purposes of section 409A. 

Accordingly, the final regulations do not 

recognize extensions of leave or salary 

and benefits as a means of delaying the 

date of separation from service for 

purposes of section 409A. In addition, 

terminal leave with no intent to return 

generally would not be treated as bona 

fide leave for purposes of the rule for 

employees addressing bona fide leave. 

Commentators expressed concern that 

the service recipient may wish to 

continue providing certain employee 

benefits, including in-kind benefits and 

reimbursement plans, during a salary 

continuation or terminal leave period. 

With respect to the application of 

section 409A, such plans generally may 

be structured to avoid providing for the 

deferral of compensation, or to provide 

deferred compensation in compliance 

with the requirements of section 409A. 

See sections III.J.6 and VII.B.2 of this 

preamble. The definition of separation 

from service for purposes of section 

409A is not applicable for purposes of 

other Code provisions, such as those 

provisions governing qualified 

retirement plans or non-taxable benefits. 

e. Rehires and Suspensions of Benefits 

Commentators also requested that the 

regulations address rehires, and 

specifically whether payments of 

deferred compensation could be 

suspended during a subsequent period 

of employment or other service until a 

subsequent separation from service. 

Such a suspension generally would 

violate the rules governing changes in 

the time and form of payment because 

payments would be delayed in a manner 

that does not satisfy the rules applicable 

to subsequent deferral elections. Neither 

the statutory language of section 409A 

nor the legislative history indicates any 

intent to permit such additional 

flexibility. Moreover, the Treasury 

Department and the IRS believe that 

suspension of benefits rules would add 

significant complexity to the 

administration of the Code section. 

However, many of the desired results of 

a suspension of benefits provision often 

may be obtained through deferrals of 

future compensation after rehire. 

f. Mergers and Acquisitions 

Comments with respect to the 

application of the separation from 

service standard in the case of a merger 

or acquisition generally focused on two 

areas. First, commentators requested 

that the final regulations adopt 

permissive use of the rule generally 

referred to as the ‘‘same desk’’ rule, 

allowing the parties to an asset purchase 

agreement to decide whether employees 

of the selling corporation that continue 

in the same position with the purchaser 

of the assets will be treated as separating 

from service. The final regulations adopt 

a rule providing that where as part of a 

sale of assets by one service recipient 

(seller) to an unrelated service recipient 

(buyer), a service provider of the seller 

would otherwise experience a 

separation from service with the seller, 

the seller and the buyer may specify 

whether a service provider providing 

services to the seller immediately before 

the asset purchase transaction and 

providing services to the buyer after and 

in connection with the asset purchase 

transaction has experienced a separation 

from service, provided that the asset 

purchase transaction results from bona 

fide, arm’s length negotiations, all 

service providers providing services to 

the seller immediately before the asset 

purchase transaction and providing 

services to the buyer after and in 

connection with the asset purchase 

transaction are treated consistently 

(regardless of position at the seller) for 

purposes of applying the provisions of 

any nonqualified deferred compensation 

plan, and such treatment is specified no 

later than the closing date of the asset 

purchase transaction. For this purpose, 

a sale of assets refers to a transfer of 

substantial assets, such as a plant or 

division or substantially all of the assets 

of a trade or business. 

Second, commentators requested 

clarification whether a spin-off of a 

subsidiary could result in a separation 

from service of an employee of the 

subsidiary, where the nonqualified 

deferred compensation plan defines a 

separation from service as including any 

action resulting in the employee no 

longer being an employee of the 

controlled group of corporations 

including the parent corporation. 

Generally such a transaction would not 

result in a termination of employment 

for an employee of the subsidiary, 

because the employee is continuing 

employment with the same employer 

both before and after the transaction. 

However, the rules that provide a 

service recipient discretion to terminate 

and liquidate a plan following a change 

in control transaction afford taxpayers 

the flexibility to pay out their deferred 

compensation liabilities in particular 

circumstances. See section VIII.B of this 

preamble. 

3. Directors 

The final regulations provide 

generally that where a service provider 

provides services to a service recipient 

both as an employee and as an 

independent contractor, the service 

provider must separate from service 

both as an employee and as an 

independent contractor to be treated as 

having separated from service. But 

where a service provider provides 

services both as an employee and a 


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member of the board of directors of a 

corporate service recipient, the services 

provided as a director are not taken into 

account for purposes of determining 

whether the service provider has a 

separation from service as an employee 

for purposes of a nonqualified deferred 

compensation plan in which the service 

provider participates in his or her 

capacity as an employee that is not 

aggregated with any plan in which the 

service provider participates as a 

director. Accordingly, where an 

employee-director participates in a 

separate plan as an employee, his or her 

termination of services as an employee 

will constitute a separation from service 

for purposes of the employee plan, 

regardless of whether he or she 

continues providing services as a 

director (and vice versa). However, if a 

non-employee director is also providing 

additional services as an independent 

contractor, he or she cannot have a 

separation from service for purposes of 

section 409A until he or she has 

separated from service both as a director 

and as an independent contractor. 

4. Delay for Specified Employees 

Section 409A(a)(2)(B) provides that 

with respect to a specified employee, a 

payment of nonqualified deferred 

compensation on account of separation 

from service may not occur before the 

date that is six months after the date of 

separation from service (or, if earlier, 

the date of death of the employee). For 

this purpose, a specified employee is a 

key employee of a corporation any stock 

of which is publicly traded on an 

established securities market or 

otherwise. With respect to identifying 

specified employees, the final 

regulations generally adopt the 

provisions set forth in the proposed 

regulations, subject to the modifications 

and clarifications described in this 

preamble. 

a. Identification of Specified Employees 

Several commentators asked whether 

an employee may be subject to the sixmonth delay requirement if the service 

recipient stock is publicly traded only 

on a foreign exchange or is traded on a 

U.S. exchange only as American 

depositary receipts or American 

depositary shares (ADRs). The final 

regulations define an established 

securities market for purposes of the sixmonth delay rule by reference to the 

rules in § 1.897–1(m), which generally 

include foreign securities markets. 

Accordingly, the six-month delay may 

apply to an employee of a service 

recipient the stock of which is publicly 

traded solely on a foreign exchange, or 

is traded on a U.S. exchange only as 

ADRs. In the case of a service recipient 

comprised of multiple entities, this rule 

would apply if one of the entities had 

stock that was publicly traded on a 

foreign exchange. 

Some commentators requested that 

the final regulations provide that 

specified employees are limited to 

common law employees, and do not 

include other individuals. Section 

409A(a)(2)(B) defines a specified 

employee as a key employee as defined 

in section 416(i) (without regard to 

section 416(i)(5)). Accordingly, where 

an individual is treated as a key 

employee for purposes of section 416(i), 

that individual generally is a specified 

employee for purposes of section 409A. 

Commentators requested clarification 

of how the definition of compensation 

under section 415 applies for purposes 

of identifying the key employees that 

may ultimately be specified employees. 

The final regulations clarify that the 

general definition of compensation 

under § 1.415(c)–2(a), applied as if the 

service recipient were not using any safe 

harbor provided in § 1.415(c)–2(d), any 

of the special timing rules provided in 

§ 1.415(c)–2(e), or any of the special 

rules provided in § 1.415(c)–2(g), will be 

treated as the general definition of 

compensation for purposes of 

identifying specified employees. 

However, the final regulations also 

provide that a service recipient may use 

any available definition of 

compensation under section 415 and the 

accompanying regulations, including 

any available safe harbor and any 

available election under the timing rules 

or special rules, provided that the 

definition is applied consistently to all 

employees of the service recipient for 

purposes of identifying specified 

employees. A service recipient may 

elect to use such a definition of 

compensation regardless of whether 

another definition of compensation is 

being used for purposes of a qualified 

plan sponsored by the service recipient. 

However, once a list of specified 

employees has become effective, the 

service recipient cannot change the 

definition of compensation for purposes 

of identifying specified employees for 

the period with respect to which such 

list is effective. For a discussion of the 

methods for making an election 

regarding the definition of 

compensation, see section VII.C.4.e of 

this preamble. 

Commentators requested clarification 

of the treatment of the compensation of 

certain nonresident alien employees. As 

discussed in the preceding paragraph, 

for purposes of identifying key 

employees, the general definition of 

compensation under § 1.415(c)–2(a) 

applies. A service recipient may elect to 

apply the rule of § 1.415–2(g)(5)(ii) and 

not treat as compensation certain 

compensation excludible from an 

employee’s gross income on account of 

the location of the services or the 

identity of the employer that is not 

effectively connected with the conduct 

of a trade or business within the United 

States. If no such election is made, the 

provisions of § 1.415(c)–2(g)(5)(i) would 

apply, requiring the treatment as 

compensation of certain compensation 

excludible from an employee’s gross 

income due to the location of the 

services or the identity of the service 

recipient. 

b. Alternative Methods for Applying the 

Six-Month Delay Requirement 

Commentators expressed concern that 

an attempt to identify key employees 

could result in an underinclusive list. 

Rather than risk a violation, 

commentators suggested that service 

recipients be permitted to use an 

alternative method for determining 

employees subject to the six-month 

delay requirement, even where such an 

alternative method may result in an 

over-inclusive list. A nonqualified 

deferred compensation plan may 

provide that all payments upon 

separation from service will commence 

six months after the separation from 

service, regardless of whether the 

service provider is a specified 

employee. In addition, the final 

regulations provide that a plan may use 

an alternative method identifying the 

service providers whose distributions 

will be subject to a six-month delay, 

provided that the alternative method is 

reasonably designed to include all 

specified employees, the alternative 

method is an objectively determinable 

standard providing no direct or indirect 

election to any service provider 

regarding the application of the rule, 

and the alternative method results in no 

more than 200 service providers being 

identified in the class as of any date. 

Use of such an alternative method to 

delay a payment in accordance with the 

rules governing the delay of payments to 

a specified employee will not be treated 

as a change in the time and form of 

payment for purposes of the subsequent 

deferral rules even if the service 

provider is not a specified employee 

when the payment is delayed. However, 

if the list fails to include any individual 

who is a specified employee and that 

individual has a right to a payment of 

deferred compensation upon a 

separation from service without the 

required six-month delay, the plan 

providing such right to such individual 

will not be in compliance with section 


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409A. For a discussion of the method of 

initiating an alternative method 

designation, see section VII.C.4.e of this 

preamble. 

c. Specified Employee Effective Date 

Issues 

Under the proposed regulations, the 

employees identified as of an 

identification date would become 

specified employees effective as of the 

first day of the fourth month following 

the identification date. Commentators 

stated that service recipients who could 

compile the list of specified employees 

more quickly should be permitted to 

make the list effective at an earlier date. 

The final regulations provide that the 

first day of the fourth month will be the 

specified employee effective date if the 

service recipient does not specify 

another date. However, the final 

regulations permit a service recipient to 

specify a specified employee effective 

date following the specified employee 

identification date upon which the new 

list of specified employees will become 

effective, provided that the specified 

employee effective date may not be later 

than the first day of the fourth month 

following the specified employee 

identification date. For example, an 

employer that designates December 31 

as a specified employee identification 

date for purposes of identifying key 

employees for purposes of the sixmonth delay rule, may specify any 

subsequent date on or before the 

following April 1 as the first date of the 

12-month period during which such list 

of key employees will be treated as 

specified employees. To prevent 

manipulation, any change to the 

specified employee effective date may 

not become applicable until 12 months 

following the change in such specified 

employee effective date. 

The final regulations also clarify that 

the six-month delay requirement applies 

only where the service provider is a 

specified employee as of the date of 

separation from service, and does not 

become applicable if the service 

provider is not a specified employee as 

of the date of separation from service 

even if the service provider 

subsequently would have become a 

specified employee if the separation had 

not occurred. 

d. Corporate Transactions 

In response to comments, the final 

regulations significantly alter the 

proposed rules governing the 

identification of specified employees 

following a corporate transaction, such 

as a merger or spin-off. Commentators 

requested clarification of the 

determination of the next applicable 

specified employee identification date 

following the corporate transaction. In 

addition, commentators generally 

objected to any rule that resulted in the 

treatment of more than 50 employees as 

specified employees due to a corporate 

transaction (in addition to 1-percent and 

5-percent owners treated as specified 

employees). The final regulations 

generally permit service recipients to 

avoid this result, but also permit service 

recipients to simply combine the pretransaction separate lists of specified 

employees where it is determined that 

such treatment would be 

administratively less burdensome. 

Service recipients can determine 

whether to combine such lists on a caseby-case basis, if there are multiple 

transactions during the same year. 

With respect to mergers and 

acquisitions, the final regulations 

address combinations of two public 

corporations, and combinations of a 

public and a closely-held corporation. 

For purposes of the discussion of the 

rules regarding the treatment of the 

identification of specified employees 

following such a transaction, references 

to specified employees include 

specified employees determined under 

any permissible method that the entities 

participating in the transaction used 

immediately before the transaction. 

Where two public corporations merge 

and become one public corporation, or 

a public corporation becomes a 

subsidiary of another public 

corporation, the final regulations 

provide that the resulting service 

recipient’s next specified employee 

identification date and the first 

specified employee effective date 

following the transaction is the 

specified employee identification date 

and specified employee effective date 

that the acquiring service recipient 

would have been required to use absent 

the merger. For the period after the date 

of the transaction and before the next 

specified employee effective date, the 

specified employee list of the resulting 

service recipient consists of the 50 most 

highly compensated service providers 

appearing on the combined lists of the 

two service recipients’ specified 

employees in effect as of the date of the 

transaction, ranking such specified 

employees in order of the amount of 

compensation used to determine each 

specified employees’ status as a 

specified employee, plus any 1-percent 

and 5-percent owners not otherwise 

included who would be treated as 

specified employees. Alternatively, 

however, the resulting service recipient 

may use any other reasonable method to 

determine its specified employees 

immediately after the transaction, 

provided that such method is adopted 

not later than 90 days after the merger 

and applied prospectively from the date 

of adoption. For a discussion of the 

procedures for adopting such a method, 

see section VII.C.4.e of this preamble. 

Where a public corporation and a 

private corporation merge and become a 

public corporation, or where a private 

corporation becomes a subsidiary of a 

public corporation, the resulting service 

recipient’s next specified employee 

identification date and specified 

employee effective date following the 

transaction will be the specified 

employee identification date and 

specified employee effective date that 

the pre-transaction public corporation 

would have been required to use absent 

such transaction. For the time period 

after the transaction and before the next 

specified employee effective date, the 

specified employees of the pretransaction public service recipient 

immediately before the transaction will 

continue to be the specified employees 

of the resulting service recipient, and 

service providers of the pre-merger 

private service recipient will not 

become specified employees until the 

next specified employee effective date. 

Consequently, the nonqualified deferred 

compensation plans in which service 

providers of the formerly private service 

recipient participate will not be 

required to contain a plan term delaying 

a payment upon separation from service 

of such service providers, or to delay 

such a payment, until the next specified 

employee effective date. 

The final regulations also address 

spin-off transactions. Where as part of a 

corporate transaction, a public service 

recipient becomes two separate public 

service recipients, the final regulations 

provide that the next specified 

employee identification date and 

specified employee effective date of 

each of the post-transaction service 

recipients is the specified employee 

identification date and specified 

employee effective date that the pretransaction service recipient would have 

been required to use absent such 

transaction. For the period after the date 

of the transaction and before the next 

specified employee effective date, the 

specified employees of the pretransaction service recipient 

immediately before the transaction 

continue to be the specified employees 

of the post-transaction service 

recipients. 

The final regulations provide 

guidance on initial public offerings and 

other corporate transactions where all or 

part of a private service recipient 

becomes one or more public service 


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recipients. In that case, except as 

discussed in this paragraph, each posttransaction public service recipient will 

have a December 31 specified employee 

identification date and an April 1 

specified employee date. Alternatively, 

the new public service recipient may 

establish a different specified employee 

identification date and specified 

employee effective date, provided that 

the specified employee identification 

date and specified employee effective 

date must be established on or before 

the date of the initial public offering or 

other corporate transaction. 

For the period between the date of the 

initial public offering or other corporate 

transaction and the first specified 

employee effective date, the list of 

specified employees of each posttransaction public service recipient is 

comprised of the service providers that 

at the time of the corporate transaction 

or public offering would have been 

classified as specified employees of the 

former private service recipient, had 

such service recipient adopted the same 

specified employee identification date 

and specified employee effective date as 

selected by such post-transaction public 

service recipient, and had such former 

private service recipient been a public 

service recipient as of such specified 

employee identification date. 

e. Alternatives for the Identification of 

Specified Employees 

As discussed in this preamble, the 

final regulations provide certain default 

definitions for purposes of identifying 

specified employees, where the service 

recipient has not adopted another 

definition. These default rules include 

the following provisions: the specified 

employee identification date is 

December 31; the specified employee 

effective date is April 1; the general 

definition of compensation under 

§ 1.415(c)–2(a) will apply (without 

giving effect to any use of the special 

timing rules under § 1.415(c)–2(e) or of 

a safe harbor definition of compensation 

under § 1.415(c)–2(d)); and certain rules 

regarding the identification of specified 

employees after a merger of public 

service recipients or an initial public 

offering or other transaction involving a 

formerly nonpublic service recipient 

becoming a public service recipient will 

apply. 

Alternatively, the final regulations 

also provide that the service recipient 

may use other permissible rules and 

definitions, provided that such 

alternatives become effective only in 

accordance with the rules and deadlines 

set forth in the final regulations. In 

addition, the final regulations permit a 

service recipient to use an alternative 

method for purposes of identifying 

specified employees, with certain 

limitations, and to make an election 

under § 1.415(c)–2(g)(5)(i) regarding the 

treatment as compensation of certain 

compensation excludible from an 

employee’s gross income due to the 

location of the services or the identity 

of the employer. For purposes of these 

rules, a service recipient may use one of 

these alternatives when all necessary 

corporate action has been taken to make 

such alternative binding for purposes of 

all affected deferred compensation plans 

in which service providers of the service 

recipient participate. Accordingly, as a 

practical matter, the service recipient 

may find it expedient either to specify 

the definition of specified employee in 

all of its nonqualified deferred 

compensation plans or to retain the 

discretion in all such plans to make 

such determinations and take any 

necessary corporate action in 

accordance with each such plan. 

f. Application of the Six-Month Delay 

Rule 

The final regulations reflect the 

statutory language that a plan may 

provide that a payment will be made, 

notwithstanding the six-month delay, 

upon the service provider’s death. A 

commentator requested similar 

treatment for the occurrence of a 

disability, unforeseeable emergency, or 

change in control event during the six 

months following the separation from 

service. The Treasury Department and 

the IRS do not believe that the statute 

permits such flexibility, but rather 

categorically prohibits any distribution 

due to a separation from service during 

the six months following the separation 

from service except where the service 

provider dies. Accordingly, where a 

payment on account of a separation 

from service has been delayed because 

the service provider is a specified 

employee, the payment may not be 

accelerated due to disability, a change 

in control event, or an unforeseeable 

emergency. However, where a payment 

is made to a specified employee on 

account of disability, a change in 

control event, or an unforeseeable 

emergency (as defined for purposes of 

section 409A), the payment need not be 

delayed merely because the specified 

employee separates from service after 

incurring the disability or unforeseeable 

emergency, or after the change in 

control event. 

Commentators further requested that 

various types of periodic benefit 

payments be excluded from the sixmonth delay requirement, even if such 

payments constitute a payment of 

deferred compensation. Commentators 

argued that the requirement to delay 

such payments would be excessively 

burdensome and impracticable, given 

the nature and amount of benefits 

generally available under such 

arrangements. The Treasury Department 

and the IRS are not convinced that 

periodic payment or reimbursement 

plans should be excluded from the sixmonth delay rule; otherwise, deferred 

compensation could simply be 

converted to such programs to avoid the 

delay. However, as clarified in the final 

regulations, certain plans that provide 

for reimbursements or in-kind benefits 

during the six months following a 

separation from service will not be 

treated as nonqualified deferred 

compensation plans under the rules 

governing separation pay plans. See 

section III.J.6 of this preamble. 

The final regulations also provide that 

the required delay of a payment to a 

specified employee upon a separation of 

service is not violated where the 

payment is made before the end of the 

six-month period due to an acceleration 

of a payment in compliance with the 

provisions of the regulations permitting 

accelerated distributions due to a 

domestic relations order, to satisfy a 

Federal, state, local, or foreign ethics 

law, or to pay certain employment taxes 

(see section VIII of this preamble). 

5. Different Times and Forms of 

Payment on Separation From Service 

Under Specified Circumstances 

The final regulations continue to 

provide that a time and form of payment 

must be specified with respect to each 

permissible payment event. Under the 

proposed regulations, a second time and 

form of payment could be established 

for a payment due to a permissible 

payment event where the distinction 

was based upon the event occurring 

before or after a certain date, such as the 

service provider reaching a certain age. 

Commentators requested that different 

times and forms of payment be 

permitted if based upon different types 

of separations from service. The final 

regulations generally provide that the 

time and form of payment upon a 

separation from service may vary 

depending upon either or both of the 

following: (1) Whether the separation 

from service occurs during a limited 

period of time not to exceed two years 

following a change in control event as 

defined for purposes of section 409A; or 

(2) whether the separation from service 

occurs before or after a specified date 

(for example, the attainment of a 

specified age), or before or after a 

combination of a specified date and a 

specified period of service determined 

under a predetermined objective 


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formula or pursuant to the method for 

crediting service under a qualified plan 

sponsored by the service recipient. The 

addition or deletion of such a different 

time and form of payment applicable to 

an existing deferral is subject to the 

subsequent deferral election rules and 

the anti-acceleration rules. 

D. Disability 

The final regulations generally adopt 

the definition of disability and other 

provisions related to the payment of an 

amount upon a service provider 

becoming disabled contained in the 

proposed regulations, subject to the 

modifications described in this 

preamble. For this purpose, a 

participant is disabled if the participant 

is unable to engage in any substantial 

gainful activity by reason of any 

medically determinable physical or 

mental impairment that can be expected 

to result in death or can be expected to 

last for a continuous period of not less 

than 12 months, or is, by reason of any 

medically determinable physical or 

mental impairment that can be expected 

to result in death or can be expected to 

last for a continuous period of not less 

than 12 months, receiving income 

replacement benefits for a period of not 

less than 3 months under an accident 

and health plan covering employees of 

the participant’s employer. The 

determination of whether a service 

provider is disabled may be made by 

any person, including the administrator 

of a disability insurance program, and 

the plan need not specify who will 

make the determination. However, the 

plan will be treated as complying with 

section 409A only if the disability 

required for a payment complies with 

the definition of disability under the 

regulations, and a payment due to a 

disability will be deemed to comply 

with section 409A if the service 

provider has actually suffered a 

qualifying disability. The final 

regulations also provide that a plan may 

provide that a service provider will be 

deemed disabled if the service provider 

is determined to be totally disabled by 

the Social Security Administration or 

the Railroad Retirement Board. 

Commentators raised questions 

concerning the ability to pay upon the 

occurrence of a disability that does not 

qualify as a disability under the statute, 

where as a result of the disability the 

service provider has a separation from 

service. Such a payment would not 

constitute a payment due to a disability 

that complied with section 409A. 

However, if the plan provided for a 

payment due to the separation from 

service, a payment would constitute a 

payment due to a separation from 

service regardless of whether the 

separation from service resulted from 

such a disability and regardless of 

whether the service provider’s right to 

receive such payment was conditioned 

upon the service provider being 

disabled under such disability 

definition. For a discussion of the 

ability to provide for different times and 

forms of payment due to different types 

of separations from service, including 

separations from service due to certain 

disabilities, see section VII.C.4 of this 

preamble. 

E. Death 

Most of the comments with respect to 

amounts that are payable due to the 

death of a service provider related to 

whether a beneficiary of the service 

provider could be given the opportunity 

to elect a time and form of payment 

under a plan without violating section 

409A. The final regulations clarify that 

elections with respect to the time and 

form of payment to a beneficiary are 

subject to the general rules governing 

subsequent deferrals and accelerated 

payments, including elections by either 

the service provider or the beneficiary 

(with an exception for amounts payable 

under a domestic relations order). 

However, a change in a beneficiary will 

not be treated as a change in the time 

and form of payment, if the change in 

the time of payment stems solely from 

the different life expectancy of the new 

beneficiary, such as in the case of a joint 

and survivor annuity. Commentators 

requested that beneficiaries be 

permitted a limited period of time in 

which to change the time and form of 

payment without being subject to the 

subsequent deferral and antiacceleration provisions. The Treasury 

Department and the IRS do not believe 

that the statutory language supports this 

type of late deferral election or payment 

acceleration. Accordingly, these 

suggestions are not adopted in the final 

regulations. 

F. Change in Ownership or Effective 

Control of a Corporation 

The final regulations generally adopt 

the provisions contained in the 

proposed regulations with respect to the 

definition of a change in control event, 

as well as certain special rules with 

respect to payments upon a change in 

control event, subject to the 

modifications described in this 

preamble. 

One commentator requested that the 

threshold for a change in the effective 

control of a corporation be lowered from 

35 percent to 20 percent, especially for 

a public corporation. The legislative 

history of section 409A indicates that 

the definition of a change in control 

event is to be based upon, but more 

restrictive than, the definition provided 

in section 280G. H.R. Conf. Rep. No. 

108–755, at 730 (2004). Given that 

§ 1.280G–1, Q&A–28(a)(1) provides for a 

20 percent standard, the adoption of 

that standard is not appropriate in light 

of the legislative history. However, the 

final regulations lower the threshold to 

30 percent. 

One commentator requested guidance 

with respect to the application of the 

change in control provisions to nonstock, non-profit corporations. The 

Treasury Department and the IRS are 

considering whether such guidance is 

appropriate, and if so what types of 

changes could be treated as analogous to 

a change in control event involving a 

stock corporation. Until further 

guidance, a non-stock, non-profit 

corporation may apply the change in 

effective control provisions in § 1.409A–

3(i)(5) (relating to a change in the 

composition of the board of directors) 

by analogy to changes in the 

composition of its board of directors, 

trustees, or other governing body. 

The final regulations continue to 

provide that in the case of a payment on 

account of certain change in control 

events (a change in ownership of a 

corporation or a change in the 

ownership of a substantial portion of a 

corporation’s assets), compensation 

payable pursuant to the service 

recipient’s purchase of service recipient 

stock or a service recipient stock right 

held by a service provider, or payment 

of amounts of deferred compensation 

calculated by reference to the value of 

service recipient stock, generally may be 

treated as complying with the 

requirements of section 409A if paid 

under the terms and conditions that 

govern the payments to shareholders or 

the service recipient in connection with 

the change in control event. The final 

regulations continue to require that such 

amounts be paid no later than five years 

after the change in control event. 

However, the final regulations also 

provide that where such compensation 

is made subject to a condition on 

payment that constitutes a substantial 

risk of forfeiture under section 409A 

(without regard to the prohibition on 

additions or extensions of forfeiture 

conditions), and such compensation is 

payable under the same terms and 

conditions as apply to payments made 

to shareholders generally with respect to 

stock of the service recipient, or to the 

service recipient itself, pursuant to the 

change in control event, for purposes of 

determining whether such 

compensation is a short-term deferral 

the requirements of the short-term 


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deferral rule are applied as if the legally 

binding right to such compensation 

arose on the date that it became subject 

to the substantial risk of forfeiture. The 

regulations also provide rules under 

which certain pre-existing forfeiture 

conditions may be extended or modified 

in connection with such a change in 

control event. 

G. Unforeseeable Emergency 

The final regulations apply the 

provisions set forth in section 

409A(a)(2)(B)(ii) regarding payments 

upon an unforeseeable emergency. The 

final regulations provide that a 

distribution on account of unforeseeable 

emergency may not be made to the 

extent that such emergency is or may be 

relieved through reimbursement or 

compensation from insurance or 

otherwise, by liquidation of the service 

provider’s assets, to the extent the 

liquidation of such assets would not 

cause severe financial hardship, or by 

cessation of deferrals under the plan. 

The final regulations clarify that for 

these purposes, the availability of 

payments due to the unforeseeable 

emergency under any other 

nonqualified deferred compensation 

plan as defined for purposes of section 

409A, including plans that would be 

nonqualified deferred compensation 

plans for purposes of section 409A 

except due to the effective date of the 

statute, or under any qualified plan 

(including any assets available by 

obtaining a loan under a qualified plan), 

need not be considered in determining 

whether an emergency is or may be 

relieved through other means. 

Accordingly, a payment due to an 

unforeseeable emergency may be made 

pursuant to a nonqualified deferred 

compensation plan that is subject to 

section 409A even though the financial 

need could be satisfied through an 

available distribution or loan from a 

qualified plan, from a grandfathered 

nonqualified deferred compensation 

plan, or from another nonqualified 

deferred compensation plan that is 

subject to section 409A. 

Section 826 of the Pension Protection 

Act of 2006, Public Law 109–280 (120 

Stat. 780) modified the rules governing 

payments upon an unforeseeable 

emergency. Specifically, section 826 

requires that the Treasury Department 

and the IRS modify the rules for 

determining whether a service provider 

has had an unforeseeable emergency for 

purposes of section 409A(a)(2)(B)(ii) to 

provide that if an event would 

constitute a hardship under the plan if 

it occurred with respect to the service 

provider’s spouse or dependent, such 

event will, to the extent permitted under 

a plan, constitute a hardship if it occurs 

with respect to a person who is a 

beneficiary under the plan with respect 

to the service provider. The final 

regulations reflect this modification. 

H. Multiple Payment Events 

The final regulations provide that a 

plan may provide for a payment based 

upon the earlier of, or the later of, a 

series of events, provided that each 

payment event would otherwise satisfy 

the requirements of section 409A. The 

final regulations also provide that for 

purposes of the subsequent deferral and 

acceleration rules, each payment event 

will be viewed separately for purposes 

of analyzing the effect of a change in the 

time and form of payment. For a 

discussion of the effect of the addition 

or deletion of a permissible payment 

event from such a list, see section IX.C 

of this preamble. 

I. Delay in Payment by the Service 

Recipient 

Commentators requested that a 

service recipient be permitted to delay 

a payment, where the delay is due to 

bona fide business concerns such as 

cash flow considerations. Where a 

payment is delayed due to the operation 

of a pre-specified objective, 

nondiscretionary formula related to the 

business performance of the service 

recipient, the payment generally may be 

delayed (for example, where payments 

in any given year are limited to a certain 

percentage of cash flow) provided that 

the time for later payment is governed 

by the objective, nondiscretionary 

formula. See section VII.B.3 of this 

preamble. In addition, the final 

regulations provide that if at the time of 

a specified payment date the making of 

the payment would jeopardize the 

ability of the service recipient to 

continue as a going concern, the 

payment will be treated as made upon 

the specified payment date if the 

payment is made during the first taxable 

year of the service provider in which the 

making of the payment would not have 

such effect. This provision is not 

required to be explicitly provided in the 

plan. 

Because this provision permits the 

service recipient to delay any payment 

the making of which would jeopardize 

the ability of the service recipient to 

continue as a going concern, the 

provision in the proposed regulations 

permitting a delay in payment required 

to avoid a violation of a loan covenant 

or similar contractual obligation, where 

such violation would cause material 

harm to the service recipient, has not 

been adopted in the final regulations. 

Rather, where the payment would result 

in a violation of a loan covenant or 

similar contractual obligation, and the 

violation would jeopardize the ability of 

the service recipient to continue as a 

going concern, the payment can be 

delayed under the general provision. 

The final regulations adopt the 

provision of the proposed regulations 

that permits a delay in payment 

necessary to avoid the application of the 

deduction limitation under section 

162(m), subject to the following 

modifications. First, a plan is not 

required to provide explicitly for such a 

delay. However, the final regulations 

require that where any payment in a 

service recipient’s taxable year is 

delayed in accordance with this 

provision, then all payments that could 

be delayed in accordance with this 

provision must be delayed (though some 

payments may be delayed until after 

separation from service and others until 

the earliest taxable year in which the 

deduction limitation no longer applies). 

Second, except as provided in the next 

sentence, the regulations provide that 

the payment must be made either during 

the service provider’s first taxable year 

in which the service recipient 

reasonably anticipates, or reasonably 

should anticipate, that if the service 

recipient makes such payment during 

such year such payment will not fail to 

be deductible because of section 162(m) 

or, if later, during the period beginning 

on the day the service provider 

separates from service and ending on 

the later of the last day of the service 

provider’s taxable year in which the 

separation from service occurs or the 

15th day of the third month following 

the separation from service. Finally, the 

final regulations provide that where the 

payment has been delayed until the 

service provider’s separation from 

service, the six-month delay 

requirement for specified employees 

may apply. Although commentators 

argued that the six-month delay rule 

should not apply because the original 

payment would not have been subject to 

the rule, this same argument could be 

made with respect to any deferral 

election to have current compensation 

paid instead at a separation from 

service, and accordingly is not adopted 

in the final regulations. 

J. Disputed Payments and Refusals to 

Pay 

The final regulations adopt the 

provisions in the proposed regulations 

with respect to disputed payments and 

refusals to pay, subject to certain 

modifications. If a payment is not made 

due to a service recipient’s refusal to 

pay an amount, the amount generally 

will be treated as paid in a timely 


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manner if the service provider makes 

reasonable, good faith efforts to collect 

the payment. This provision is intended 

to address not only intentional refusals 

to pay, but also inadvertent delays (but, 

in either case, only if there is no 

collusion between the service provider 

and service recipient). For example, 

where through oversight a service 

recipient fails to make a payment on the 

required payment date, the payment 

will be treated as made on the specified 

date if the service provider makes 

reasonable, good faith efforts to collect 

the payment, generally through 

providing timely notice to the service 

recipient that the payment is due and 

unpaid. For this purpose, efforts to 

collect the payment will be presumed 

not to be reasonable, good faith efforts 

if notice is not given to the service 

recipient within 90 days of the latest 

date upon which the payment could 

have been timely made in accordance 

with the terms of the plan and the 

regulations and, if not paid, further 

measures to enforce the payment are not 

taken within 180 days after such date. 

For a discussion of payments that are 

accelerated due to a settlement of a bona 

fide dispute as to the service provider’s 

right to the payment, see section VIII.G 

of this preamble. 

K. Back-to-Back Arrangements 

The proposed regulations addressed 

certain arrangements under which an 

entity (the intermediate service 

recipient) receives services from a 

service provider and provides services 

to a client (the ultimate service 

recipient), and the time the intermediate 

service recipient is entitled to receive a 

payment for services rendered to the 

ultimate service recipient is controlled 

by the date on which the intermediate 

service recipient is obligated to make a 

payment of deferred compensation to 

the service provider. For example, 

assume an intermediate service 

recipient provides investment 

management services for a group of 

investors. Pursuant to a nonqualified 

deferred compensation plan, the 

intermediate service recipient has 

agreed to pay its employee a sum certain 

when the employee terminates 

employment. Under the intermediate 

service recipient’s agreement with the 

investor group, the investors will pay 

the same sum certain to the 

intermediate service recipient when the 

employee terminates employment. The 

proposed regulations referred to these 

types of arrangements as back-to-back 

arrangements. 

The final regulations adopt the 

proposed provisions that addressed 

back-to-back nonqualified deferred 

compensation arrangements, subject to 

the modifications described in this 

section. The final regulations clarify that 

the rules addressing back-to-back 

arrangements apply regardless of 

whether the arrangement between the 

service provider and the intermediate 

service recipient is actually subject to 

section 409A, as long as each 

arrangement that is part of the overall 

back-to-back scheme complies with the 

requirements of section 409A without 

regard to whether such arrangement is 

actually subject to section 409A. 

Accordingly, the accommodations 

afforded to back-to-back arrangements 

are only applicable to the extent that 

each arrangement satisfies the 

requirements of section 409A as if those 

requirements applied to each such 

arrangement (modified in accordance 

with the back-to-back rules). 

Commentators also requested that, 

with respect to taxpayers providing 

management services that are not 

eligible for the exception from coverage 

for independent contractors with 

multiple unrelated customers, the 

exception from the general payment 

timing rules permitting certain back-toback arrangements be expanded to 

include not only arrangements where 

the payment from an ultimate service 

recipient to the intermediate service 

recipient is based upon the timing of a 

required payment under a section 409A 

compliant plan from the intermediate 

service recipient to a service provider (a 

forward back-to-back arrangement), but 

also where the payment to the service 

provider is based upon a required 

payment under a section 409A 

compliant arrangement from the 

ultimate service recipient to the 

intermediate service recipient (a reverse 

back-to-back arrangement). For example, 

a service recipient that provides 

investment management services to an 

investor group may have an 

arrangement whereby the investors are 

required to pay all amounts due to the 

investment manager service recipient if 

the investor group terminates the client 

relationship, and the investment 

manager service recipient in turn has an 

agreement with an employee to pay the 

employee a certain percentage of the 

amount the investor group pays to the 

investment manager service recipient, 

following termination of the client 

relationship. The final regulations do 

not provide an exception from the 

requirements of section 409A for reverse 

back-to-back arrangements, but the 

Treasury Department and the IRS will 

continue to study the matter. 

VIII. Prohibition of Accelerated 

Payments 

A. In General 

Section 409A(a)(3) provides that a 

plan may not permit the acceleration of 

the time or schedule of any payment 

under the plan, except as provided in 

regulations by the Secretary. The final 

regulations retain the provisions in the 

proposed regulations relating to 

accelerated payments, subject to the 

modifications described in this 

preamble. 

The final regulations generally 

provide that a payment of an amount as 

a substitute for a payment of deferred 

compensation will be treated as a 

payment of the deferred compensation, 

including for purposes of the 

prohibition on accelerated payments. 

Where a payment of an amount results 

in an actual or potential reduction of, or 

an actual or potential current or future 

offset to, an amount of deferred 

compensation, or the service provider 

receives a loan the repayment of which 

is secured by or may be accomplished 

through an offset of a nonqualified 

deferred compensation benefit, then the 

payment or loan is a substitute for the 

deferred compensation and is treated as 

a payment of the deferred compensation 

itself. If a service provider’s rights to 

deferred compensation are subject to 

anticipation, alienation, sale, transfer, 

assignment, pledge, encumbrance, 

attachment, or garnishment by creditors 

of the service provider or the service 

provider’s beneficiary, such amounts are 

treated as having been paid to the 

service provider. 

The receipt of a payment of 

compensation, or right to a payment of 

compensation, proximate to the 

purported forfeiture or voluntary 

relinquishment of a right to deferred 

compensation generally is treated as a 

substituted payment for the payment of 

the deferred compensation. For 

example, where the right to an amount 

of deferred compensation is purportedly 

relinquished or forfeited, and 

concurrently or subsequently the service 

provider receives a current bonus 

payment, the bonus payment will be 

presumed to be a substitute payment for 

the amount of deferred compensation. 

The presumption is rebuttable by a 

showing that the compensation paid 

would have been paid regardless of the 

relinquishment or forfeiture of the right 

to the deferred compensation. For a 

discussion of the application of this 

provision to amounts forfeitable upon a 

separation from service, see section 

III.J.1 of this preamble. 

A plan may not provide discretion to 

a service provider regarding whether a 


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payment will be accelerated under one 

of the rules permitting the acceleration 

of payments under specified 

circumstances (for example, to comply 

with a domestic relations order), 

including through the provision of an 

election. However, where a plan 

provides a service recipient discretion 

to accelerate payments under one of the 

rules permitting the acceleration of a 

payment, the failure to accelerate such 

a payment will not constitute a 

subsequent deferral election. 

B. Plan Termination and Liquidation 

The proposed regulations contained 

provisions permitting a service recipient 

to terminate and liquidate a 

nonqualified deferred compensation 

plan, including when the service 

recipient has declared bankruptcy, 

when the service recipient has 

participated in certain change in control 

events, or at the discretion of the service 

recipient, all subject to certain 

restrictions and limitations. 

Commentators expressed concern over 

the restrictions and limitations. Some 

comments reflected confusion as to the 

meaning of these terms in the context of 

section 409A. The termination and 

liquidation of a nonqualified deferred 

compensation plan involves both the 

amendment of the plan to cease 

deferrals under the plan and provide for 

payment of all benefits accrued under 

the plan, and the accelerated payment of 

benefits accrued under the plan. 

Several comments suggested that the 

final regulations expand the 

circumstances under which a service 

recipient may terminate and liquidate a 

nonqualified deferred compensation 

plan. Generally these comments 

requested discretion in case of a change 

in business conditions or circumstances, 

resulting in the service recipient’s desire 

to terminate and liquidate the plan. The 

final regulations expand the 

circumstances under which a sale of 

assets of a corporation will result in a 

separation from service. See section 

VII.C.2.f of this preamble. In addition, 

the final regulations continue to allow 

the service recipient to terminate and 

liquidate a plan during a defined period 

following a change in control event. 

Outside of these particular business 

events, the comments failed to provide 

an objective standard or category of 

changes in business conditions or 

circumstances that would provide a 

safeguard against the use of plan 

termination and liquidation provisions 

to circumvent the prohibition on 

accelerations. Accordingly, the final 

regulations do not expand the ability of 

a service recipient to exercise its 

discretion to terminate and liquidate a 

deferred compensation plan. However, 

the period of time during which a 

service recipient may not commence a 

new plan after terminating and 

liquidating a nonqualified deferred 

compensation plan has been shortened 

from five years to three years. Also, the 

final regulations provide that a 

discretionary plan termination and 

liquidation will not qualify for this 

exception if it is proximate to a 

downturn in the financial health of the 

service recipient. 

The final regulations clarify the rules 

under which a deferred compensation 

plan may be terminated and liquidated 

upon a change in control event. Under 

the final regulations, the service 

recipient must, within the 30 days 

preceding or the 12 months following 

the change in control event, take all 

necessary action to terminate and 

liquidate the plan and such action must 

be irrevocable. In addition, for the plan 

to be treated as terminated and 

liquidated, all other arrangements that 

would be classified with the plan as a 

single plan if the same service provider 

participated in the plan and all the other 

arrangements must be terminated and 

liquidated, so that all service providers 

who are participants in the plan and all 

such other arrangements required to be 

terminated and liquidated must receive 

all amounts of compensation deferred 

under the terminated and liquidated 

plan and other arrangements within 12 

months of the date the service recipient 

takes such irrevocable action to 

terminate and liquidate the 

arrangements. For purposes of the rule, 

the entities comprising the service 

recipient are determined immediately 

following the change in control event, 

and the rule only applies with respect 

to service providers for whom a change 

in control has occurred. For example, 

where the change in control event 

consists of a sale of a subsidiary 

corporation such that the subsidiary 

corporation is no longer treated as a 

single service recipient with the 

(former) parent corporation, the 

requirement to terminate and liquidate 

substantially similar arrangements 

applies only to the purchaser service 

recipient group of corporations that now 

owns the subsidiary corporation. In 

addition, the rule would apply only to 

the service providers that had 

experienced a change in control, 

generally consisting only of the service 

providers of the subsidiary corporation. 

Where the change in control event 

consists of an asset purchase, the 

applicable service recipient with 

discretion to terminate and liquidate the 

plan is deemed to be the entity retaining 

the deferred compensation liability after 

the transaction. 

Some commentators asked whether 

the plan termination and liquidation 

rules apply if a plan is terminated and 

liquidated when the service provider 

has no vested right to a payment, and 

all payments are forfeited. Where the 

service recipient retained the unfettered 

discretion to terminate such a plan 

without paying benefits, the service 

provider may not have obtained a 

legally binding right to a payment. In 

addition, if a service provider forfeits 

benefits under a nonqualified deferred 

compensation plan in exchange for 

other taxable benefits, those benefits 

may be treated as a payment of amounts 

under the nonqualified deferred 

compensation plan. 

C. Conflicts of Interest and Ethics Rules 

The proposed regulations contained a 

special accelerated payment rule to 

permit accelerated payments required to 

be made by a certificate of divestiture. 

Notice 2006–64, 2006–29 IRB 88, see 

§ 601.601(d)(2), expanded this exception 

to address situations in which a letter is 

received from the Office of Government 

Ethics that divestiture of the deferred 

compensation is required. Several 

commentators requested an expansion 

of these rules. 

The final regulations provide that a 

payment may be accelerated where 

necessary for a Federal officer or 

employee in the executive branch to 

comply with an ethics agreement with 

the Federal government. The final 

regulations also provide that a payment 

may be accelerated where reasonably 

necessary to avoid the violation of a 

Federal, state, local, or foreign conflict 

of interest law or ethics law (including 

where such payment is reasonably 

necessary to permit the service provider 

to participate in activities in the normal 

course of his or her position in which 

the service provider would otherwise 

not be able to participate under an 

applicable law). For this purpose, a 

payment will be reasonably necessary to 

avoid such a violation if the making of 

the payment is a necessary part of a 

combination of actions resulting in 

compliance with the applicable law. A 

payment may be considered necessary 

to avoid such a violation even though 

actions other than making the payment 

could also result in compliance with the 

applicable law. For example, as 

requested by several commentators, this 

provision would provide a public 

accounting firm the ability to accelerate 

payments where reasonably necessary to 

satisfy conflict of interest rules 

prescribed by the Securities and 

Exchange Commission. This paragraph 


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is intended to address payments to 

service providers, as well as payments 

to a spouse or minor children where 

such payments are reasonably necessary 

to comply with the applicable law. For 

this purpose, foreign law is considered 

to be applicable only to foreign earned 

income from sources within the foreign 

country that promulgated such law. 

D. State and Local Taxes, RRTA Tax and 

Foreign Taxes 

Commentators stated that certain state 

and local jurisdictions tax nonqualified 

deferred compensation plans under a 

different set of rules than the Federal 

income tax rules, typically by reference 

to the rules applicable to FICA taxes. 

Commentators also requested that 

accelerations be permitted to cover 

applicable RRTA taxes. Finally, 

commentators requested that 

accelerated payments be permitted to 

account for the tax laws of foreign 

jurisdictions that may not be consistent 

with the Federal income tax rules. The 

final regulations adopt the suggestions 

with respect to state and local taxes, 

RRTA taxes, and foreign taxes. 

E. Minimum Distributions Under 

Section 280H(d) 

One commentator suggested that 

acceleration be permitted to allow a 

personal service corporation to make 

minimum distributions to avoid 

taxation under section 280H(d). The 

Treasury Department and the IRS 

believe that such a provision would give 

taxpayers excessive control over the 

payment of deferred amounts that 

would be inconsistent with the 

purposes of section 409A. Therefore, 

this suggestion was not adopted. 

F. Top Hat Plan Rules 

Some commentators requested that 

the final regulations permit a service 

recipient to accelerate payments or 

cancel deferral elections with respect to 

a service provider who is not part of a 

select group of management or highly 

compensated employees for purposes of 

the exclusion from coverage under 

certain provisions of the Employee 

Retirement Income Security Act of 1974 

relating to top hat plans. See, for 

example, 29 U.S.C. 1051(2). Given the 

current lack of clarity with respect to 

the scope of coverage of the top hat plan 

rules, and the actions required when a 

plan participant no longer satisfies the 

requirement to qualify for the top hat 

plan rules, the Treasury Department and 

the IRS are not confident that an 

exception to the anti-acceleration 

provisions based upon these rules is 

feasible. Accordingly, the final 

regulations do not adopt this suggestion. 

G. Settlements of Bona Fide Disputes 

Regarding the Right to a Payment 

Commentators requested relief for 

certain payments made as a settlement 

of a dispute as to a service provider’s 

right to a deferred amount. For example, 

assume that a plan provides for a 

payment of deferred compensation upon 

a termination of an employee’s 

employment other than for cause and 

the employee and employer have a bona 

fide dispute as to whether the employee 

was terminated for cause, and thus 

whether the service provider is entitled 

to any payment under the plan. The 

final regulations provide that payments 

may be accelerated, including 

acceleration to payment as a lump sum, 

where the right to such payments arises 

as part of a settlement between the 

service provider and the service 

recipient of a bona fide dispute as to the 

service provider’s right to the deferred 

amount. The provision applies only to 

a deferred amount, the right to which is 

the subject of an arm’s length settlement 

of a bona fide dispute between the 

service provider and the service 

recipient, and only to the portion of the 

deferred amount that is the subject of 

the bona fide dispute. The provision 

does not apply to disputes that relate 

only to when (and not whether) a 

payment is due. Whether a payment 

qualifies for the exception is based on 

the particular facts and circumstances. 

A payment will be presumed not to 

meet this exception unless the payment 

is subject to a substantial reduction in 

the value of the payment made in 

relation to the amount that would have 

been payable had there been no dispute 

as to the service provider’s right to the 

payment. For this purpose, a reduction 

that is less than 25 percent of the 

present value of the deferred amount in 

dispute generally is not a substantial 

reduction. In addition, a payment will 

be presumed not to meet this exception 

if the payment is made proximate to a 

downturn in the financial health of the 

service recipient. 

H. Cashout Rules 

Commentators requested various 

modifications to the cashout rules 

generally expanding the conditions 

under which a service recipient may 

exercise discretion to cash out a service 

provider’s entire amount deferred under 

a plan. The final regulations generally 

provide that a service recipient may 

exercise such discretion at any time that 

a service provider’s amount deferred 

under the plan is less than the 

applicable dollar amount under section 

402(g)(1)(B) for that calendar year. For 

this purpose, the plan aggregation rules 

apply, so a service recipient may not use 

this rule to cash out an amount under 

one arrangement but not another 

arrangement where the two 

arrangements would be treated as one 

plan. The final regulations, unlike the 

proposed regulations, do not require 

that a service provider have separated 

from service for the service recipient to 

cash out the amount deferred. In 

addition, the plan does not need to be 

amended to provide this discretion to 

the service recipient. Finally, the 

amount has been changed from $10,000 

to the limit on elective deferrals under 

section 402(g) to permit the amount to 

be adjusted for changes in the cost of 

living. 

The final regulations also provide that 

a plan under which amounts are to be 

paid in installments may provide for 

immediate payment of all remaining 

installments if the present value of the 

deferred amount to be paid in the 

remaining installments falls below a 

predetermined amount, and such 

immediate payment will not constitute 

an accelerated payment for purposes of 

§ 1.409A–3(j)(1), provided that such 

feature (including the predetermined 

amount) is established no later than the 

latest time at which the time and form 

of payment is otherwise required to be 

established, and provided further that 

any change in such feature including 

the predetermined amount must comply 

with the requirements for a change in 

the time and form of payment. 

I. Other Acceleration Issues 

Commentators requested that a 

service recipient be permitted to cancel 

a service provider’s deferral elections in 

two situations. First, commentators 

asked that such a cancellation be 

allowed when the service provider is 

transferred to a position that is not 

eligible to participate in the plan. The 

Treasury Department and the IRS are 

not confident that a standard can be 

established that would clearly 

distinguish a bona fide transfer to an 

ineligible position from a pro forma 

transfer designed to avoid the 

prohibition on accelerated payments, 

especially when the underlying plan is 

specific to the service provider, as in the 

case of an individual employment 

agreement, and accordingly the final 

regulations do not adopt this suggestion. 

Second, commentators asked that a 

service provider’s deferral election be 

cancelled if the service provider 

becomes disabled. The final regulations 

permit the cancellation of the service 

provider’s deferral election due to a 

disability, provided that for this purpose 

a disability is defined as any medically 

determinable physical or mental 


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impairment resulting in the service 

provider’s inability to perform the 

duties of his or her position or any 

substantially similar position, where 

such impairment can be expected to 

result in death or can be expected to last 

for a continuous period of not less than 

six months. 

IX. Subsequent Changes in the Time 

and Form of Payment 

A. In General 

The final regulations clarify that the 

rules governing changes in the time and 

form of payment apply both to service 

providers and service recipients. 

Accordingly, a service provider, a 

service recipient, or both a service 

provider and a service recipient may 

have and exercise discretion to defer a 

deferred compensation payment after 

the time and form of payment have been 

specified, provided that such discretion 

is limited to changes that comply with 

the requirements of these regulations 

addressing subsequent changes in the 

time and form of payment. 

B. Annuities 

Many commentators requested 

clarification and expansion of the rules 

that allow taxpayers to treat actuarially 

equivalent life annuities as one form of 

payment, thereby allowing elections 

among such annuity forms at any time 

before the initial annuity payment 

without regard to the rules on 

subsequent deferral elections. The final 

regulations clarify the circumstances 

under which two actuarially equivalent 

life annuities may be treated as one form 

of payment. 

The final regulations generally 

provide that certain specified features 

are ignored for purposes of determining 

whether a particular annuity is treated 

as a life annuity for purposes of the form 

of payment rules (but not for purposes 

of determining whether a life annuity 

with such a feature is actuarially 

equivalent to a life annuity without 

such a feature). The specified features 

include: (1) Term certain features (under 

which annuity payments continue for 

the longer of the life of the annuitant or 

a fixed period of time); (2) pop-up 

provisions (under which payments 

increase upon the death of the 

beneficiary or another event that 

eliminates the right to a survivor 

annuity); (3) cash refund features (under 

which payment is provided upon the 

death of the last annuitant in an amount 

that is not greater than the excess of the 

present value of the annuity at the 

annuity starting date over the total of 

payments before the death of the last 

annuitant); (4) Social Security or 

Railroad Retirement leveling features 

(including leveling features related to 

early retirement, survivor or disability 

benefits); and (5) features applying a 

permissible cost-of-living index. 

Accordingly, a life annuity with any of 

the specified features may be treated as 

a life annuity without regard to the fact 

that the features cause the annuity to 

fail to satisfy the general definition for 

life annuities, for example, because the 

periodic payments are not substantially 

equal. However, the life annuity with 

such a feature may only be treated as the 

same form of payment as a life annuity 

without such a feature if the two life 

annuities are actuarially equivalent 

(taking into account the feature) and 

have the same initial payment date. 

Commentators also raised issues 

concerning the availability of subsidized 

joint and survivor annuities. The final 

regulations provide that for purposes of 

the definition of a time and form of 

payment, a subsidized joint and 

survivor annuity is treated as actuarially 

equivalent to a single life annuity 

provided that, neither the annual 

lifetime annuity benefit nor the annual 

survivor benefit available under the 

joint and survivor annuity is greater 

than the annual lifetime annuity benefit 

available under the single life annuity. 

For example, a single life annuity 

providing $100 a month for the lifetime 

of the service provider may be treated as 

actuarially equivalent to a joint and 

survivor annuity providing up to $100 

a month for the lifetime of the service 

provider and up to $100 a month to the 

surviving joint annuitant. 

Commentators asked whether the 

actuarial assumptions and methods 

used to determine actuarial equivalency 

must be applied consistently. The final 

regulations clarify that in determining 

whether two life annuities are 

actuarially equivalent, the same 

actuarial assumptions and methods 

must be used in valuing each life 

annuity. This requirement applies over 

the entire term of the service provider’s 

participation in the plan, such that the 

annuities must be actuarially equivalent 

at all times for the annuity options to be 

treated as one time and form of 

payment. However, provided the 

actuarial methods and assumptions are 

reasonable, there is no requirement that 

consistent actuarial assumptions and 

methods be used over the term of the 

service provider’s participation in the 

plan. Accordingly, the plan may change 

the actuarial assumptions and methods 

used to determine the life annuity 

payments, provided that all of the 

actuarial assumptions and methods are 

reasonable. In addition, there is no 

requirement that the actuarial 

assumptions and methods used under a 

nonqualified deferred compensation 

plan be the same as those used in a 

qualified plan sponsored by the service 

recipient. 

C. Application to Multiple Payment 

Events 

The final regulations continue to 

provide that the subsequent deferral and 

anti-acceleration rules generally will 

apply to the addition or deletion of a 

permissible payment event. 

Commentators asked for clarification of 

how these rules apply. 

The Treasury Department and the IRS 

believe that a failure to provide for a 

payment event at death, disability or an 

unforeseeable emergency generally will 

result from oversight, and that the 

addition of such a provision generally 

would not be abusive. Accordingly, the 

final regulations provide that the 

addition of death, disability, or an 

unforeseeable emergency as a 

potentially earlier payment event is a 

permissible acceleration. This provision 

does not apply to the addition of death, 

disability, or an unforeseeable 

emergency as a potentially later 

payment event, such as through the 

addition of death as a payment event to 

a plan providing for a payment of 

deferred compensation on a fixed date, 

so that after the change the payment 

would be due on the later of the fixed 

date or death. Nor, for example, would 

it apply to an amendment of a plan to 

substitute a service provider’s death as 

a new payment event, instead of a fixed 

payment date. In those cases, the rules 

governing subsequent deferral elections 

apply. In addition, the substitution of 

death as a payment event for an amount 

that is deferred compensation will not 

cause the plan to be treated as a death 

benefit plan not subject to section 409A, 

but the substitution or addition of a 

payment event other than death as a 

payment event in a death benefit plan 

may result in the plan being treated as 

providing for deferred compensation. 

The anti-acceleration provisions 

apply to the addition of a specified date 

or fixed schedule, a change in control 

event, or separation from service as a 

potentially earlier payment event, 

including the substitution of one of 

these payment events for another 

payment event. In addition, the antiacceleration provisions apply where a 

payment event is removed from a plan 

term requiring payment upon the latest 

of two or more payment events. The 

provisions governing subsequent 

deferral elections apply to all changes in 

the time and form of payment, whether 

resulting from the addition, deletion or 

substitution of another payment event. 


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Commentators requested clarification of 

how this provision would apply where 

the events were not specified dates, 

such as the substitution of a change in 

control payment event for a separation 

from service event. In such a situation, 

to satisfy the rules governing subsequent 

deferrals, this substitution would only 

be permissible if the change were not 

effective for one year, and provided that 

the payment would only occur upon the 

later of a change in control event or at 

least five years following a separation 

from service. 

D. Application to Domestic Relations 

Orders 

The final regulations provide that the 

rules governing changes in the time and 

form of payment do not apply to 

changes in the time and form of 

payment under the terms of a domestic 

relations order, to the extent the change 

in the time and form of payment applies 

to a payment that will be made to the 

alternate payee and not the service 

provider. Accordingly, for example, a 

domestic relations order generally may 

provide for a new time and form of 

payment to a spouse or former spouse 

of the service provider, or provide such 

spouse or former spouse discretion to 

determine the time and form of payment 

to such spouse or former spouse. 

X. Application to Nonqualified Deferred 

Compensation Plans Linked to Qualified 

Plans and Other Arrangements 

A. Plans Linked to Qualified Plans and 

Certain Broad-Based Foreign Retirement 

Plans 

The final regulations generally adopt 

the relief provided in the proposed 

regulations with respect to the electiontiming and the anti-acceleration rules 

for changes in the amount of benefits 

under a nonqualified deferred 

compensation plan that result from an 

election (or failure to elect) by a service 

provider, or an amendment by a service 

recipient, in respect of a subsidized or 

ancillary benefit under a qualified plan. 

In response to comments, this relief is 

similarly extended to certain broadbased foreign retirement plans. In 

addition, this relief is extended for 

benefit formulas that include a 

reduction for amounts credited to the 

service provider’s account under a taxqualified plan (which may include 

matching contributions) or certain 

broad-based foreign retirement plans 

that provide benefits expressed as an 

account balance. 

In response to comments, the final 

regulations also clarify that the linked 

plan relief provided for elective 

deferrals (including designated Roth 

contributions) and matching type 

contributions, each up to the section 

402(g) dollar limit on elective deferrals, 

are separate, additive limits and are not 

a single, coordinated limit. In addition, 

the final regulations clarify that the 

section 402(g) dollar limits are increased 

by the limit on catch-up contributions 

under section 414(v) for any year in 

which the service provider qualifies for 

such increase. 

Commentators raised issues 

concerning other types of plans under 

which a service provider must 

participate in a qualified plan to receive 

nonqualified deferred compensation. 

Specifically, commentators asked 

whether a plan could comply with 

section 409A if it provided that an 

employee must defer the maximum 

amount permissible under a qualified 

plan in order to defer any amount under 

a nonqualified deferred compensation 

plan. Where the service provider can 

change the service provider’s election to 

defer the maximum amount permissible 

under the qualified plan during the 

taxable year, and thereby change or 

discontinue deferrals under a 

nonqualified deferred compensation 

plan, the service provider can 

effectively make a late election to defer 

(or not defer) amounts under the 

nonqualified plan. The final regulations 

generally do not provide any additional 

relief with respect to this type of plan. 

However, where the additional amounts 

deferred under the nonqualified 

deferred compensation plan reflect only 

matching contributions that would be 

available under the qualified plan 

absent the restrictions in the qualified 

plan intended to reflect limits on 

qualified plan contributions under 

sections 401(m) and 401(a)(17), the final 

regulations provide relief but solely 

with respect to the matching amount 

that could have been contributed to the 

qualified plan absent such limits. 

Commentators also stated that the 

rules in the proposed regulations did 

not adequately address the impact of 

after-tax contributions. Specifically, 

commentators requested relief for 

service providers who change their 

after-tax contributions (other than 

designated Roth contributions) under a 

qualified plan during a year where such 

decrease causes a corresponding change 

in nonqualified plan elective deferrals. 

The final regulations provide some 

additional relief concerning matching or 

other contributions contingent upon the 

making of an after-tax contribution. 

However, other suggestions were not 

adopted in the final regulations, because 

the Treasury Department and the IRS 

are concerned that such plans may give 

the service provider excessive control 

over amounts deferred under a 

nonqualified deferred compensation 

plan, contrary to the statutory intent. 

B. Plans Linked to Cafeteria Plans 

Commentators expressed concern that 

changes to elections under a section 125 

cafeteria plan could change the amount 

of eligible compensation used for 

purposes of a benefit formula under a 

nonqualified deferred compensation 

plan and thereby create an 

impermissible deferral election or 

acceleration of payment under the 

nonqualified deferred compensation 

plan. The final regulations provide relief 

from the deferral election-timing and 

anti-acceleration rules for changes to 

section 125 elections properly made in 

accordance with the rules under section 

125, to the extent that the change in the 

amount deferred under the nonqualified 

deferred compensation plan results 

solely from the application of the 

change in amount of eligible 

compensation resulting from the 

election change under the cafeteria plan 

to a benefit formula based upon the 

service provider’s eligible 

compensation, and only to the extent 

that such change applies in the same 

manner as any other increase or 

decrease in the eligible compensation 

would apply to such benefit formula. 

C. Offsets 

i. In General 

Some commentators requested 

clarification whether an arrangement 

under which a specified amount paid by 

a service recipient to a service provider 

reduces or offsets an amount that is 

payable to the service provider under a 

nonqualified deferred compensation 

plan will be treated as providing for an 

acceleration of a payment under the 

nonqualified deferred compensation 

plan. As an example, one commentator 

stated that a plan may require that any 

payout at separation from service of 

accrued leave that is determined to be 

in excess of the correct amount of such 

payment will be deducted from the 

amount due under a nonqualified 

deferred compensation plan, rather than 

repaid separately by the service 

provider. One commentator suggested 

that offsets be permitted for all service 

provider debts of a kind and in amounts 

customarily incurred in the ordinary 

course of the business relationship 

between the service provider and the 

service recipient. 

The Treasury Department and the IRS 

believe that the unfettered discretion to 

settle debts between a service recipient 

and a service provider through offsets 

from payments of nonqualified deferred 


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compensation is not consistent with the 

intent of the statute, because it creates 

opportunities to disguise accelerated 

payments of deferred compensation. 

Accordingly, amounts that currently or 

in the future may be offset against 

nonqualified deferred compensation are 

treated as payments of deferred 

compensation and may violate the antiacceleration rules under section 409A. 

See section VIII.A of this preamble. 

However, the Treasury Department and 

the IRS agree that the ability to offset 

small routine debts against amounts 

payable under a nonqualified deferred 

compensation plan is useful so that 

service recipients can avoid the 

administrative burden involved in 

paying deferred compensation amounts 

to a service provider while at the same 

time attempting to collect small 

amounts owed by the same service 

provider. Accordingly, the final 

regulations provide that payments of 

deferred compensation may be offset by 

amounts owed to the service recipient 

by the service provider, where such debt 

is incurred in the ordinary course of the 

service relationship, to the extent the 

entire offset in any taxable year does not 

exceed $5,000 and the offset is taken at 

the same time and in the same amount 

as the debt otherwise would have been 

due from the service provider. 

ii. Social Security Benefits and 

Disability Benefits 

Commentators requested clarification 

of the treatment of nonqualified 

deferred compensation plans that offset 

benefits with payments received as 

Social Security benefits and disability 

benefits. A plan provision providing for 

a direct, dollar-for-dollar reduction of 

payments due under a nonqualified 

deferred compensation plan by the 

amount of payments received or 

receivable as Social Security benefits 

will not fail to provide for a fixed 

schedule of payments. However, the 

rule relates solely to direct reductions in 

deferred compensation benefits to 

reflect eligibility for, or payment of, 

Social Security benefits, and does not 

permit other changes in the time and 

form of benefit based upon a service 

provider’s eligibility or elections related 

to Social Security benefits. A reduction 

in a nonqualified deferred 

compensation plan benefit equal to the 

amount receivable under a service 

recipient sponsored disability plan 

generally will be treated similarly, 

provided that a substantial number of 

service providers participate in the 

disability plan. However, to allow the 

payment schedule to qualify as a fixed 

schedule, the disability plan must be 

established before the date the service 

provider becomes disabled. In addition, 

any subsequent amendment to the 

disability plan or other change in the 

benefit payable under the disability plan 

may result in an acceleration of a 

payment or a subsequent deferral under 

the nonqualified deferred compensation 

plan unless the facts and circumstances 

establish otherwise (for example, 

because the amendment or change 

results from actions taken by an 

independent third party, such as an 

unrelated insurer that issued a disability 

insurance policy for such disability 

plan, over which the service recipient 

and service provider have no control, or 

an action of the service recipient with 

respect to the disability plan that is 

generally applicable to a substantial 

number of other service providers who 

participate in such disability plan and 

has a material effect on the disability 

benefits of such other service providers). 

XI. Statutory Effective Dates 

A. Effective Dates—Earned and Vested 

Amounts 

As provided in section 885(d) of the 

American Jobs Creation Act of 2004, 

section 409A generally is effective for 

amounts deferred after December 31, 

2004. The final regulations adopt the 

definition set forth in the proposed 

regulations of an amount deferred on or 

before December 31, 2004, for purposes 

of the effective date, subject to the 

modifications described in this 

preamble. The final regulations clarify 

that the grandfathered amount includes 

any account balance that is earned and 

vested, as well as the present value of 

any earned and vested right to future 

account credits, even if such amounts 

had not been credited to the account as 

of December 31, 2004. For example, if 

a service provider had a vested right on 

December 31, 2004, to have a bonus 

amount added to the service provider’s 

account balance in a nonqualified 

deferred compensation plan, the service 

provider’s grandfathered amount would 

include the amount of such bonus even 

though such amount was not calculated 

and credited to the account until some 

time in 2005. 

B. Effective Dates—Calculation of 

Grandfathered Amount 

One commentator requested that the 

grandfathered amount in a nonaccount 

balance plan be expressed in terms of 

the form of benefit under the plan. So, 

for example, where the normal benefit 

was expressed in the form of an annuity 

payable at a certain age, that is how the 

amount of the grandfathered benefit 

would also be expressed. The final 

regulations do not adopt this suggestion, 

but reach a similar result by providing 

that any actuarial assumptions and 

methods that were reasonable to use as 

of December 31, 2004, may continue to 

be used in subsequent years for 

purposes of determining the 

grandfathered amount. 

C. Material Modifications 

Section 885(d)(2) of the American 

Jobs Creation Act of 2004 provides 

generally that amounts deferred in 

taxable years beginning before January 

1, 2005, are treated as amounts deferred 

in a taxable year beginning on or after 

such date if the plan under which the 

deferral is made is materially modified 

after October 3, 2004. The final 

regulations adopt the definition set forth 

in the proposed regulations of a material 

modification for these purposes, subject 

to the changes described in this 

preamble. 

For purposes of the definition of a 

material modification under the 

effective date rules, the final regulations 

incorporate the exclusions from the 

definition of a modification for purposes 

of the rules governing stock rights. For 

example, a change to a discounted 

grandfathered stock right that could be 

covered by section 409A if materially 

modified under the effective date rules, 

will not be treated as materially 

modified and subject to section 409A if 

the change would not be treated under 

the rules governing stock rights as a 

modification resulting in treatment as a 

new grant of a stock right or an 

extension resulting in treatment of the 

stock right as having had a deferral 

feature from the date of grant. 

The final regulations provide that 

neither the amendment of a plan to 

include a provision allowing for a 

payment to a person other than the 

service provider due to the application 

of a domestic relations order, nor the 

making of a payment in compliance 

with a domestic relations order where a 

plan did not address the ability to make 

such a payment, is treated as a material 

modification for purposes of the 

grandfathering rules. 

Commentators also requested that a 

grandfathered plan be permitted to 

remove a provision requiring a 

cancellation of deferrals for a prescribed 

period of time under all nonqualified 

deferred compensation plans to receive 

a distribution from the grandfathered 

plan, without resulting in a material 

modification. Commentators argued that 

because the enforcement of such a 

provision by cancelling a current 

deferral election generally would result 

in an immediate violation of section 

409A, the inability to remove the 

requirement that the deferral election be 


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cancelled effectively nullifies the 

grandfathered right. Under the final 

regulations, an amendment to a 

grandfathered plan that changes such a 

provision to require a cancellation of 

deferrals for the equivalent period of 

time beginning with the first possible 

date that such a cancellation would not 

result in a prohibited accelerated 

payment (generally the beginning of the 

subsequent calendar year for a service 

provider with a calendar year taxable 

year) will not constitute a material 

modification. For example, taxpayers 

may amend an early distribution 

provision that requires the immediate 

cessation of deferrals for 12 months to 

apply only to deferrals over the first 12 

month period with respect to which the 

service provider can make a timely 

deferral election, for example, by 

prohibiting deferrals of compensation 

attributable to services performed 

during the service provider’s next 

taxable year. 

Commentators requested clarification 

of the effect of a material modification 

of a plan. The specific consequences of 

a material modification of a plan are 

being considered as part of the 

anticipated guidance related to income 

inclusion and calculation. However, the 

final regulations provide that for 

amounts deferred in taxable years 

beginning before January 1, 2005, under 

a plan that is materially modified after 

October 3, 2004, whether the plan 

complies with the requirements of 

section 409A is determined by reference 

to the terms of the plan in effect, and 

any actions taken under the plan, on 

and after the date of the material 

modification. Accordingly, where the 

materially modified plan is compliant 

with section 409A and these regulations 

immediately following the material 

modification, the material modification 

generally will not itself result in a 

violation. 

XII. Effective Date of Final Regulations 

A. Existing Transition Relief 

Nothing in this preamble or the final 

regulations is intended to restrict the 

otherwise applicable transition relief. 

For a description of the applicable 

transition relief, see Notice 2006–79, 

2006–43 IRB 763 (extension of certain 

transition relief through 2007), Notice 

2006–64, 2006–29 IRB 88 (transition 

relief applicable to certain accelerated 

payments necessary to comply with 

Federal ethics requirements), Notice 

2006–33, 2006–15 IRB 754 (transition 

rules with respect to section 409A(b)), 

Notice 2006–4, 2006–3 IRB 307 

(transition relief with respect to the 

valuation standards applicable to stock 

rights issued on or before the effective 

date of the final regulations for purposes 

of the exclusion from coverage under 

section 409A for certain stock rights), 

the preamble to the proposed 

regulations (extension of certain 

transition relief through 2006), and 

Notice 2005–1, 2005–1 CB 274 (initial 

transition relief). See § 601.601(d)(2). 

B. Application of Final Regulations 

The final regulations are generally 

effective January 1, 2008. For periods 

before January 1, 2008, the standards 

and transition rules set forth in Notice 

2006–79 continue to apply. For further 

information regarding the transition 

relief for periods before the effective 

date of the final regulations, see Notice 

2006–79 and section XI of the preamble 

to the proposed regulations. 

Commentators requested clarification 

of the impact of the final regulations 

becoming effective January 1, 2008, on 

plans that continue to defer 

compensation on or after January 1, 

2008. Specifically, commentators asked 

whether actions taken with respect to 

nonqualified deferred compensation 

plans that would not have resulted in 

income inclusion under section 409A 

before 2008 because such actions were 

consistent with applicable guidance, but 

would not be consistent with the final 

regulations, would need to be modified 

to avoid income inclusion under section 

409A in 2008 and later years. The 

following sections discuss the effect of 

the final regulations with respect to the 

requirements necessary to comply with 

section 409A, including the various 

requirements necessary for a plan to be 

excluded from coverage under section 

409A. 

C. Stock Rights 

Many of the comments related to 

stock options and stock appreciation 

rights. Some commentators requested 

that section 409A not apply to any stock 

rights issued before the effective date of 

the final regulations. Neither the statute 

nor the legislative history indicates an 

intent for such a broad exception. The 

Treasury Department and the IRS 

understand that certain aspects of the 

guidance on stock rights have changed. 

However, the final regulations generally 

expand the exclusion from coverage 

under section 409A for certain stock 

rights to eliminate many issues raised 

by the proposed regulations. In 

addition, with respect to certain types of 

stock rights, such as discounted stock 

options, the guidance has explicitly and 

consistently indicated that either rights 

that would be excluded from coverage 

under section 409A must be substituted 

for such rights or such rights must be 

modified to comply with section 409A. 

Accordingly, the final regulations do not 

adopt a categorical exclusion from 

coverage under section 409A of all stock 

rights issued before the issuance of the 

final regulations. 

Commentators also asked whether a 

stock option must be repriced to avoid 

coverage under section 409A if the 

exercise price would be treated as 

having been set at fair market value 

under section 409A under the 

applicable guidance, but would not be 

treated as having been set at fair market 

value if the standard of the final 

regulations had been applicable. For 

this purpose, the guidance provided in 

Notice 2006–4, 2006–3 IRB 307, see 

§ 601.601(d)(2), remains in effect. Notice 

2006–4 provided certain standards 

applicable to stock rights issued before 

January 1, 2005, for determining 

whether the exercise price of such stock 

right would be treated as having been 

set at fair market value for purposes of 

the exclusion from coverage under 

section 409A for certain stock rights. As 

provided in Notice 2006–4, for stock 

rights issued before January 1, 2005, the 

standards applicable to incentive stock 

options under section 422 are 

applicable. Generally this means that 

where the sole reason the stock right 

would fail to qualify for the exclusion 

from coverage under section 409A is 

due to the exercise price not being set 

at or above fair market value, the 

exercise price will be treated as set at or 

above fair market value if based upon a 

good faith attempt by the issuer to set 

the exercise price at or above fair market 

value. As further explained in Notice 

2006–4, for stock rights issued on or 

after January 1, 2005, but before January 

1, 2008, the provisions of Notice 2005–

1 will apply, generally requiring that 

fair market value for purposes of setting 

the exercise price of a stock right must 

be determined using a reasonable 

valuation method. In addition, for stock 

rights issued on any date before January 

1, 2008, taxpayers may rely upon the 

provisions of the proposed or final 

regulations with regard to the 

determination of the fair market value of 

the underlying stock. 

Commentators requested that 

taxpayers not be required to bring stock 

rights granted before January 1, 2008, 

into compliance with section 409A if 

such rights were properly treated as not 

being subject to section 409A under the 

applicable guidance, but instead be 

permitted to keep such rights 

outstanding and unmodified. 

The final regulations significantly 

expand the permissible classes of stock 

and the permissible issuers of stock 

under the service recipient stock rule, 


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and taxpayers may rely on the final 

regulations for periods before the 

effective date of the final regulations. In 

addition, with respect to stock rights 

issued before April 10, 2007 on stock 

that would have constituted service 

recipient stock under a reasonable good 

faith interpretation of the statute and 

applicable guidance, but would not 

constitute service recipient stock under 

the final regulations, such stock will 

continue to constitute service recipient 

stock for purposes of applying section 

409A to such stock right until the 

exercise or termination of such right, or 

until the stock right is modified in a 

manner that is treated as the grant of a 

new right. However, for a stock right 

issued on or after April 10, 2007, stock 

subject to such stock right will not be 

treated as service recipient stock after 

December 31, 2007, unless such stock 

satisfies the requirements of the final 

regulations, and if the stock does not 

satisfy these requirements, such stock 

right will be required to be modified 

either to be excluded from coverage 

under section 409A, or to comply with 

the requirements of section 409A and 

these regulations. 

Commentators also expressed 

concerns about modifications and 

extensions of stock rights that occur 

before January 1, 2008. Different 

concerns and arguments arise 

depending upon whether these 

modifications and extensions occurred 

on or before the enactment of the statute 

(October 23, 2004), on or before the 

issuance of Notice 2005–1 (December 

20, 2004), on or before the issuance of 

the proposed regulations (September 30, 

2005) or on or before the effective date 

of the final regulations (January 1, 

2008). The final regulations significantly 

expand the permissible types of 

modifications and extensions that will 

not result in treatment of the stock right 

as a new grant or as having had a 

deferral feature from the date of grant, 

and taxpayers may rely on these 

regulations for periods before the 

effective date of the regulations. In 

addition, any modifications or 

extensions occurring before the 

enactment of the statute (October 23, 

2004) will not be considered in 

determining whether the right is 

excluded from coverage under section 

409A. Finally, any extension granted 

before April 10, 2007 solely in order to 

give the holder of a stock right an 

additional period of time within which 

to exercise the stock right beyond the 

time originally prescribed is disregarded 

for purposes of the rules treating certain 

extensions as deferral features from the 

time of grant. See § 1.409A–1(b)(5)(v)(C). 

D. Initial Deferral Elections 

Commentators asked whether and to 

what extent the final regulations would 

impact initial deferral elections made 

before the effective date of the final 

regulations. If a deferral election made 

before January 1, 2008, was consistent 

with the proposed regulations or the 

applicable transition guidance, the 

initial deferral election will be deemed 

to comply with the provisions of section 

409A, regardless of whether the period 

of deferral extends beyond December 

31, 2007. 

In addition, commentators asked 

whether and to what extent the final 

regulations would impact programs 

established before the effective date of 

the final regulations, where initial 

deferral elections have not been made 

by January 1, 2008. For example, 

commentators asked how section 409A 

would apply if a service recipient has 

interpreted a program as providing for 

performance-based compensation and 

permitted deferral elections to occur in 

2008 or later in accordance with the 

rules governing deferrals of 

performance-based compensation, but 

such compensation does not qualify as 

performance-based compensation under 

the final regulations. For a program 

established before April 10, 2007 that 

under a reasonable, good faith 

interpretation of the statute and 

applicable guidance would have 

permitted an initial deferral election to 

be made after December 31, 2007, and 

on or before December 31, 2008, an 

initial deferral election will be deemed 

to comply with the initial deferral 

election rules if made by the deadline 

established in the plan. For a program 

established before April 10, 2007 that 

under a reasonable, good faith 

interpretation of the statute and 

applicable guidance would have 

permitted an initial deferral election to 

be made after December 31, 2008, an 

initial deferral election will be deemed 

to comply with the initial deferral 

election rules if made by December 31, 

2008. 

E. Designation of Time and Form of 

Payment 

Notice 2005–1 and the preamble to 

the proposed regulations consistently 

provide that elections as to the time and 

form of payment of deferred 

compensation would need to be 

compliant with the final regulations by 

the time such regulations were effective. 

Both Notice 2005–1 and the preamble to 

the proposed regulations provide 

detailed transition guidance, generally 

permitting service providers and service 

recipients to change the time and form 

of payment at any time through the end 

of the transition period. Accordingly, a 

payment scheme that violates the 

provisions of the final regulations will 

need to be brought into compliance with 

the final regulations in accordance with 

the transition relief. 

F. Service Providers in Pay Status 

Commentators asked how the final 

regulations apply to service providers 

that are already in pay status, where the 

payment trigger is based upon a 

reasonable, good faith interpretation of 

the statute and applicable guidance but 

is not in compliance with the final 

regulations. This may occur where the 

service provider has already begun 

receiving payments before January 1, 

2008, or where all events necessary to 

receive the payment have occurred 

before January 1, 2008. For example, a 

service provider may have been treated 

as having separated from service before 

January 1, 2008, under a reasonable, 

good faith interpretation of the statute, 

but would not be treated as having 

separated from service under the final 

regulations. Where payments have 

commenced before January 1, 2008, the 

plan may continue to make such 

payments consistent with the 

application of the plan terms at the time 

the payments commenced, or may halt 

such payments on or before December 

31, 2007, and amend the time and form 

of any remaining payments to comply 

with the final regulations in accordance 

with the transition guidance provided. 

Where payments have not commenced 

by January 1, 2008, but all the events 

necessary to receive the payment have 

occurred, the plan may make payments 

in accordance with the application of 

the plan terms on December 31, 2007, or 

may amend the time and form of 

payments to comply with section 409A 

in accordance with the transition 

guidance provided. Similarly, where 

payments have not commenced on or 

before December 31, 2007, because the 

service provider was treated as not 

having separated from service under a 

reasonable, good faith interpretation, 

but under the final regulations the 

service provider would be treated as 

having separated from service on or 

before December 31, 2007, the plan 

must treat the service provider as having 

separated from service on a date on or 

after April 10, 2007 and on or before 

December 31, 2007. Nothing in this 

paragraph is to be construed to permit 

the continuation of any payment 

schedule based upon an application of 

section 409A on or before December 31, 

2007, that failed to meet the 

requirements of the applicable 

transition guidance. In addition, nothing 


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in this paragraph is intended to waive 

the application of the constructive 

receipt doctrine or section 451 with 

respect to any discretion provided to the 

service provider (or former service 

provider) with respect to the application 

of these provisions. 

In addition, commentators asked how 

the final regulations would apply in the 

case of the six-month delay for specified 

employees of public corporations. 

Where a separation from service occurs 

on or before December 31, 2007, under 

circumstances that under a reasonable, 

good faith interpretation of the statute 

and applicable guidance would not 

result in application of the six-month 

delay requirement for a payment to a 

specified employee, the beginning or 

continuation of payments of deferred 

compensation on or after January 1, 

2008, will not result in a violation of the 

six-month delay requirement for a 

payment to a specified employee. 

XIII. Additional Transition Relief 

A. Collectively Bargained Plans 

Consistent with Notice 2006–79, 

§ 3.05, the final regulations provide that 

a nonqualified deferred compensation 

plan maintained pursuant to one or 

more collective bargaining agreements 

in effect on October 3, 2004, is not 

required to comply with the provisions 

of section 409A on or before the earlier 

of the date on which the last of such 

collective bargaining agreements 

terminates (determined without regard 

to any extension of any agreement after 

October 3, 2004) or December 31, 2009. 

With respect to amounts deferred 

under a nonqualified deferred 

compensation plan maintained pursuant 

to one or more collective bargaining 

agreements in effect on October 3, 2004, 

the plan may provide, or be amended to 

provide, for new payment elections with 

respect to both the time and form of 

payment of such amounts, and the 

election or amendment will not be 

treated as a change in the time or form 

of payment under section 409A(a)(4) or 

an acceleration of a payment under 

section 409A(a)(3), provided that the 

plan is so amended and elections are 

made before the date on which section 

409A first applies to such plan. A 

deferral election may be made with 

respect to an amount that is a short-term 

deferral within the meaning of 

§ 1.409A–1(b)(4), provided that the 

election is made before the date on 

which section 409A would apply to an 

amount deferred under such plan and 

before January 1 of the calendar year in 

which the amount would otherwise 

have been paid. 

B. Requirement To Amend Plans on or 

Before December 31, 2007 

Where there have been deferrals of 

compensation under a plan as of 

January 1, 2008 but the deferred 

compensation has not been paid, the 

plan must be made compliant with 

section 409A on or before December 31, 

2007, with respect to such deferred 

compensation. These amendments are 

required only to bring the document 

into compliance effective January 1, 

2008, and are not required to reflect any 

amendments made or actions taken 

under the transition rules to the extent 

such amendments or actions do not 

affect the plan’s compliance with 

section 409A and these regulations for 

periods on or after January 1, 2008. For 

example, if a plan contains a haircut 

provision permitting an immediate 

distribution contingent on the forfeiture 

of a certain portion of a deferred 

amount, the haircut provision need not 

be removed retroactively for periods 

before January 1, 2008, where the plan 

has been operated in compliance with 

the applicable transition guidance (and 

thus no payment pursuant to the haircut 

provision has been made after December 

31, 2004). In addition, a plan need not 

be amended to be made compliant with 

section 409A with respect to amounts 

deferred under the plan that were paid 

on or before December 31, 2007, in 

compliance with the transition 

guidance. However, the taxpayer must 

be able to demonstrate that the plan was 

operated in compliance with the 

transition guidance, including 

demonstrating that amounts were 

deferred or paid in compliance with the 

transition rules. For example, where 

payments were made in conjunction 

with elections of payment dates by 

either the service recipient or service 

provider during the transition period, 

the taxpayer must be able to 

demonstrate that the elections were 

provided and made in accordance with 

the transition rules. 

XIV. Calculation and Timing of Income 

Inclusion Amounts, Reporting and 

Withholding 

A. In General 

These regulations do not address the 

calculation and timing of amounts 

required to be included in income under 

section 409A(a). Nor do these 

regulations address the reporting and 

withholding requirements applicable to 

service recipients providing 

nonqualified deferred compensation 

covered by section 409A. The Treasury 

Department and the IRS intend to issue 

further guidance, including such 

transition guidance as may be 

appropriate with respect to the reporting 

and withholding requirements. See 

Notice 2006–100, 51 IRB 1109, for 

transition rules applicable to the 

reporting and withholding requirements 

for 2005 and 2006. See § 601.601(d)(2). 

B. Operational Violations During the 

Transition Period 

Commentators on the proposed 

regulations and Notice 2006–100 asked 

whether a service provider whose 

nonqualified deferred compensation 

plan violated section 409A in operation 

before January 1, 2008, would be 

required to include an amount in 

income under section 409A only in the 

taxable year of the service provider in 

which the operational failure occurred 

(assuming this was the only year of an 

operational failure), or in such year and 

all prior years beginning after December 

31, 2004. Commentators argued that for 

years before the operational violation, 

the taxpayer could be treated as 

operating the plan in reasonable, good 

faith compliance with the statute and 

Notice 2005–1, and therefore should be 

required to include an amount in 

income under section 409A only for the 

year in which the operational violation 

occurred. For example, where a 

taxpayer exercised a discounted stock 

option covered by section 409A in 2006, 

commentators argued that the taxpayer 

should be treated as operating the plan 

in reasonable, good faith compliance 

with section 409A during 2005, so that 

the taxpayer would be required to 

include an amount in income as a result 

of the section 409A violation only to 

2006. 

Where an operational failure occurs in 

2006 or 2007, and no operational 

failures occurred in any prior year, the 

taxpayer (including the service 

recipient) may report the amounts 

required to be included in income under 

section 409A as taxable income only in 

the year of the operational failure. In 

addition, where the violation results 

from a payment, a taxpayer may include 

the required amount in income only for 

the year in which such violation occurs, 

regardless of whether the portion of the 

deferred compensation plan under 

which such payment was made is ever 

amended to comply with the 

requirements of section 409A for 

periods before such payment. For 

example, where a taxpayer exercises a 

discounted stock option subject to 

section 409A in 2006, and there was no 

operational violation in 2005, the 

taxpayer may include an amount in 

income under section 409A for 2006, 

and the taxpayer will not be required to 

include an amount in income with 

respect to such stock option for 2005, 


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even if the taxpayer does not amend the 

stock option to comply with section 

409A for 2005. However, where all or 

part of the total amount deferred in the 

year of the violation was also an amount 

deferred in one or more prior years that 

was not subject to a substantial risk of 

forfeiture in such year, taxpayers are 

also required to calculate and pay any 

applicable tax under section 

409A(a)(1)(B)(i)(I) (based on the amount 

of interest determined under section 

409A(a)(1)(B)(ii)). For example, if the 

discounted stock right in the previous 

example was not subject to a substantial 

risk of forfeiture as of December 31, 

2005, the taxpayer would be required to 

compute and report the additional tax 

under section 409A(a)(1)(B)(i)(I) on the 

taxpayer’s 2006 return. For purposes of 

this paragraph, the service recipient 

should treat the application of section 

409A in the same manner for purposes 

of income tax withholding and reporting 

obligations. 

C. Application of Plan Aggregation 

Rules During the Transition Period 

Notice 2006–100 provides that where 

there is a required income inclusion 

under section 409A in 2006, the plan 

aggregation rules apply in determining 

the amount includible in income. 

Commentators asked whether the plan 

aggregation rules would apply where 

the taxpayer violates section 409A in 

2006 with respect to one arrangement 

(the first arrangement), but retains the 

right to modify another arrangement 

(the second arrangement) to exclude a 

right to an amount provided under the 

second arrangement from coverage 

under section 409A, where the second 

arrangement would otherwise be 

aggregated with the first arrangement. 

For this purpose, if the legally binding 

right to the amount under the second 

arrangement ultimately is modified 

(including, where permitted by 

applicable guidance, by the substitution 

of another right for such right), so that 

the right to the amount is excluded from 

coverage under section 409A, then the 

right to the amount is treated as always 

having been excluded from coverage 

under section 409A. Accordingly, the 

amount payable under the second 

arrangement would not be required to 

be aggregated with the first arrangement 

for purposes of determining the amount 

includible in income under section 

409A. However, if the right to the 

amount under the second arrangement 

is not timely modified to be excluded 

from coverage under section 409A, the 

right to the amount under the second 

arrangement will remain subject to the 

plan aggregation rules regardless of 

whether the second arrangement is, or is 

amended to be, compliant with the 

requirements of section 409A. In such a 

case, because the right to the amount 

under the second arrangement could 

have been modified to be excluded from 

coverage under section 409A, and 

would not have been subject to the plan 

aggregation rules, the violation with 

respect to the second arrangement is not 

treated as occurring until the first 

taxable year of the service provider 

during which the arrangement could not 

have been so modified. 

For example, assume a taxpayer with 

a calendar year taxable year exercised a 

discounted stock right during 2006 in 

violation of section 409A and that the 

taxpayer held another unexercised 

discounted stock right described in 

Notice 2006–79, § 3.07 (relating to 

certain stock rights issued to corporate 

insiders) that could have been modified 

by December 31, 2006, to be excluded 

from coverage (by exchanging such 

stock right for another stock right 

pursuant to the preamble to the 

proposed regulations). If the 

unexercised stock right was not so 

modified by December 31, 2006, it 

would violate section 409A on January 

1, 2007. Alternatively, assume a second 

taxpayer exercised a discounted stock 

right in 2006 in violation of section 

409A and that taxpayer held another 

unexercised discounted stock right (not 

described in Notice 2006–79, § 3.07) 

that could have been modified by 

December 31, 2007, to be excluded from 

coverage. If the second taxpayer failed 

to timely modify such unexercised stock 

right, the unexercised stock right would 

violate section 409A on January 1, 2008. 

D. Failures to Amend During the 

Transition Period to Comply With the 

Rules of Section 409A 

Commentators asked how section 

409A and these regulations would apply 

to a plan that was operated in 

compliance with the transition guidance 

through December 31, 2007, but is not 

amended to become compliant with 

section 409A and these regulations by 

December 31, 2007. For these purposes, 

the plan will be treated as failing to 

comply with the requirements of section 

409A and these regulations as of January 

1, 2008, so that no amounts will be 

required to be included in income under 

section 409A with respect to such a 

violation for any taxable year ending 

before January 1, 2008. However, this 

does not affect the application of the tax 

imposed by section 409A(a)(1)(B)(i)(I) to 

amounts that were deferred in taxable 

years ending before January 1, 2008, to 

the extent that such amounts were not 

subject to a substantial risk of forfeiture 

in one or more of such earlier taxable 

years. 

XV. Offshore Trusts and Arrangements 

With Financial Triggers 

These regulations do not address the 

application of section 409A(b), generally 

prohibiting the use of offshore trusts 

associated with nonqualified deferred 

compensation plans, and the use of 

triggers whereby amounts held in a trust 

or other arrangement become restricted 

to the use for payment of nonqualified 

deferred compensation upon an event 

related to the financial health of the 

service recipient. For transition 

guidance related to the application of 

section 409A(b) to certain outstanding 

arrangements, see Notice 2006–33, 

2006–15 IRB 754. See § 601.601(d)(2). 

Taxpayers may continue to rely upon 

Notice 2006–33 until further guidance is 

issued. 

Applicability Date 

These regulations are applicable for 

taxable years beginning on or after 

January 1, 2008. Taxpayers may relay on 

the provisions of these final regulations 

for taxable years beginning before 

January 1, 2008. 

Effect on Other Documents 

Notice 2005–1, 2005–1 CB 274, is 

obsoleted for taxable years beginning on 

or after January 1, 2008, except for the 

following sections of the guidance 

which remain effective as modified by 

any other applicable guidance: Q&A–6 

(application to arrangements covered by 

section 457); Q&A–7 (application to 

arrangements between a partnership and 

a partner of the partnership); and Q&A–

24 through Q&A–38 (information 

reporting and withholding guidance). 

For a discussion of the effect of reliance 

upon Notice 2005–1 or the proposed 

regulations for taxable years beginning 

before January 1, 2008, for arrangements 

continuing into taxable years beginning 

on or after January 1, 2008, see section 

XII of this preamble. See § 601.601(d)(2). 

Notice 2006–4, 2006–3 IRB 307, 

addressing certain stock rights issued 

before January 1, 2008, is superseded by 

these final regulations with respect to 

stock rights issued in taxable years of 

the service provider beginning on or 

after January 1, 2008. For a discussion 

of the effect of reliance upon Notice 

2005–1, Notice 2006–4, or the proposed 

regulations for taxable years beginning 

before January 1, 2008, for stock rights 

remaining outstanding on or after 

January 1, 2008, see section XII of this 

preamble. 

Notice 2006–33, 2006–15 IRB 754, 

Notice 2006–79, 2006–43 IRB 763, and 

Notice 2006–100, 2006–51 IRB 1109, are 


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not affected by these final regulations. 

Notice 2006–64, 2006–29 IRB 88, is 

superseded by the final regulations 

effective for taxable years of a service 

provider beginning on or after January 1, 

2008. See § 601.601(d)(2). 

Special Analyses 

It has been determined that this 

Treasury decision 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, the notice 

of proposed rulemaking preceding these 

regulations was submitted to the Chief 

Counsel for Advocacy of the Small 

Business Administration for comment 

on its impact on small business. 

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. 

Adoption of Amendments to the 

Regulations 

■ Accordingly, 26 CFR part 1 is 

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. Sections 1.409A–0 through 

1.409A–6 are added to read as follows: 

§ 1.409A–0 Table of contents. 

This section lists captions contained 

in §§ 1.409A–1, 1.409A–2, 1.409A–3, 

1.409A–4, 1.409A–5 and 1.409A–6. 

§ 1.409A–1 Definitions and covered plans. 

(a) Nonqualified deferred compensation plan. 

(1) In general. 

(2) Qualified employer plans. 

(3) Certain foreign plans. 

(i) Participation addressed by treaty. 

(ii) Participation by nonresident aliens, 

certain resident aliens, and bona fide 

residents of possessions. 

(iii) Participation by U.S. citizens and lawful 

permanent residents. 

(iv) Plans subject to a totalization agreement 

and similar plans. 

(v) Broad-based foreign retirement plan. 

(4) Section 457 plans. 

(5) Certain welfare benefits. 

(b) Deferral of compensation 

(1) In general. 

(2) Earnings. 

(3) Compensation payable pursuant to the 

service recipient’s customary payment 

timing arrangement. 

(4) Short-term deferrals. 

(i) In general. 

(ii) Certain delayed payments. 

(iii) Examples. 

(5) Stock options, stock appreciation rights, 

and other equity-based compensation. 

(i) Stock rights. 

(A) Nonstatutory stock options not providing 

for the deferral of compensation. 

(B) Stock appreciation rights not providing 

for the deferral of compensation. 

(C) Stock rights that may provide for the 

deferral of compensation. 

(D) Feature for the deferral of compensation. 

(E) Rights to dividends. 

(ii) Statutory stock options. 

(iii) Service recipient stock. 

(A) In general. 

(B) American depositary receipts. 

(C) Mutual company units. 

(D) Other entities. 

(E) Eligible issuer of service recipient stock. 

(1) In general. 

(2) Investment vehicles. 

(3) Corporate structures established or 

transactions undertaken for purposes of 

avoiding coverage under section 409A. 

(4) Substitutions and assumptions by reason 

of a corporate transaction. 

(iv) Determination of the fair market value of 

service recipient stock. 

(A) Stock readily tradable on an established 

securities market. 

(B) Stock not readily tradable on an 

established securities market. 

(1) In general. 

(2) Presumption of reasonableness. 

(3) Use of alternative methods. 

(v) Modifications, extensions, substitutions, 

and assumptions of stock rights. 

(A) Treatment of modified and extended 

stock rights. 

(B) Modification in general. 

(C) Extensions. 

(1) In general. 

(2) Certain extensions before April 10, 2007. 

(3) Examples. 

(D) Substitutions and assumptions of stock 

rights by reason of a corporate 

transaction. 

(E) Acceleration of date when exercisable. 

(F) Discretionary added benefits. 

(G) Change in underlying stock increasing 

value. 

(H) Change in the number of shares 

purchasable. 

(I) Rescission of changes. 

(J) Successive modifications and extensions. 

(K) Modifications and extensions in effect on 

October 23, 2004. 

(vi) Meaning and use of certain terms. 

(A) Option. 

(B) Date of grant of option. 

(C) Stock. 

(D) Exercise price. 

(E) Exercise. 

(F) Transfer. 

(G) Readily tradable. 

(H) Application to stock appreciation rights. 

(6) Restricted property, section 402(b) trusts, 

and section 403(c) annuities. 

(i) In general. 

(ii) Promises to transfer property. 

(7) Arrangements between partnerships and 

partners. [Reserved] 

(8) Certain foreign plans. 

(i) Plans with respect to compensation 

covered by treaty or other international 

agreement. 

(ii) Plans with respect to certain other 

compensation. 

(iii) Tax equalization agreements. 

(iv) Certain limited deferrals of a nonresident 

alien. 

(v) Additional foreign plans. 

(vi) Earnings. 

(9) Separation pay plans. 

(i) In general. 

(ii) Collectively bargained separation pay 

plans. 

(iii) Separation pay due to involuntary 

separation from service or participation 

in a window program. 

(iv) Foreign separation pay plans. 

(v) Reimbursements and certain other 

separation payments. 

(A) In general. 

(B) Medical benefits. 

(C) In-kind benefits and direct service 

recipient payments. 

(D) Limited payments. 

(E) Limited period of time. 

(vi) Window programs—definition. 

(10) Certain indemnification and liability 

insurance plans. 

(11) Legal settlements. 

(12) Certain educational benefits. 

(c) Plan. 

(1) In general. 

(2) Plan aggregation rules. 

(i) In general. 

(ii) Dual status. 

(3) Establishment of plan. 

(i) In general. 

(ii) Initial deferral election provisions. 

(iii) Subsequent deferral election provisions. 

(iv) Payment accelerations. 

(v) Six-month delay for specified employees. 

(vi) Plan amendments. 

(vii) Transition rule for written plan 

requirement. 

(viii) Plan aggregation rules. 

(d) Substantial risk of forfeiture. 

(1) In general. 

(2) Stock rights. 

(3) Enforcement of forfeiture condition. 

(i) In general. 

(ii) Examples. 

(e) Performance-based compensation. 

(1) In general. 

(2) Payments based upon subjective 

performance criteria. 

(3) Equity-based compensation. 

(f) Service provider. 

(1) In general. 

(2) Independent contractors. 

(i) In general. 

(ii) Related person. 

(iii) Significant services. 


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(iv) Management services. 

(v) Services provided to related persons. 

(g) Service recipient. 

(h) Separation from service. 

(1) Employees. 

(i) In general. 

(ii) Termination of employment. 

(2) Independent contractors. 

(i) In general. 

(ii) Special rule. 

(3) Definition of service recipient and 

employer. 

(4) Asset purchase transactions. 

(5) Dual status. 

(6) Collectively bargained plans covering 

multiple employers. 

(i) Specified employee. 

(1) In general. 

(2) Definition of compensation. 

(3) Specified employee identification date. 

(4) Specified employee effective date. 

(5) Alternative methods of satisfying the sixmonth delay rule. 

(6) Corporate transactions. 

(i) Mergers and acquisitions of public service 

recipients. 

(ii) Mergers and acquisitions of nonpublic 

service recipients. 

(iii) Spinoffs. 

(iv) Public offerings and other corporate 

transactions. 

(v) Alternative methods of compliance. 

(7) Nonresident alien employees. 

(8) Elections affecting the identification of 

specified employees. 

(j) Nonresident alien. 

(k) Established securities market. 

(l) Stock right. 

(m) Separation pay plan. 

(n) Involuntary separation from service. 

(1) In general. 

(2) Separations from service for good reason. 

(i) In general. 

(ii) Safe harbor. 

(3) Special rule for certain collectively 

bargained plans. 

(o) Earnings. 

(p) In-kind benefits. 

(q) Application of definitions and rules. 

§ 1.409A–2 Deferral elections. 

(a) Initial elections as to the time and form 

of payment. 

(1) In general. 

(2) Service recipient elections. 

(3) General rule. 

(4) Initial deferral election with respect to 

short-term deferrals. 

(5) Initial deferral election with respect to 

certain forfeitable rights. 

(6) Initial deferral election with respect to 

fiscal year compensation. 

(7) First year of eligibility. 

(i) In general. 

(ii) Eligibility to participate. 

(iii) Application to excess benefit plans. 

(8) Initial deferral election with respect to 

performance-based compensation. 

(9) Nonqualified deferred compensation 

plans linked to qualified employer plans 

or certain other arrangements. 

(10) Changes in elections under a cafeteria 

plan. 

(11) Initial deferral election with respect to 

certain separation pay. 

(12) Initial deferral election with respect to 

certain commissions. 

(i) Sales commission compensation. 

(ii) Investment commission compensation. 

(iii) Commission compensation and related 

persons. 

(13) Initial deferral election with respect to 

compensation paid for final payroll 

period. 

(i) In general. 

(ii) Transition rule. 

(14) Elections to annualize recurring partyear compensation. 

(15) USERRA rights. 

(b) Subsequent changes in time and form of 

payment. 

(1) In general. 

(2) Definition of payments for purposes of 

subsequent changes in the time and form 

of payment. 

(i) In general. 

(ii) Life annuities. 

(A) In general. 

(B) Certain features disregarded. 

(C) Subsidized joint and survivor annuities. 

(D) Actuarial assumptions and methods. 

(iii) Installment payments. 

(iv) Transition rule. 

(3) Beneficiaries. 

(4) Domestic relations orders. 

(5) Coordination with prohibition against 

acceleration of payments. 

(6) Application to multiple payment events. 

(7) Delay of payments under certain 

circumstances. 

(i) Payments subject to section 162(m). 

(ii) Payments that would violate Federal 

securities laws or other applicable law. 

(iii) Other events and conditions. 

(8) USERRA rights. 

(9) Examples. 

(c) Special rules for certain resident aliens. 

§ 1.409A–3 Permissible payments 

(a) In general. 

(b) Designation of payment upon a 

permissible payment event. 

(c) Designation of alternative specified dates 

or payment schedules based upon date of 

permissible event. 

(d) When a payment is treated as made upon 

the designated payment date. 

(e) Designation of time and form of payment 

with respect to earnings. 

(f) Substitutions. 

(g) Disputed payments and refusals to pay. 

(h) Special rule for certain resident aliens. 

(i) Definitions and special rules. 

(1) Specified time or fixed schedule. 

(i) In general. 

(ii) Payment schedules with formula and 

fixed limitations. 

(A) Individual limitations. 

(B) Limitations on aggregate payments to all 

participants in substantially identical 

plans. 

(iii) Payment schedules determined by timing 

of payments received by the service 

recipient. 

(iv) Reimbursement or in-kind benefit plans. 

(A) General rule. 

(B) Medical reimbursement arrangements. 

(v) Tax gross-up payments. 

(vi) Examples. 

(2) Separation from service—required delay 

in payment to a specified employee 

pursuant to a separation from service. 

(i) In general. 

(ii) Application of payment rules to delayed 

payments. 

(3) Unforeseeable emergency. 

(i) Definition. 

(ii) Amount of payment permitted upon an 

unforeseeable emergency. 

(iii) Payments due to an unforeseeable 

emergency. 

(4) Disability. 

(i) In general. 

(ii) Limited plan definition of disability. 

(iii) Determination of disability. 

(5) Change in the ownership or effective 

control of a corporation, or a change in 

the ownership of a substantial portion of 

the assets of a corporation. 

(i) In general. 

(ii) Identification of relevant corporation. 

(A) In general. 

(B) Majority shareholder. 

(C) Example. 

(iii) Attribution of stock ownership. 

(iv) Special rules for certain delayed 

payments pursuant to a change in 

control event. 

(A) Certain transaction-based compensation. 

(B) Certain nonvested compensation. 

(v) Change in the ownership of a corporation. 

(A) In general. 

(B) Persons acting as a group. 

(vi) Change in the effective control of a 

corporation. 

(A) In general. 

(B) Multiple change in control events. 

(C) Acquisition of additional control. 

(D) Persons acting as a group. 

(vii) Change in the ownership of a substantial 

portion of a corporation’s assets. 

(A) In general. 

(B) Transfers to a related person. 

(C) Persons acting as a group. 

(6) Certain back-to-back arrangements. 

(i) In general. 

(ii) Example. 

(j) Prohibition on acceleration of payments. 

(1) In general. 

(2) Application to multiple payment events. 

(3) Beneficiaries. 

(4) Exceptions. 

(i) In general. 

(ii) Domestic relations order. 

(iii) Conflicts of interest. 

(A) Compliance with ethics agreements with 

the Federal government. 

(B) Compliance with ethics laws or conflicts 

of interest laws. 

(iv) Section 457 plans. 

(v) Limited cashouts. 

(vi) Payment of employment taxes. 

(vii) Payment upon income inclusion under 

section 409A. 

(viii) Cancellation of deferrals following an 

unforeseeable emergency or hardship 

distribution. 

(ix) Plan terminations and liquidations. 

(x) Certain distributions to avoid a 

nonallocation year under section 409(p). 

(xi) Payment of state, local, or foreign taxes. 

(xii) Cancellation of deferral elections due to 

disability. 

(xiii) Certain offsets. 

(xiv) Bona fide disputes as to a right to a 

payment. 

(5) Nonqualified deferred compensation 

plans linked to qualified employer plans 

or certain other arrangements. 

(6) Changes in elections under a cafeteria 

plan. 


sroberts on PROD1PC70 with RULES
19278 Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 

§ 1.409A–4 Calculation of income inclusion 

[Reserved] 

§ 1.409A–5 Funding [Reserved] 

§ 1.409A–6 Application of section 409A and 

effective dates. 

(a) Statutory application and effective dates 

(1) Application to amounts deferred. 

(i) In general. 

(ii) Collectively bargained plans. 

(2) Identification of date of deferral for 

statutory effective date purposes. 

(3) Calculation of amount of compensation 

deferred for statutory effective date 

purposes. 

(i) Nonaccount balance plans. 

(ii) Account balance plans. 

(iii) Equity-based compensation plans. 

(iv) Earnings. 

(v) Definition of plan. 

(4) Material modifications. 

(i) In general. 

(ii) Adoptions of new plans. 

(iii) Suspension or termination of a plan. 

(iv) Changes to investment measures—

account balance plans. 

(v) Stock rights. 

(vi) Rescission of modifications. 

(vii) Definition of plan. 

(b) Regulatory applicability date. 

§ 1.409A–1 Definitions and covered plans. 

(a) Nonqualified deferred 

compensation plan—(1) In general. 

Except as otherwise provided in this 

paragraph (a), the term nonqualified 

deferred compensation plan means any 

plan (within the meaning of paragraph 

(c) of this section) that provides for the 

deferral of compensation (within the 

meaning of paragraph (b) of this 

section). Whether a plan provides for 

the deferral of compensation generally 

is determined at the time the service 

provider obtains a legally binding right 

to the compensation under the plan, and 

is not affected by any retroactive change 

to the plan to characterize the right as 

one that does not provide for the 

deferral of compensation. For example, 

amounts deferred under a nonqualified 

deferred compensation plan do not 

become an excluded death benefit if the 

plan is amended so that the amounts are 

payable only upon the death of the 

service provider. If a principal purpose 

of a plan is to achieve a result with 

respect to a deferral of compensation 

that is inconsistent with the purposes of 

section 409A, the Commissioner may 

treat the plan as a nonqualified deferred 

compensation plan for purposes of 

section 409A and the regulations 

thereunder. 

(2) Qualified employer plans. The 

term nonqualified deferred 

compensation plan does not include a 

qualified employer plan. The term 

qualified employer plan means any of 

the following plans: 

(i) Any plan described in section 

401(a) and a trust exempt from tax 

under section 501(a) or that is described 

in section 402(d). 

(ii) Any annuity plan described in 

section 403(a). 

(iii) Any annuity contract described in 

section 403(b). 

(iv) Any simplified employee pension 

(within the meaning of section 408(k)). 

(v) Any simple retirement account 

(within the meaning of section 408(p)). 

(vi) Any plan under which an active 

participant makes deductible 

contributions to a trust described in 

section 501(c)(18). 

(vii) Any eligible deferred 

compensation plan (within the meaning 

of section 457(b)). 

(viii) Any plan described in section 

415(m). 

(ix) Any plan described in § 1022(i)(2) 

of the Employee Retirement Income 

Security Act of 1974, Public Law 93–

406 (88 Stat. 829, 942) (Sept. 2, 1974) 

(ERISA). 

(3) Certain foreign plans—(i) 

Participation addressed by treaty. With 

respect to an individual for a taxable 

year, the term nonqualified deferred 

compensation plan does not include 

any scheme, trust, arrangement, or plan 

maintained with respect to such 

individual, to the extent contributions 

made by or on behalf of such individual 

to such scheme, trust, arrangement, or 

plan, or credited allocations, accrued 

benefits, earnings, or other amounts 

constituting income, of such individual 

under such scheme, trust, arrangement, 

or plan, are excludable by such 

individual for Federal income tax 

purposes pursuant to any bilateral 

income tax convention to which the 

United States is a party. 

(ii) Participation by nonresident 

aliens, certain resident aliens, and bona 

fide residents of possessions. With 

respect to an alien individual for a 

taxable year during which such 

individual is a nonresident alien, a 

resident alien classified as a resident 

alien solely under section 

7701(b)(1)(A)(ii) (and not section 

7701(b)(1)(A)(i)), or a bona fide resident 

of a possession (within the meaning of 

section 937(a)), the term nonqualified 

deferred compensation plan does not 

include any broad-based foreign 

retirement plan (within the meaning of 

paragraph (a)(3)(v) of this section). 

(iii) Participation by U.S. citizens and 

lawful permanent residents. With 

respect to an individual for a given 

taxable year during which such 

individual is a U.S. citizen or a resident 

alien classified as a resident alien under 

section 7701(b)(1)(A)(i), other than an 

individual who is also a bona fide 

resident of a possession (within the 

meaning of section 937(a)), the term 

nonqualified deferred compensation 

plan does not include a broad-based 

foreign retirement plan (within the 

meaning of paragraph (a)(3)(v) of this 

section), but only with respect to a plan, 

or a portion of a plan where such 

portion may be distinguished, providing 

for nonelective deferrals of modified 

foreign earned income, and earnings 

with respect to such nonelective 

deferrals, and only to the extent that the 

amounts deferred under all such plans 

of the service recipient, or all portions 

of such plans, in which the service 

provider participates in such taxable 

year, do not exceed the applicable limits 

under section 415(b) (applied to 

nonaccount balance plans as defined in 

paragraph (c)(2)(i)(C) of this section) and 

section 415(c) (applied to account 

balance plans as defined in paragraph 

(c)(2)(i)(A) of this section) that would be 

applicable if such plans were plans 

subject to section 415 and the modified 

foreign earned income of such 

individual were treated as 

compensation for purposes of applying 

section 415(b) and (c). For purposes of 

this paragraph (a)(3)(iii), the term 

modified foreign earned income means 

foreign earned income as defined in 

section 911(b)(1) without regard to 

section 911(b)(1)(B)(iv) and without 

regard to the requirement that the 

income be attributable to services 

performed during the period described 

in section 911(d)(1)(A) or (B). The 

provisions of this paragraph (a)(3)(iii) do 

not apply to any individual with respect 

to any taxable year in which the 

individual is simultaneously eligible to 

participate in a broad-based foreign 

retirement plan and a qualified 

employer plan described in paragraph 

(a)(2) of this section. For purposes of 

this paragraph (a)(3)(iii), an individual 

is eligible to participate in a qualified 

employer plan if under the terms of the 

plan and without further amendment or 

action by the plan sponsor, the 

individual is eligible to make or receive 

contributions or accrue benefits under 

the plan (regardless of whether the 

individual has elected to participate in 

the plan). 

(iv) Plans subject to a totalization 

agreement and similar plans. The term 

nonqualified deferred compensation 

plan does not include any social 

security system of a jurisdiction to the 

extent that benefits provided under or 

contributions made to the system are 

subject to an agreement entered into 

pursuant to section 233 of the Social 

Security Act (42 U.S.C. 433) with any 

foreign jurisdiction. In addition, the 

term nonqualified deferred 

compensation plan does not include a 


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social security system of a foreign 

jurisdiction to the extent that benefits 

are provided under or contributions are 

made to a government-mandated plan as 

part of that foreign jurisdiction’s social 

security system. 

(v) Broad-based foreign retirement 

plan. The term broad-based foreign 

retirement plan means a scheme, trust, 

arrangement, or plan (regardless of 

whether sponsored by a U.S. person) 

that is written and that, in the case of 

an employer-maintained plan, satisfies 

the following conditions: 

(A) The plan is nondiscriminatory 

insofar as the employees who, under the 

terms of the plan (alone or in 

combination with other comparable 

plans) and without further amendment 

or action by the employer, are eligible 

to make or receive contributions or 

accrue benefits under the plan other 

than earnings (regardless of whether the 

employee has elected to participate in 

the plan), are a wide range of 

employees, substantially all of whom 

are nonresident aliens, resident aliens 

classified as resident aliens solely under 

section 7701(b)(1)(A)(ii) (and not section 

7701(b)(1)(A)(i)), or bona fide residents 

of a possession (within the meaning of 

section 937(a)), including rank and file 

employees. 

(B) The plan (alone or in combination 

with other comparable plans) actually 

provides significant benefits for a 

substantial majority of such covered 

employees. 

(C) The benefits actually provided 

under the plan to such covered 

employees are nondiscriminatory. 

(D) The plan contains provisions or is 

the subject of tax law provisions or 

other legal restrictions that generally 

discourage employees from using plan 

benefits for purposes other than 

retirement or restrict access to plan 

benefits before separation from service, 

including (but not limited to), restricting 

in-service distributions except in events 

similar to an unforeseeable emergency 

(as defined in § 1.409A–3(i)(3)(i)) or 

hardship (as defined for purposes of 

section 401(k)(2)(B)(i)(IV)), or for 

educational purposes or the purchase of 

a primary residence. 

(4) Section 457 plans. A nonqualified 

deferred compensation plan under 

section 457(f) may constitute a 

nonqualified deferred compensation 

plan for purposes of this paragraph (a). 

The rules of section 409A apply to 

nonqualified deferred compensation 

plans separately and in addition to any 

requirements applicable to such plans 

under section 457(f). In addition, 

nonelective deferred compensation of 

non-employees described in section 

457(e)(12) and a grandfathered plan or 

arrangement described in § 1.457–

2(k)(4) may constitute a nonqualified 

deferred compensation plan for 

purposes of this paragraph (a). The term 

nonqualified deferred compensation 

plan does not include a length of service 

award to a bona fide volunteer under 

section 457(e)(11)(A)(ii). For purposes of 

the application of section 409A to a plan 

to which section 457 applies, a payment 

under the plan generally means the 

provision of cash or property to the 

service provider, provided that for 

purposes of the application of the shortterm deferral rule set forth in paragraph 

(b)(4) of this section, the inclusion in 

income of an amount under section 

457(f) is treated as a payment of the 

amount. 

(5) Certain welfare benefits. The term 

nonqualified deferred compensation 

plan does not include any bona fide 

vacation leave, sick leave, compensatory 

time, disability pay, or death benefit 

plan. For these purposes, the term 

‘‘disability pay’’ has the same meaning 

as provided in § 31.3121(v)(2)–

1(b)(4)(iv)(C) of this chapter, and the 

term death benefit plan refers to a plan 

providing death benefits as defined in 

§ 31.3121(v)(2)–1(b)(4)(iv)(C) of this 

chapter, provided that for purposes of 

this paragraph, such disability pay and 

death benefits may be provided through 

insurance and the lifetime benefits 

payable under the plan are not treated 

as including the value of any taxable 

term life insurance coverage or taxable 

disability insurance coverage provided 

under the plan. The term nonqualified 

deferred compensation plan also does 

not include any Archer Medical Savings 

Account as described in section 220, 

any Health Savings Account as 

described in section 223, or any other 

medical reimbursement arrangement, 

including a health reimbursement 

arrangement, that satisfies the 

requirements of section 105 and section 

106 such that the benefits or 

reimbursements provided under such 

arrangement are not includible in 

income. 

(b) Deferral of compensation—(1) In 

general. Except as otherwise provided 

in paragraphs (b)(3) through (b)(12) of 

this section, a plan provides for the 

deferral of compensation if, under the 

terms of the plan and the relevant facts 

and circumstances, the service provider 

has a legally binding right during a 

taxable year to compensation that, 

pursuant to the terms of the plan, is or 

may be payable to (or on behalf of) the 

service provider in a later taxable year. 

Such compensation is deferred 

compensation for purposes of section 

409A, this section and §§ 1.409A–2 

through 1.409A–6. A legally binding 

right to an amount that will be excluded 

from income when and if received does 

not constitute a deferral of 

compensation, unless the service 

provider has received the right in 

exchange for, or has the right to 

exchange the right for, an amount that 

will be includible in income (other than 

due to participation in a cafeteria plan 

described in section 125). A service 

provider does not have a legally binding 

right to compensation to the extent that 

compensation may be reduced 

unilaterally or eliminated by the service 

recipient or other person after the 

services creating the right to the 

compensation have been performed. 

However, if the facts and circumstances 

indicate that the discretion to reduce or 

eliminate the compensation is available 

or exercisable only upon a condition, or 

the discretion to reduce or eliminate the 

compensation lacks substantive 

significance, a service provider will be 

considered to have a legally binding 

right to the compensation. Whether the 

discretion to reduce or eliminate the 

compensation lacks substantive 

significance depends on all the relevant 

facts and circumstances. However, 

where the service provider to whom the 

compensation may be paid has effective 

control of the person retaining the 

discretion to reduce or eliminate the 

compensation, or has effective control 

over any portion of the compensation of 

the person retaining the discretion to 

reduce or eliminate the compensation, 

or is a member of the family (as defined 

in section 267(c)(4) applied as if the 

family of an individual includes the 

spouse of any member of the family) of 

the person retaining the discretion to 

reduce or eliminate the compensation, 

the discretion to reduce or eliminate the 

compensation will not be treated as 

having substantive significance. For this 

purpose, compensation is not 

considered subject to unilateral 

reduction or elimination merely because 

it may be reduced or eliminated by 

operation of the objective terms of the 

plan, such as the application of a 

nondiscretionary, objective provision 

creating a substantial risk of forfeiture. 

Similarly, a service provider does not 

fail to have a legally binding right to 

compensation merely because the 

amount of compensation is determined 

under a formula that provides for 

benefits to be offset by benefits provided 

under another plan (including a plan 

that is qualified under section 401(a)), 

or because benefits are reduced due to 

actual or notional investment losses, or, 

in a final average pay plan, subsequent 

decreases in compensation. 


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19280 Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 

(2) Earnings. References to the 

deferral of compensation or deferred 

compensation include references to 

earnings. When the right to earnings is 

specified under the terms of the plan, 

the legally binding right to earnings 

arises at the time of the deferral of the 

compensation to which the earnings 

relate. A plan may provide that the time 

and form of payment of earnings is 

treated separately from the time and 

form of payment of the underlying 

compensation, so that, provided that the 

rules of section 409A are otherwise met, 

a plan may provide that earnings will be 

paid at a separate time or in a separate 

form from the payment of the 

underlying compensation. For the 

application of the deferral election rules 

to current payments of earnings and 

dividend equivalents, see § 1.409A–3(e). 

(3) Compensation payable pursuant to 

the service recipient’s customary 

payment timing arrangement. A deferral 

of compensation does not occur solely 

because compensation is paid after the 

last day of the service provider’s taxable 

year pursuant to the timing arrangement 

under which the service recipient 

normally compensates service providers 

for services performed during a payroll 

period described in section 3401(b), or 

with respect to a non-employee service 

provider, a period not longer than the 

payroll period described in section 

3401(b) or if no such payroll period 

exists, a period not longer than the 

earlier of the normal timing arrangement 

under which the service provider 

normally compensates non-employee 

service providers or 30 days after the 

end of the service provider’s taxable 

year. 

(4) Short-term deferrals—(i) In 

general. A deferral of compensation 

does not occur if the plan under which 

a payment (as defined in § 1.409A–

2(b)(2)) is made does not provide for a 

deferred payment and the service 

provider actually or constructively 

receives such payment on or before the 

last day of the applicable 21⁄2 month 

period. The following rules apply for 

purposes of this paragraph (b)(4)(i): 

(A) The applicable 21⁄2 month period 

is the period ending on the later of the 

15th day of the third month following 

the end of the service provider’s first 

taxable year in which the right to the 

payment is no longer subject to a 

substantial risk of forfeiture or the 15th 

day of the third month following the 

end of the service recipient’s first 

taxable year in which the right to the 

payment is no longer subject to a 

substantial risk of forfeiture. 

(B) A payment is treated as actually or 

constructively received if the payment 

is includible in income, including if the 

payment is includible in income under 

section 83, the economic benefit 

doctrine, section 402(b), or section 

457(f). 

(C) A right to a payment that is never 

subject to a substantial risk of forfeiture 

is considered to be no longer subject to 

a substantial risk of forfeiture on the 

first date the service provider has a 

legally binding right to the payment. 

(D) A plan provides for a deferred 

payment if the plan provides that any 

payment will be made or completed on 

or after any date, or upon or after the 

occurrence of any event, that will or 

may occur later than the end of the 

applicable 21⁄2 month period, such as a 

separation from service, death, 

disability, change in control event, 

specified time or schedule of payment, 

or unforeseeable emergency, regardless 

of whether an amount is actually paid 

as a result of the occurrence of such a 

payment date or event during the 

applicable 21⁄2 month period. If a plan 

provides that the service provider or 

service recipient may make an election 

under the plan (including an election 

under § 1.409A–2(a)(4)) of a different 

payment date, schedule, or event, such 

right is disregarded for this purpose. In 

such cases, whether a plan provides for 

a deferred payment is determined based 

on the payment date, schedule, or event 

that would apply if no such election 

were made, except that if the plan 

would not provide for a deferred 

payment absent such an election, and 

the service provider or service recipient 

makes such an election, whether the 

plan provides for a deferred payment is 

determined based upon the payment 

date, schedule, or event that the service 

provider or service recipient in fact 

elected. 

(E) A stock right provides for a 

deferred payment if such right includes 

any provision pursuant to which the 

holder of the stock right will or may 

have the right to exercise the stock right 

after the applicable 21⁄2 month period. 

(F) This paragraph (b)(4)(i) is applied 

separately to each payment (as defined 

in § 1.409A–2(b)(2)) required to be made 

under a plan. 

(G) If a plan provides for a deferred 

payment with respect to part of a 

payment (for example a life annuity or 

a series of installment amounts treated 

as a single payment), the plan provides 

for a deferred payment with respect to 

the entire payment. 

(ii) Certain delayed payments. A 

payment that otherwise qualifies as a 

short-term deferral under paragraph 

(b)(4)(i) of this section but is made after 

the applicable 21⁄2 month period may 

continue to qualify as a short-term 

deferral if the taxpayer establishes that 

it was administratively impracticable to 

make the payment by the end of the 

applicable 21⁄2 month period and, as of 

the date upon which the legally binding 

right to the compensation arose, such 

impracticability was unforeseeable, or 

the taxpayer establishes that making the 

payment by the end of the applicable 

21⁄2 month period would have 

jeopardized the ability of the service 

recipient to continue as a going concern, 

and provided further that the payment 

is made as soon as administratively 

practicable or as soon as the payment 

would no longer have such effect. For 

purposes of this paragraph (b)(4)(ii), an 

action or failure to act of the service 

provider or a person under the service 

provider’s control, such as a failure to 

provide necessary information or 

documentation, is not an unforeseeable 

event. In addition, a payment that 

otherwise qualifies as a short-term 

deferral under paragraph (b)(4)(i) of this 

section but is made after the applicable 

21⁄2 month period may continue to 

qualify as a short-term deferral if the 

taxpayer establishes that the service 

recipient reasonably anticipated that the 

service recipient’s deduction with 

respect to such payment otherwise 

would not be permitted by application 

of section 162(m), and, as of the date the 

legally binding right to the payment 

arose, a reasonable person would not 

have anticipated the application of 

section 162(m) at the time of the 

payment, and provided further that the 

payment is made as soon as reasonably 

practicable following the first date on 

which the service recipient anticipates 

or reasonably should anticipate that, if 

the payment were made on such date, 

the service recipient’s deduction with 

respect to such payment would no 

longer be restricted due to the 

application of section 162(m). For 

additional rules applicable to certain 

transaction-based compensation, see 

§ 1.409A–3(i)(5)(iv)(A). 

(iii) Examples. The following 

examples illustrate the provisions of 

this paragraph (b)(4). In these examples, 

except as otherwise noted, each 

employee and each employer has a 

calendar year taxable year and each 

employee is an individual who is 

employed by the specified employer. 

Example 1. On November 1, 2008, 

Employer Z awards a bonus to Employee A 

such that Employee A has a legally binding 

right to the payment as of November 1, 2008, 

that is not subject to a substantial risk of 

forfeiture. The bonus plan does not provide 

for a payment date or a deferred payment. 

The bonus plan will not be considered to 

have provided for a deferral of compensation 

if the bonus is paid or made available to 

Employee A on or before March 15, 2009. 


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Example 2. Employer Y has a taxable year 

ending August 31. On November 1, 2008, 

Employer Y awards a bonus to Employee B 

so that Employee B has a legally binding 

right to the payment as of November 1, 2008, 

that is not subject to a substantial risk of 

forfeiture. The bonus plan does not provide 

for a payment date or a deferred payment. 

The bonus plan will not be considered to 

have provided for a deferral of compensation 

if the bonus is paid or made available to 

Employee B on or before November 15, 2009. 

Example 3. On November 1, 2008, 

Employer X awards a bonus to Employee C 

such that Employee C has a legally binding 

right to the payment as of November 1, 2008. 

Under the bonus plan, Employee C will 

forfeit the bonus unless Employee C 

continues performing services through 

December 31, 2010. The right to the payment 

is subject to a substantial risk of forfeiture 

through December 31, 2010. Employee C has 

the right to make a written election not later 

than December 31, 2009, to receive the bonus 

on or after December 31, 2015, but Employee 

C does not make such election. The bonus 

plan does not provide for a default payment 

date or a deferred payment in the absence of 

an election by Employee C. The bonus plan 

will not be considered to have provided for 

a deferral of compensation if the bonus is 

paid or made available to Employee C on or 

before March 15, 2011 (and generally any 

payment before June 1, 2011 would 

constitute an impermissible acceleration of a 

payment). 

Example 4. On November 1, 2008, 

Employer W awards a bonus to Employee D 

such that Employee D has a legally binding 

right to the payment as of November 1, 2008. 

Under the bonus plan, the bonus will be 

determined based on services performed 

during the period from January 1, 2009 

through December 31, 2010. The bonus is 

scheduled to be paid as a lump sum payment 

on February 15, 2011. Under the bonus plan, 

Employee D will forfeit the bonus unless 

Employee D continues performing services 

through the scheduled payment date 

(February 15, 2011). Provided that at all 

times before the scheduled payment date 

Employee D is required to continue to 

perform services to retain the right to the 

bonus, and the bonus is paid on or before 

March 15, 2012, the bonus plan will not be 

considered to have provided for a deferral of 

compensation. 

Example 5. On November 1, 2008, 

Employer V awards a bonus to Employee E 

such that Employee E has a legally binding 

right to the payment as of November 1, 2008. 

Under the bonus plan, Employee E will 

forfeit the bonus unless Employee E 

continues performing services through 

December 31, 2010. Under the bonus plan, 

the bonus is scheduled to be paid as a lump 

sum payment on July 1, 2011. By specifying 

a payment date after the applicable 21⁄2

month period, the bonus plan provides for a 

deferred payment. The bonus plan provides 

for a deferral of compensation, and will not 

qualify as a short-term deferral regardless of 

whether the bonus is paid or made available 

on or before March 15, 2011. 

Example 6. On November 1, 2008, 

Employer U awards a bonus to Employee F 

such that Employee F has a legally binding 

right to the payment as of November 1, 2008, 

that is not subject to a substantial risk of 

forfeiture. The bonus plan provides for a 

lump sum payment upon Employee F’s 

separation from service. Because the 

separation from service is an event that may 

occur after the applicable 21⁄2 month period, 

the bonus plan provides for a deferred 

payment and therefore provides for a deferral 

of compensation. Accordingly, the bonus 

plan will not qualify as a short-term deferral 

regardless of whether Employee F separates 

from service and the bonus is paid or made 

available on or before March 15, 2009. 

Example 7. On November 1, 2008, 

Employer T grants Employee G a legally 

binding right to the payment of a life annuity 

with the first annuity payment on November 

1, 2013, provided that Employee G continues 

performing services for Employer T 

continuously through November 1, 2013. 

Because the life annuity is treated as a single 

payment, and because all payments of the life 

annuity may not occur during the applicable 

21⁄2 month period, the plan provides for a 

deferred payment and none of the amounts 

payable under the annuity will qualify as a 

short-term deferral, so that section 409A 

applies to all amounts that are payable under 

the plan. 

Example 8. On November 1, 2008, 

Employer S grants Employee H a stock right 

providing for an exercise price less than the 

fair market value of the underlying stock on 

November 1, 2008. The stock right is subject 

to a substantial risk of forfeiture requiring 

services through November 1, 2010. The 

stock right becomes exercisable when the 

substantial risk of forfeiture lapses and 

expires on November 1, 2013. Employee H 

continues providing services through 

November 1, 2010, at which time the 

substantial risk of forfeiture lapses. The stock 

right provides for a deferred payment and 

will not qualify as a short-term deferral 

regardless of whether Employee H exercises 

the stock right on or before March 15, 2011. 

(5) Stock options, stock appreciation 

rights, and other equity-based 

compensation—(i) Stock rights—(A) 

Nonstatutory stock options not 

providing for the deferral of 

compensation. An option to purchase 

service recipient stock does not provide 

for a deferral of compensation if—

(1) The exercise price may never be 

less than the fair market value of the 

underlying stock (disregarding lapse 

restrictions as defined in § 1.83–3(i)) on 

the date the option is granted and the 

number of shares subject to the option 

is fixed on the original date of grant of 

the option; 

(2) The transfer or exercise of the 

option is subject to taxation under 

section 83 and § 1.83–7; and 

(3) The option does not include any 

feature for the deferral of compensation 

other than the deferral of recognition of 

income until the later of the following: 

(i) The exercise or disposition of the 

option under § 1.83–7. 

(ii) The time the stock acquired 

pursuant to the exercise of the option 

first becomes substantially vested (as 

defined in § 1.83–3(b)). 

(B) Stock appreciation rights not 

providing for the deferral of 

compensation. A right to compensation 

based on the appreciation in value of a 

specified number of shares of service 

recipient stock occurring between the 

date of grant and the date of exercise of 

such right (a stock appreciation right) 

does not provide for a deferral of 

compensation if—

(1) Compensation payable under the 

stock appreciation right cannot be 

greater than the excess of the fair market 

value of the stock (disregarding lapse 

restrictions as defined in § 1.83–3(i)) on 

the date the stock appreciation right is 

exercised over an amount specified on 

the date of grant of the stock 

appreciation right (the stock 

appreciation right exercise price), with 

respect to a number of shares fixed on 

or before the date of grant of the right; 

(2) The stock appreciation right 

exercise price may never be less than 

the fair market value of the underlying 

stock (disregarding lapse restrictions as 

defined in § 1.83–3(i)) on the date the 

right is granted; and 

(3) The stock appreciation right does 

not include any feature for the deferral 

of compensation other than the deferral 

of recognition of income until the 

exercise of the stock appreciation right. 

(C) Stock rights that may provide for 

the deferral of compensation. An option 

to purchase stock other than service 

recipient stock, or a stock appreciation 

right with respect to stock other than 

service recipient stock, generally will 

provide for the deferral of compensation 

within the meaning of this paragraph 

(b). If under the terms of an option to 

purchase service recipient stock (other 

than an incentive stock option described 

in section 422 or a stock option granted 

under an employee stock purchase plan 

described in section 423), the exercise 

price is or could become less than the 

fair market value of the stock 

(disregarding lapse restrictions as 

defined in § 1.83–3(i)) on the date of 

grant, the grant of the option generally 

will provide for the deferral of 

compensation within the meaning of 

this paragraph (b). If under the terms of 

a stock appreciation right with respect 

to service recipient stock, the 

compensation payable under the stock 

appreciation right is or could be any 

amount greater than, with respect to a 

predetermined number of shares, the 

excess of the fair market value of the 

stock (disregarding lapse restrictions as 

defined in § 1.83–3(i)) on the date the 

stock appreciation right is exercised 


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over the fair market value of the stock 

(disregarding lapse restrictions as 

defined in § 1.83–3(i)) on the date of 

grant of the stock appreciation right, the 

grant of the stock appreciation right 

generally will provide for a deferral of 

compensation within the meaning of 

this paragraph (b). 

(D) Feature for the deferral of 

compensation. To the extent a stock 

right provides a right other than the 

right to receive cash or stock on the date 

of exercise and such additional right 

would otherwise allow compensation to 

be deferred beyond the date of exercise, 

the entire arrangement (including the 

underlying stock right) provides for the 

deferral of compensation. For purposes 

of this paragraph (b)(5)(i), neither the 

right to receive substantially nonvested 

stock (as defined in § 1.83–3(b)) upon 

the exercise of a stock right, nor the 

right to pay the exercise price with 

previously acquired shares, constitutes a 

feature for the deferral of compensation. 

(E) Rights to dividends. For purposes 

of this paragraph (b)(5)(i), the right, 

directly or indirectly contingent upon 

the exercise of a stock right, to receive 

an amount equal to all or part of the 

dividends or other distributions (other 

than stock dividends described in 

paragraph (b)(5)(v)(H) of this section) 

declared and paid on the number of 

shares underlying the stock right 

between the date of grant and the date 

of exercise of the stock right constitutes 

an offset to the exercise price of the 

stock option or an increase in the 

amount payable under the stock 

appreciation right (generally causing 

such stock right to be subject to section 

409A). A plan providing a right to 

dividends or other distributions 

declared and paid on the number of 

shares underlying a stock right, the 

payment of which is not contingent 

upon, or otherwise payable on, the 

exercise of the stock right, may provide 

for a deferral of compensation, but the 

existence of the right to receive such an 

amount will not be treated as a 

reduction to the exercise price of (or an 

increase to the compensation payable 

under) the stock right. Thus, a right to 

such dividends or distributions that is 

not contingent, directly or indirectly, 

upon the exercise of a stock right will 

not cause the related stock right to fail 

to satisfy the requirements of the 

exclusion from the definition of a 

deferral of compensation provided in 

paragraphs (b)(5)(i)(A) and (B) of this 

section. 

(ii) Statutory stock options. The grant 

of an incentive stock option as 

described in section 422, or the grant of 

an option under an employee stock 

purchase plan described in section 423 

(including the grant of an option with 

an exercise price discounted in 

accordance with section 423(b)(6) and 

the accompanying regulations), does not 

constitute a deferral of compensation. 

However, the exclusion for statutory 

stock options under this paragraph 

(b)(5)(ii) does not apply to a 

modification, extension, or renewal of a 

statutory option that is treated as the 

grant of a new option that is not a 

statutory option. See § 1.424–1(e). In 

such event, the option is treated for 

purposes of this paragraph (b) as if it 

had been a nonstatutory stock option 

from the date of the original grant. 

Accordingly, if such modification, 

extension, or renewal of the stock 

option would have been treated as the 

grant of a new option or as causing the 

option to have had a deferral feature 

from the date of grant under paragraph 

(b)(5)(v) of this section, the 

modification, extension, or renewal of 

the stock option is treated as the grant 

of a new option or as causing the option 

to have had a deferral feature from the 

date of grant for purposes of this 

paragraph (b)(5). 

(iii) Service recipient stock—(A) In 

general. Except as otherwise provided 

in paragraphs (b)(5)(iii)(B), (C), and (D) 

of this section, the term service recipient 

stock means a class of stock that, as of 

the date of grant, is common stock for 

purposes of section 305 and the 

regulations thereunder of a corporation 

that is an eligible issuer of service 

recipient stock (as defined in paragraph 

(b)(5)(iii)(E) of this section). 

Notwithstanding the foregoing, the term 

service recipient stock does not include 

a class of stock that has any preference 

as to distributions other than 

distributions of service recipient stock 

and distributions in liquidation of the 

issuer. The term service recipient stock 

also does not include any stock that is 

subject to a mandatory repurchase 

obligation (other than a right of first 

refusal), or a put or call right that is not 

a lapse restriction as defined in § 1.83–

3(i), if the stock price under such right 

or obligation is based on a measure 

other than the fair market value 

(disregarding lapse restrictions as 

defined in § 1.83–3(i)) of the equity 

interest in the corporation represented 

by the stock. 

(B) American depositary receipts. An 

American depositary receipt or 

American depositary share may 

constitute service recipient stock, to the 

extent that the stock traded on a foreign 

securities market to which the American 

depositary receipt or American 

depositary share relates qualifies as 

service recipient stock. 

(C) Mutual company units. Mutual 

company units may constitute service 

recipient stock. For this purpose, the 

term mutual company unit means a 

fixed percentage of the overall value of 

a non-stock mutual company or 

association. For purposes of 

determining the value of the mutual 

company unit, the unit may be valued 

in accordance with the rules set forth in 

paragraph (b)(5)(iv)(B) of this section 

governing valuation of service recipient 

stock the shares of which are not traded 

on an established securities market, 

applied as if the mutual company were 

a stock corporation with one class of 

common stock and the number of shares 

of such stock determined according to 

such fixed percentage. For example, an 

appreciation right based on the 

appreciation of 10 mutual company 

units, where each unit is defined as one 

percent of the overall value of the 

mutual company, would be valued as if 

the appreciation right were based upon 

10 shares of a corporation, with 100 

shares of common stock (and no other 

class of stock), the shares of which are 

not readily tradable on an established 

securities market. 

(D) Other entities. An interest in an 

entity other than a corporation or nonstock mutual company or association 

may constitute service recipient stock to 

the extent designated by the 

Commissioner in revenue procedures, 

notices, or other guidance published in 

the Internal Revenue Bulletin (see 

§ 601.601(d)(2) of this chapter). 

(E) Eligible issuer of service recipient 

stock—(1) In general. The term eligible 

issuer of service recipient stock means 

only the corporation for which the 

service provider provides direct services 

on the date of grant of the stock right (if 

the entity receiving such services is a 

corporation), and any corporation in a 

chain of corporations or other entities in 

which each corporation or other entity 

has a controlling interest in another 

corporation or other entity in the chain, 

ending with the corporation or other 

entity that has a controlling interest in 

the corporation or other entity for which 

the service provider provides direct 

services on the date of grant of the stock 

right. For this purpose, the term 

controlling interest has the same 

meaning as provided in § 1.414(c)–

2(b)(2)(i), provided that the language ‘‘at 

least 50 percent’’ is used instead of ‘‘at 

least 80 percent’’ each place it appears 

in § 1.414(c)–2(b)(2)(i). In addition, 

where the use of such stock with respect 

to the grant of a stock right to such 

service provider is based upon 

legitimate business criteria, the term 

controlling interest has the same 

meaning as provided in § 1.414(c)–


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2(b)(2)(i), provided that the language ‘‘at 

least 20 percent’’ is used instead of ‘‘at 

least 80 percent’’ each place it appears 

in § 1.414(c)–2(b)(2)(i). For purposes of 

determining ownership of an interest in 

an organization, the rules of §§ 1.414(c)–

3 and 1.414(c)–4 apply. The 

determination of whether a grant is 

based on legitimate business criteria is 

based on the facts and circumstances, 

focusing primarily on whether there is 

a sufficient nexus between the service 

provider and the issuer of the stock right 

so that the grant serves a legitimate nontax business purpose other than simply 

providing compensation to the service 

provider that is excluded from the 

requirements of section 409A. For 

example, stock of a corporation that 

owns an interest in a joint venture 

involving an operating business, used 

with respect to stock rights granted to 

service providers of the joint venture 

who are former service providers of 

such corporation, generally will 

constitute use of service recipient stock 

based upon legitimate business criteria, 

and therefore could constitute service 

recipient stock with respect to such 

service providers if the corporation 

owns at least 20 percent of the joint 

venture and the other requirements of 

this paragraph (b)(5)(iii) are met. 

Similarly, the legitimate business 

criteria requirement generally would be 

met if the corporate venturer issued 

such a right to an employee of the joint 

venture who it reasonably expected 

would in the future become an 

employee of the corporate venturer. 

However, where a service provider has 

no real nexus with a corporate venturer, 

such as generally happens when the 

corporate venturer is a passive investor 

in the service recipient joint venture, a 

stock right issued to that employee on 

the investor corporation’s stock 

generally would not be based upon 

legitimate business criteria. Similarly, 

where a corporation holds only a 

minority interest in an entity that in 

turn holds a minority interest in the 

entity for which the service provider 

performs services, such that the 

corporation holds only an insubstantial 

indirect interest in the entity receiving 

the services, legitimate business criteria 

generally would not exist for issuing a 

stock right on the corporation’s stock to 

the service provider. 

(2) Investment vehicles. 

Notwithstanding the provisions of 

paragraph (b)(5)(iii)(E)(1) of this section, 

except as to a service provider providing 

services directly to such corporation, for 

purposes of this paragraph (b)(5), an 

eligible issuer of service recipient stock 

does not include any corporation whose 

primary purpose is to serve as an 

investment vehicle with respect to the 

corporation’s minority ownership 

interests in entities other than the 

service recipient. 

(3) Corporate structures established or 

transactions undertaken for purposes of 

avoiding coverage under section 409A. 

Notwithstanding the provisions of 

paragraph (b)(5)(iii)(E)(1) of this section, 

an eligible issuer of service recipient 

stock does not include any corporation 

within a group of entities treated as a 

single service recipient if a purpose of 

the establishment of the structure of the 

ownership, or a purpose of a significant 

transaction between or among two or 

more entities comprising a single 

service recipient, is to provide deferred 

compensation not subject to the 

application of section 409A. If an entity 

becomes a member of a group of 

corporations or other entities treated as 

a single service recipient, and the 

primary source of income or value of 

such entity arises from the provision of 

management services to other members 

of the service recipient group, it is 

presumed that such structure was 

established for purposes of avoiding the 

application of section 409A if any stock 

rights are issued with respect to such 

entity. 

(4) Substitutions and assumptions by 

reason of a corporate transaction. If the 

requirements of paragraph (b)(5)(v)(D) of 

this section are met such that the 

substitution of a new stock right 

pursuant to a corporate transaction for 

an outstanding stock right, or the 

assumption of an outstanding stock 

right pursuant to a corporate 

transaction, would not be treated as the 

grant of a new stock right or a change 

in the form of payment for purposes of 

this section and §§ 1.409A–2 through 

1.409A–6, the stock underlying the 

stock right that replaced the stock right 

that is substituted or assumed will be 

treated as service recipient stock for 

purposes of applying this paragraph 

(b)(5) to the replacement stock rights if 

such underlying stock otherwise 

satisfies the requirements of paragraph 

(b)(5)(iii)(A) of this section. For 

example, if by reason of a spinoff 

transaction (under which the stock of a 

subsidiary corporation is distributed to 

the stockholders of a distributing 

corporation), a stock option to purchase 

distributing corporation stock is 

replaced with a stock option to purchase 

distributing corporation stock and a 

stock option to purchase the spun off 

subsidiary corporation’s stock (each 

otherwise satisfying the requirements of 

paragraph (b)(5)(iii)(A) of this section), 

and where such substitution is not 

treated as a modification of the original 

stock option pursuant to paragraph 

(b)(5)(v)(D) of this section, both the 

distributing corporation stock and the 

subsidiary corporation stock are treated 

as service recipient stock for purposes of 

applying this paragraph (b)(5) to the 

replacement stock options. 

(iv) Determination of the fair market 

value of service recipient stock—(A) 

Stock readily tradable on an established 

securities market. For purposes of 

paragraph (b)(5)(i) of this section, in the 

case of service recipient stock that is 

readily tradable on an established 

securities market, the fair market value 

of the stock may be determined based 

upon the last sale before or the first sale 

after the grant, the closing price on the 

trading day before or the trading day of 

the grant, the arithmetic mean of the 

high and low prices on the trading day 

before or the trading day of the grant, or 

any other reasonable method using 

actual transactions in such stock as 

reported by such market. The 

determination of fair market value also 

may be determined using an average 

selling price during a specified period 

that is within 30 days before or 30 days 

after the applicable valuation date, 

provided that the program under which 

the stock right is granted, including a 

program with a single participant, must 

irrevocably specify the commitment to 

grant the stock right with an exercise 

price set using such an average selling 

price before the beginning of the 

specified period. For this purpose, the 

term average selling price refers to the 

arithmetic mean of such selling prices 

on all trading days during the specified 

period, or the average of such prices 

over the specified period weighted 

based on the volume of trading of such 

stock on each trading day during such 

specified period. To satisfy this 

requirement, the service recipient must 

designate the recipient of the stock 

right, the number and class of shares of 

stock that are subject to the stock right, 

and the method for determining the 

exercise price including the period over 

which the averaging will occur, before 

the beginning of the specified averaging 

period. Notwithstanding the forgoing 

provisions of this paragraph 

(b)(5)(iv)(A), where applicable foreign 

law requires that a compensatory stock 

right be priced based upon a specific 

price averaging method and period, a 

stock right granted in accordance with 

such applicable foreign law will be 

treated as meeting the requirements of 

this paragraph (b)(5)(iv)(A), provided 

that the averaging period does not 

exceed 30 days. 

(B) Stock not readily tradable on an 

established securities market—(1) In 

general. For purposes of paragraph 


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(b)(5)(i) of this section, in the case of 

service recipient stock that is not readily 

tradable on an established securities 

market, the fair market value of the 

stock as of a valuation date means a 

value determined by the reasonable 

application of a reasonable valuation 

method. The determination whether a 

valuation method is reasonable, or 

whether an application of a valuation 

method is reasonable, is made based on 

the facts and circumstances as of the 

valuation date. Factors to be considered 

under a reasonable valuation method 

include, as applicable, the value of 

tangible and intangible assets of the 

corporation, the present value of 

anticipated future cash-flows of the 

corporation, the market value of stock or 

equity interests in similar corporations 

and other entities engaged in trades or 

businesses substantially similar to those 

engaged in by the corporation the stock 

of which is to be valued, the value of 

which can be readily determined 

through nondiscretionary, objective 

means (such as through trading prices 

on an established securities market or 

an amount paid in an arm’s length 

private transaction), recent arm’s length 

transactions involving the sale or 

transfer of such stock or equity interests, 

and other relevant factors such as 

control premiums or discounts for lack 

of marketability and whether the 

valuation method is used for other 

purposes that have a material economic 

effect on the service recipient, its 

stockholders, or its creditors. The use of 

a valuation method is not reasonable if 

such valuation method does not take 

into consideration in applying its 

methodology all available information 

material to the value of the corporation. 

Similarly, the use of a value previously 

calculated under a valuation method is 

not reasonable as of a later date if such 

calculation fails to reflect information 

available after the date of the calculation 

that may materially affect the value of 

the corporation (for example, the 

resolution of material litigation or the 

issuance of a patent) or the value was 

calculated with respect to a date that is 

more than 12 months earlier than the 

date for which the valuation is being 

used. The service recipient’s consistent 

use of a valuation method to determine 

the value of its stock or assets for other 

purposes, including for purposes 

unrelated to compensation of service 

providers, is also a factor supporting the 

reasonableness of such valuation 

method. 

(2) Presumption of reasonableness. 

For purposes of this paragraph 

(b)(5)(iv)(B), the use of any of the 

following methods of valuation is 

presumed to result in a reasonable 

valuation, provided that the 

Commissioner may rebut such a 

presumption upon a showing that either 

the valuation method or the application 

of such method was grossly 

unreasonable: 

(i) A valuation of a class of stock 

determined by an independent appraisal 

that meets the requirements of section 

401(a)(28)(C) and the regulations as of a 

date that is no more than 12 months 

before the relevant transaction to which 

the valuation is applied (for example, 

the date of grant of a stock option). 

(ii) A valuation based upon a formula 

that, if used as part of a nonlapse 

restriction (as defined in § 1.83–3(h)) 

with respect to the stock, would be 

considered to be the fair market value of 

the stock pursuant to § 1.83–5, provided 

that such stock is valued in the same 

manner for purposes of any nonlapse 

restriction applicable to the transfer of 

any shares of such class of stock (or any 

substantially similar class of stock) to 

the issuer or any person that owns stock 

possessing more than 10 percent of the 

total combined voting power of all 

classes of stock of the issuer (applying 

the stock attribution rules of § 1.424–

1(d)), other than an arm’s length 

transaction involving the sale of all or 

substantially all of the outstanding stock 

of the issuer, and such valuation 

method is used consistently for all such 

purposes, and provided further that this 

paragraph (b)(5)(iv)(B)(2)(ii) does not 

apply with respect to stock subject to a 

stock right payable in stock, where the 

stock acquired pursuant to the exercise 

of the stock right is transferable other 

than through the operation of a 

nonlapse restriction. 

(iii) A valuation, made reasonably and 

in good faith and evidenced by a written 

report that takes into account the 

relevant factors described in paragraph 

(b)(5)(iv)(B)(1) of this section, of illiquid 

stock of a start-up corporation. For this 

purpose, illiquid stock of a start-up 

corporation means service recipient 

stock of a corporation that has no 

material trade or business that it or any 

predecessor to it has conducted for a 

period of 10 years or more and has no 

class of equity securities that are traded 

on an established securities market (as 

defined in paragraph (k) of this section), 

where such stock is not subject to any 

put, call, or other right or obligation of 

the service recipient or other person to 

purchase such stock (other than a right 

of first refusal upon an offer to purchase 

by a third party that is unrelated to the 

service recipient or service provider and 

other than a right or obligation that 

constitutes a lapse restriction as defined 

in § 1.83–3(i)), and provided that this 

paragraph (b)(5)(iv)(B)(2)(iii) does not 

apply to the valuation of any stock if the 

service recipient or service provider 

may reasonably anticipate, as of the 

time the valuation is applied, that the 

service recipient will undergo a change 

in control event as described in 

§ 1.409A–3(i)(5)(v) or § 1.409A–

3(i)(5)(vii) within the 90 days following 

the action to which the valuation is 

applied, or make a public offering of 

securities within the 180 days following 

the action to which the valuation is 

applied. For purposes of this paragraph 

(b)(5)(iv)(B)(2)(iii), a valuation will not 

be treated as made reasonably and in 

good faith unless the valuation is 

performed by a person or persons that 

the corporation reasonably determines 

is qualified to perform such a valuation 

based on the person’s or persons’’

significant knowledge, experience, 

education, or training. Generally, a 

person will be qualified to perform such 

a valuation if a reasonable individual, 

upon being apprised of such knowledge, 

experience, education, and training, 

would reasonably rely on the advice of 

such person with respect to valuation in 

deciding whether to accept an offer to 

purchase or sell the stock being valued. 

For this purpose, significant experience 

generally means at least five years of 

relevant experience in business 

valuation or appraisal, financial 

accounting, investment banking, private 

equity, secured lending, or other 

comparable experience in the line of 

business or industry in which the 

service recipient operates. 

(3) Use of alternative methods. For 

purposes of this paragraph (b)(5), a 

different valuation method may be used 

for each separate action for which a 

valuation is relevant, provided that a 

single valuation method is used for each 

separate action and, once used, may not 

retroactively be altered. For example, 

one valuation method may be used to 

establish the exercise price of a stock 

option, and a different valuation method 

may be used to determine the value at 

the date of the repurchase of stock 

pursuant to a put or call right. However, 

once an exercise price or amount to be 

paid has been established, the exercise 

price or amount to be paid may not be 

changed through the retroactive use of 

another valuation method. In addition, 

notwithstanding the foregoing, where 

after the date of grant, but before the 

date of exercise or transfer, of the stock 

right, the service recipient stock to 

which the stock right relates becomes 

readily tradable on an established 

securities market, the service recipient 

must use the valuation method set forth 

in paragraph (b)(5)(iv)(A) of this section 


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for purposes of determining the 

payment at the date of exercise or the 

purchase of the stock, as applicable. 

(v) Modifications, extensions, 

substitutions, and assumptions of stock 

rights—(A) Treatment of modified and 

extended stock rights. A modification of 

the terms of a stock right within the 

meaning of paragraph (b)(5)(v)(B) of this 

section is considered to be the grant of 

a new stock right. The new stock right 

may or may not constitute a deferral of 

compensation under paragraph (b)(5)(i) 

of this section, determined at the date of 

grant of the new stock right. If there is 

an extension of a stock right (within the 

meaning of paragraph (b)(5)(v)(C) of this 

section), the stock right is treated as 

having had an additional deferral 

feature from the original date of grant of 

the stock right, and therefore will be 

treated as a plan providing for the 

deferral of compensation from the 

original grant date for purposes of this 

paragraph (b). 

(B) Modification in general. Except as 

otherwise provided in paragraph 

(b)(5)(v) of this section, the term 

modification means any change in the 

terms of the stock right (or change in the 

terms of the plan pursuant to which the 

stock right was granted or in the terms 

of any other agreement governing the 

stock right) that may provide the holder 

of the stock right with a direct or 

indirect reduction in the exercise price 

of the stock right regardless of whether 

the holder in fact benefits from the 

change in terms. A change in the terms 

of the stock right shortening the period 

during which the stock right is 

exercisable is not a modification. It is 

not a modification to add a feature 

providing the ability to tender 

previously acquired stock for the stock 

purchasable under the stock right, or to 

withhold or have withheld shares of 

stock to facilitate the payment of the 

exercise price or the employment taxes 

or required withholding taxes resulting 

from the exercise of the stock right. In 

addition, it is not a modification for the 

grantor to exercise discretion 

specifically reserved under a stock right 

with respect to the transferability of the 

stock right. 

(C) Extensions—(1) In general. An 

extension of a stock right refers to the 

provision to the holder of an additional 

period of time within which to exercise 

the stock right beyond the time 

originally prescribed under the terms of 

the stock right, the conversion or 

exchange of a stock right for a legally 

binding right to compensation in a 

future taxable year, or the addition of 

any feature for the deferral of 

compensation not permitted in 

paragraph (b)(5)(i)(A)(3) of this section 

(in the case of a stock option) or not 

permitted in paragraph (b)(5)(i)(B)(3) of 

this section (in the case of a stock 

appreciation right) to the terms of the 

stock right, other than at a time when 

the exercise price of the stock right 

equals or exceeds the fair market value 

of the service recipient stock that could 

be purchased (in the case of an option) 

or the fair market value of the service 

recipient stock used to determine the 

payment to the service provider (in the 

case of a stock appreciation right), and 

includes a renewal of such right that has 

such effect. It is not an extension if the 

exercise period of a stock right is 

extended to a date no later than the 

earlier of the latest date upon which the 

stock right could have expired by its 

original terms under any circumstances 

or the 10th anniversary of the original 

date of grant of the stock right. If the 

exercise period of a stock right is 

extended at a time when the exercise 

price of the stock right equals or exceeds 

the fair market value of the service 

recipient stock that could be purchased 

(in the case of an option) or the fair 

market value of the service recipient 

stock used to determine the payment to 

the service provider (in the case of a 

stock appreciation right), it is not an 

extension of the original stock right. 

Instead, in such a case, the original 

stock right is treated as modified rather 

than extended and a new stock right is 

treated as having been granted for 

purposes of this section. In addition, it 

is not an extension of a stock right if the 

expiration of the stock right is tolled 

while the holder cannot exercise the 

stock right because such an exercise 

would violate an applicable Federal, 

state, local, or foreign law, or would 

jeopardize the ability of the service 

recipient to continue as a going concern, 

provided that the period during which 

the stock right may be exercised is not 

extended more than 30 days after the 

exercise of the stock right first would no 

longer violate an applicable Federal, 

state, local, and foreign laws or would 

first no longer jeopardize the ability of 

the service recipient to continue as a 

going concern. For this purpose, a 

provision of foreign law shall be 

considered applicable only to foreign 

earned income (as defined under section 

911(b)(1) without regard to section 

911(b)(1)(B)(iv) and without regard to 

the requirement that the income be 

attributable to services performed 

during the period described in section 

911(d)(1)(A) or (B)) from sources within 

the foreign country that promulgated 

such law. 

(2) Certain extensions before April 10, 

2007. An extension of a stock right 

before April 10, 2007 solely in order to 

provide the holder of such stock right an 

additional period of time beyond the 

time originally prescribed under the 

terms of such stock right within which 

to exercise the stock right is disregarded 

for purposes of applying the rules 

contained in paragraph (b)(5)(v)(C)(1) of 

this section. For purposes of applying 

the rules contained in paragraph 

(b)(5)(v)(C)(1) of this section on and 

after April 10, 2007, such a stock right 

is treated as having specified at the date 

of grant the time within which to 

exercise such stock right that was 

prescribed under the terms of such stock 

right in effect on April 10, 2007. 

Nothing in this paragraph (b)(5)(v)(C)(2) 

affects any other action treated as the 

extension of a stock right, including the 

addition of a deferral feature. 

(3) Examples. The following examples 

illustrate the provisions of this 

paragraph (b)(5)(v)(C). In the examples, 

each employee is an individual 

employed by the specified employer, 

and each employee and each employer 

has a calendar year taxable year. 

Example 1. On July 1, 2009, Employer Z 

grants Employee A a nonstatutory stock 

option that does not provide for the deferral 

of compensation in accordance with 

paragraph (b)(5)(i)(A) of this section. The 

terms of the nonstatutory stock option 

provide that the exercise period of the stock 

option expires on the earlier of July 1, 2019, 

or 3 months after Employee A’s separation 

from service. On July 1, 2011, Employee A 

separates from service. On the same day, 

Employee A and Employer Z change the 

exercise period of the option so that it 

expires on July 1, 2013. Because the exercise 

period of the stock right is not extended 

beyond July 1, 2019, the change is not an 

extension for purposes of this paragraph 

(b)(5)(v)(C). 

Example 2. The facts are the same as in 

Example 1 except that Employee A separates 

from service on July 1, 2018, and on the same 

day, Employee A and Employer Z change the 

exercise period of the option so that it 

expires on July 1, 2020. As of July 1, 2018, 

the fair market value of the underlying stock 

exceeds the exercise price. Because the 

exercise period of the stock right is extended 

beyond July 1, 2019, the change is an 

extension for purposes of this paragraph 

(b)(5)(v)(C). 

Example 3. The facts are the same as in 

Example 2 except that as of July 1, 2018, the 

fair market value of the underlying stock is 

less than the exercise price of the option. 

Because the exercise period of the stock right 

is extended at a time when the fair market 

value of the underlying stock is less than the 

exercise price, the change is not an extension 

for purposes of this paragraph (b)(5)(v)(C) 

and the change is treated as a modification 

of the option, resulting in the extension of 

the exercise period being treated as the grant 

of a new option on July 1, 2018. 

Example 4. On July 1, 2009, Employer Y 

grants to Employee B a stock appreciation 


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right with respect to 200 shares of Employer 

Y common stock that does not provide for the 

deferral of compensation in accordance with 

paragraph (b)(5)(i)(B) of this section. Upon 

exercise of the stock appreciation right, 

Employee B is entitled to receive the excess 

of the fair market value of a share of 

Employer Y common stock on the date of 

exercise over $100 (the fair market value of 

a share of Employer Y common stock on July 

1, 2009), multiplied by the number of shares 

with respect to which Employee B is 

exercising the right. The exercise period of 

the right expires on the earlier of July 1, 

2019, or 3 months after Employee B separates 

from service. Employee B cannot exercise the 

stock appreciation right with respect to more 

than 100 shares unless Employee B continues 

to be employed by Employer Y through June 

30, 2014. On July 1, 2011, when the fair 

market value of a share of Employer Y 

common stock is $200, Employee B and 

Employer Y amend the stock appreciation 

right to provide that the right will be 

exercisable only during calendar year 2018, 

except that before January 1, 2017, Employee 

B may elect to designate calendar year 2023 

or any subsequent calendar year before 2033 

as the year in which the right will be 

exercisable. The amendment constitutes an 

extension of the stock appreciation right 

under paragraph (b)(5)(v)(C)(1) of this 

section. Under paragraph (b)(5)(v)(A) of this 

section, the stock appreciation right is treated 

as having had an additional deferral feature 

from the original date of grant (July 1, 2009) 

of the right, and therefore is treated as a plan 

providing for the deferral of compensation 

from that date. During the period from July 

1, 2009, through June 30, 2011, the 

provisions of the stock appreciation right 

relating to the time and form of payment did 

not satisfy the requirements of § 1.409A–3(a). 

Therefore, the stock appreciation right 

provides for a deferral of compensation that 

does not comply with section 409A. 

(D) Substitutions and assumptions of 

stock rights by reason of a corporate 

transaction. If the requirements of 

§ 1.424–1 (without regard to the 

requirement described in § 1.424–1(a)(2) 

that an eligible corporation be the 

employer of the optionee) would be met 

if the stock right were a statutory option, 

the substitution of a new stock right 

pursuant to a corporate transaction (as 

defined in § 1.424–1(a)(3)) for an 

outstanding stock right or the 

assumption of an outstanding stock 

right pursuant to a corporate transaction 

will not be treated as the grant of a new 

stock right or a change in the form of 

payment for purposes of this section 

and §§ 1.409A–2 through 1.409A–6. For 

purposes of the preceding sentence, the 

requirement of § 1.424–1(a)(5)(iii) will 

be deemed to be satisfied if the ratio of 

the exercise price to the fair market 

value of the shares subject to the stock 

right immediately after the substitution 

or assumption is not greater than the 

ratio of the exercise price to the fair 

market value of the shares subject to the 

stock right immediately before the 

substitution or assumption. In the case 

of a transaction described in section 355 

in which the stock of the distributing 

corporation and the stock distributed in 

the transaction are both readily tradable 

on an established securities market 

immediately after the transaction, for 

purposes of this paragraph (b)(5)(v), the 

requirements of § 1.424–1(a)(5) related 

to the fair market value of the stock may 

be satisfied by—

(1) Using the last sale before or the 

first sale after the specified date as of 

which such valuation is being made, the 

closing price on the last trading day 

before or the trading day of a specified 

date, the arithmetic mean of the high 

and low prices on the last trading day 

before or the trading day of such 

specified date, or any other reasonable 

method using actual transactions in 

such stock as reported by such market 

on a specified date, for the stock of the 

distributing corporation and the stock 

distributed in the transaction, provided 

the specified date is designated before 

such specified date, and such specified 

date is not more than 60 days after the 

transaction; 

(2) Using the arithmetic mean of such 

market prices on trading days during a 

specified period designated before the 

beginning of such specified period, 

where such specified period is not 

longer than 30 days and ends no later 

than 60 days after the transaction; or 

(3) Using an average of such prices 

during such prespecified period 

weighted based on the volume of 

trading of such stock on each trading 

day during such prespecified period. 

(E) Acceleration of date when 

exercisable. Although with respect to a 

stock right not immediately exercisable 

in full, a change in the terms of the right 

solely to accelerate or delay, within the 

original term of the stock right, the time 

at which the stock right (or any portion 

of such stock right) may be exercised is 

not a modification for purposes of this 

section, with respect to a stock right 

subject to section 409A, such an 

acceleration may constitute an 

impermissible acceleration of a payment 

date under § 1.409A–3(j) or a 

subsequent deferral under § 1.409A–

2(b). 

(F) Discretionary added benefits. If a 

change to a stock right provides, either 

by its terms or in substance, that the 

holder may receive an additional benefit 

under the stock right at the future 

discretion of the grantor, and the 

addition of such benefit would 

constitute a modification or extension, 

then the addition of such discretion is 

a modification or extension at the time 

that the stock right is changed to 

provide such discretion. 

(G) Change in underlying stock 

increasing value. A change in the terms 

of the stock subject to a stock right that 

increases the value of the stock is a 

modification of such stock right, except 

to the extent that a new stock right is 

substituted for such stock right by 

reason of the change in the terms of the 

stock in accordance with paragraph 

(b)(5)(v)(D) of this section. 

(H) Change in the number of shares 

purchasable. If a stock right is amended 

solely to increase the number of shares 

subject to the stock right, the increase is 

not considered a modification of the 

stock right but is treated as the grant of 

a new additional stock right to which 

the additional shares are subject. 

Notwithstanding the previous sentence, 

if the exercise price and number of 

shares subject to a stock right are 

proportionally adjusted to reflect a stock 

split (including a reverse stock split) or 

stock dividend, and the only effect of 

the stock split or stock dividend is to 

increase (or decrease) on a pro rata basis 

the number of shares owned by each 

shareholder of the class of stock subject 

to the stock right, then there is no 

modification of the stock right if it is 

proportionally adjusted to reflect the 

stock split or stock dividend and the 

aggregate exercise price of the stock 

right is not less than the aggregate 

exercise price before the stock split or 

stock dividend. 

(I) Rescission of changes. A change to 

the terms of a stock right (or change in 

the terms of the plan pursuant to which 

the stock right was granted or in the 

terms of any other agreement governing 

the right) is not considered a 

modification or extension of the stock 

right to the extent the change in the 

terms of the stock right is rescinded by 

the earlier of the date the stock right is 

exercised or the last day of the service 

provider’s taxable year during which 

such change occurred. Thus, for 

example, if the terms of a stock right 

granted to an individual employee with 

a calendar year taxable year are changed 

on March 1 in a manner that would 

result in an extension of the stock right, 

and the change is rescinded on 

November 1 of the same year, and the 

stock right is not exercised before the 

change is rescinded, the stock right is 

not considered extended under this 

paragraph (b)(5)(v). 

(J) Successive modifications and 

extensions. The rules of this paragraph 

(b)(5)(v) apply as well to successive 

modifications and extensions. 

(K) Modifications and extensions in 

effect on October 23, 2004. For purposes 

of the application of section 409A and 


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these regulations to a stock right, if a 

legally binding right to a modification or 

extension of such stock right existed on 

October 23, 2004, such modification or 

extension is disregarded, and the stock 

right is treated as if granted with the 

terms and conditions in effect on 

October 23, 2004. 

(vi) Meaning and use of certain 

terms—(A) Option. The term option 

means the right or privilege of an 

individual to purchase stock from a 

corporation by virtue of an offer of the 

corporation continuing for a stated 

period of time, whether or not 

irrevocable, to sell such stock at a price 

determined under paragraph 

(b)(5)(vi)(D) of this section, such 

individual being under no obligation to 

purchase. While no particular form of 

words is necessary, the option must 

express an offer to sell at the option 

price, the maximum number of shares 

purchasable under the option, and the 

period of time during which the offer 

remains open. The term option includes 

a warrant that meets the requirements of 

this paragraph (b)(5)(vi)(A). An option 

may be granted as part of or in 

conjunction with an employee stock 

purchase plan or subscription contract. 

An option must be in writing (in paper 

or electronic form) provided that such 

writing is adequate to establish an 

option right or privilege that is 

enforceable under applicable law. 

(B) Date of grant of option. (1) The 

language the date of grant of the option, 

and similar phrases, refer to the date 

when the granting corporation 

completes the corporate action 

necessary to create the legally binding 

right constituting the option. A 

corporate action creating the legally 

binding right constituting the option is 

not considered complete until the date 

on which the maximum number of 

shares that can be purchased under the 

option and the minimum exercise price 

are fixed or determinable, and the class 

of underlying stock and the identity of 

the service provider is designated. 

Ordinarily, if the corporate action 

provides for an immediate offer of stock 

for sale to a service provider, or 

provides for a particular date on which 

such offer is to be made, the date of the 

granting of the option is the date of such 

corporate action if the offer is to be 

made immediately, or the date provided 

as the date of the offer, as the case may 

be. However, an unreasonable delay in 

the giving of notice of such offer to the 

service provider will be taken into 

account as indicating that the 

corporation provided that the offer was 

to be made at the subsequent date on 

which such notice is given. 

(2) If the corporation imposes a 

condition on the granting of an option 

(as distinguished from a condition 

governing the exercise of the option), 

such condition generally will be given 

effect in accordance with the intent of 

the corporation. However, if the grant of 

an option is subject to approval by 

stockholders, the date of grant of the 

option will be determined as if the 

option had not been subject to such 

approval. A condition that does not 

require corporate action, such as the 

approval of, or registration with, some 

regulatory or government agency, for 

example, a stock exchange or the 

Securities and Exchange Commission, is 

ordinarily considered a condition upon 

the exercise of the option unless the 

corporate action clearly indicates that 

the option is not to be granted until 

such condition has been satisfied. 

(3) In general, a condition imposed 

upon the exercise of an option will not 

operate to make ineffective the granting 

of the option. For example, on June 1, 

2008, Corporation A grants to X, an 

employee, an option to purchase 5,000 

shares of the corporation’s common 

stock, exercisable by X on or after June 

1, 2009, provided X is employed by the 

corporation on June 1, 2009, and 

provided that A’s profits during the 

fiscal year preceding the year of exercise 

exceed $200,000. Such an option is 

granted to X on June 1, 2008, and will 

be treated as outstanding as of such 

date. 

(C) Stock. The term stock means 

capital stock of any class, including 

voting or nonvoting common or 

preferred stock. Except as otherwise 

provided, the term stock includes both 

treasury stock and stock of original 

issue. Special classes of stock 

authorized to be issued to and held by 

employees are within the scope of the 

term stock for this purpose, provided 

such stock otherwise possesses the 

rights and characteristics of capital 

stock. 

(D) Exercise price. The term exercise 

price means the consideration in cash or 

property that, pursuant to the terms of 

the option, is the price at which the 

stock subject to the option is purchased. 

The term exercise price does not include 

any amounts paid as interest under a 

deferred payment plan or treated as 

interest. 

(E) Exercise. The term exercise, when 

used in reference to an option, means 

the act of acceptance by the holder of 

the option of the offer to sell contained 

in the option. In general, the time of 

exercise is the time when there is a sale 

or a contract to sell between the 

corporation and the individual. A 

promise to pay the exercise price does 

not constitute an exercise of the option 

unless the holder of the option is subject 

to personal liability on such promise. 

An agreement or undertaking by the 

service provider to make payments 

under a stock purchase plan does not 

constitute the exercise of an option to 

the extent the payments made remain 

subject to withdrawal by or refund to 

the service provider. 

(F) Transfer. The term transfer, when 

used in reference to the transfer to an 

individual of a share of stock pursuant 

to the exercise of an option, means the 

transfer of ownership of such share, or 

the transfer of substantially all the rights 

of ownership. Such transfer must, 

within a reasonable time, be evidenced 

on the books of the corporation. A 

transfer may occur even if a share of 

stock is subject to a substantial risk of 

forfeiture or is not otherwise 

transferable immediately after the date 

of exercise. A transfer does not fail to 

occur merely because, under the terms 

of the arrangement, the individual may 

not dispose of the share for a specified 

period of time, or the share is subject to 

a right of first refusal or a right to 

acquire the share at the share’s fair 

market value at the time of the sale. 

(G) Readily tradable. For purposes of 

this section and §§ 1.409A–2 through 

1.409A–6, stock is treated as readily 

tradable if it is regularly quoted by 

brokers or dealers making a market in 

such stock. 

(H) Application to stock appreciation 

rights. For purposes of this section and 

§§ 1.409A–2 through 1.409A–6, the 

definitions provided in paragraphs 

(b)(5)(vi)(A) through (G) of this section 

may be applied by analogy to the 

issuance of, exercise of, or payment 

upon the exercise of, a stock 

appreciation right. 

(6) Restricted property, section 402(b) 

trusts, and section 403(c) annuities—(i) 

In general. If a service provider receives 

property from, or pursuant to, a plan 

maintained by a service recipient, there 

is no deferral of compensation merely 

because the value of the property is not 

includible in income by reason of the 

property being substantially nonvested 

(as defined in § 1.83–3(b)), or is 

includible in income solely due to a 

valid election under section 83(b). For 

purposes of this paragraph (b)(6)(i), a 

transfer of property includes the transfer 

of a beneficial interest in a trust or 

annuity plan, or a transfer to or from a 

trust or under an annuity plan, to the 

extent such a transfer is subject to 

section 83, section 402(b) or section 

403(c). In addition, for purposes of this 

paragraph (b), a right to compensation 

income that will be required to be 

included in income under section 


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402(b)(4)(A) is not a deferral of 

compensation. 

(ii) Promises to transfer property. A 

plan under which a service provider 

obtains a legally binding right to receive 

property in a future taxable year where 

the property will be substantially vested 

(as defined in § 1.83–3(b)) at the time of 

transfer of the property may provide for 

the deferral of compensation and, 

accordingly, may constitute a 

nonqualified deferred compensation 

plan. A legally binding right to receive 

property in a future taxable year where 

the property will be substantially 

nonvested (as defined in § 1.83–3(b)) at 

the time of transfer of the property will 

not provide for the deferral of 

compensation and, accordingly, will not 

constitute a nonqualified deferred 

compensation plan unless offered in 

conjunction with another legally 

binding right that constitutes a deferral 

of compensation. 

(7) Arrangements between 

partnerships and partners. [Reserved.] 

(8) Certain foreign plans—(i) Plans 

with respect to compensation covered 

by treaty or other international 

agreement. A plan in which a service 

provider participates does not provide 

for a deferral of compensation for 

purposes of this paragraph (b) to the 

extent that the compensation under the 

plan would have been excluded from 

gross income for Federal income tax 

purposes under the provisions of any 

bilateral income tax convention or other 

bilateral or multilateral agreement to 

which the United States is a party if the 

compensation had been paid to the 

service provider at the time that the 

legally binding right to the 

compensation first arose or, if later, the 

time that the legally binding right was 

no longer subject to a substantial risk of 

forfeiture. 

(ii) Plans with respect to certain other 

compensation. A plan in which a 

service provider participates does not 

provide for a deferral of compensation 

for purposes of this paragraph (b) to the 

extent that compensation under the plan 

would not have been includible in gross 

income for Federal tax purposes if it had 

been paid to the service provider at the 

time that the legally binding right to the 

compensation first arose or, if later, the 

time that the legally binding right was 

no longer subject to a substantial risk of 

forfeiture, due to one of the following: 

(A) The service provider was a 

nonresident alien at such time and the 

compensation would not have been 

includible in gross income under 

section 872. 

(B) The service provider was a 

qualified individual (as defined in 

section 911(d)(1)) at such time, the 

compensation would have been foreign 

earned income within the meaning of 

section 911(b)(1) (without regard to 

section 911(b)(1)(B)(iv)) if paid at such 

time, and the amount of such 

compensation was equal to or less than 

the excess (if any) of the maximum 

exclusion amount under section 

911(b)(2)(D) for such taxable year over 

the amount of foreign earned income 

actually excluded from gross income by 

such qualified individual for such 

taxable year under section 911(a)(1). 

(C) The compensation would have 

been excludible from gross income 

under section 893. 

(D) The compensation would have 

been excludible from gross income 

under section 931 or section 933. 

(iii) Tax equalization agreements. 

Compensation paid under a tax 

equalization agreement does not provide 

for a deferral of compensation if 

payments made under such tax 

equalization agreement are made no 

later than the end of the second taxable 

year of the service provider beginning 

after the taxable year of the service 

provider in which the service provider’s 

U.S. Federal income tax return is 

required to be filed (including any 

extensions) for the year to which the 

compensation subject to the tax 

equalization payment relates, or, if later, 

the second taxable year of the service 

provider beginning after the latest such 

taxable year in which the service 

provider’s foreign tax return or payment 

is required to be filed or made for the 

year to which the compensation subject 

to the tax equalization payment relates. 

Where such payments arise due to an 

audit, litigation or similar proceeding, 

the right to the payments will not be 

treated as resulting in a deferral of 

compensation if the payments are 

scheduled and made in accordance with 

the provisions of § 1.409A–3(i)(1)(v) 

(timing of tax gross-up payments). For 

purposes of this paragraph (b)(8)(iii), the 

term tax equalization agreement refers 

to an agreement, method, program, or 

other arrangement that provides 

payments intended to compensate the 

service provider for some or all of the 

excess of the taxes actually imposed by 

a foreign jurisdiction on the 

compensation paid by the service 

recipient to the service provider over 

the taxes that would be imposed if the 

compensation were subject solely to 

United States Federal, state, and local 

income tax, or some or all of the excess 

of the United States Federal, state, and 

local income tax actually imposed on 

the compensation paid by the service to 

the service provider over the taxes that 

would be imposed if the compensation 

were subject solely to taxes in the 

foreign jurisdiction, provided that the 

payment made under such agreement, 

method, program, or other arrangement 

may not exceed such excess and the 

amount necessary to compensate for the 

additional taxes on the amount paid 

under the agreement, method, program, 

or other arrangement. 

(iv) Certain limited deferrals of a 

nonresident alien. With respect to a 

nonresident alien, a foreign plan does 

not provide for a deferral of 

compensation if the amounts deferred 

under the foreign plan based upon 

services performed by the nonresident 

alien in the United States (including 

amounts deferred based upon service 

credits or compensation received due to 

services performed in the United States) 

do not exceed the applicable dollar 

amount under section 402(g)(1)(B) for 

the taxable year. If the amounts deferred 

under the foreign plan based upon the 

services performed by the nonresident 

alien in the United States exceed the 

applicable dollar amount, an amount of 

such deferrals equal to such amount is 

treated as not deferred under a 

nonqualified deferred compensation 

plan. For purposes of this paragraph 

(b)(8)(iv), the term foreign plan means a 

plan that, together with all substantially 

similar plans, is maintained by a service 

recipient for a substantial number of 

participants, substantially all of whom 

are nonresident aliens or resident aliens 

classified as resident aliens solely under 

section 7701(b)(1)(A)(ii) (and not section 

7701(b)(1)(A)(i)). 

(v) Additional foreign plans. A plan in 

which a service provider participates 

does not provide for a deferral of 

compensation for purposes of this 

paragraph (b) to the extent designated 

by the Commissioner in revenue 

procedures, notices, or other guidance 

published in the Internal Revenue 

Bulletin (see § 601.601(d)(2) of this 

chapter). 

(vi) Earnings. Earnings on 

compensation excluded from the 

definition of deferral of compensation 

pursuant to this paragraph (b)(8) are also 

not treated as a deferral of 

compensation. 

(9) Separation pay plans—(i) In 

general. A plan that otherwise provides 

for a deferral of compensation under 

this paragraph (b) does not fail to 

provide a deferral of compensation 

merely because the right to payment of 

the compensation is conditioned upon a 

separation from service. However, 

paragraphs (b)(9)(ii), (iii), (iv), and (v) of 

this section provide rules concerning 

the extent to which certain separation 

pay plans do not provide for the deferral 

of compensation. The exceptions 

contained in paragraphs (b)(9)(ii), (iii), 


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(iv), and (v) of this section may be used 

in combination, such that compensation 

under a plan that would be excepted 

under one of those paragraphs may be 

treated as excepted under another of 

those paragraphs, so that other 

compensation under a plan may be 

treated as excepted under the first of 

such paragraphs. Notwithstanding any 

other provision of this paragraph (b)(9), 

any payment or benefit, or entitlement 

to a payment or benefit, that acts as a 

substitute for, or replacement of, 

amounts deferred by the service 

recipient under a separate nonqualified 

deferred compensation plan constitutes 

a payment or a deferral of compensation 

under the separate nonqualified 

deferred compensation plan, and does 

not constitute a payment or deferral of 

compensation under a separation pay 

plan. If a service provider receives a 

payment at separation from service and 

also has a legally binding right to an 

amount of deferred compensation that 

would be forfeited upon the separation 

from service, whether the payment acts 

as an acceleration of vesting and 

substitute payment for the amount of 

deferred compensation forfeited, or 

whether the deferred compensation is 

treated as forfeited and the amount paid 

is treated as a separate payment of 

current compensation, is determined 

based on the facts and circumstances, 

provided that, where the separation 

from service is voluntary, it is presumed 

that the payment results from an 

acceleration of vesting followed by a 

payment of the deferred compensation 

that is subject to section 409A. 

Accordingly, any change in the payment 

schedule to accelerate or defer the 

payments would be subject to the rules 

of section 409A. The presumption that 

a right to a payment is not a new right, 

but is instead a right substituted for a 

pre-existing forfeited right, may be 

rebutted by demonstrating that the 

service provider would have obtained 

the right to the payment regardless of 

the forfeiture of the nonvested right. A 

factor indicating that the service 

provider would have obtained a right to 

a payment regardless of the forfeiture of 

the nonvested right is that the amount 

to which the service provider obtains a 

right is materially less than an amount 

equal to the present value of the 

forfeited amount multiplied by a 

fraction, the numerator of which is the 

period of service the service provider 

actually completed, and the 

denominator of which is the full period 

of service the service provider would 

have been required to complete to 

receive the full amount of the payment. 

For example, where a service provider 

is entitled to a future payment only if 

the service provider completes three 

years of service and at the time of 

termination the service provider has 

completed one year of service, the 

presumption could be rebutted if the 

payment to the service provider is 

materially less than the present value of 

one-third of the nonvested amount. 

Another such factor is that the payment 

to the service provider is of a type 

customarily made to service providers 

who separate from service with the 

service recipient and do not forfeit 

nonvested rights to deferred 

compensation (for example, a payment 

of accrued but unused leave or a 

payment for a release of actual or 

potential claims). 

(ii) Collectively bargained separation 

pay plans. A separation pay plan does 

not provide for a deferral of 

compensation to the extent the plan is 

a collectively bargained separation pay 

plan that provides for separation pay 

only upon an involuntary separation 

from service or pursuant to a window 

program. Only the portion of the 

separation pay plan attributable to 

employees covered by a bona fide 

collective bargaining agreement is 

considered to be provided under a 

collectively bargained separation pay 

plan. A collectively bargained 

separation pay plan is a separation pay 

plan that meets the following 

conditions: 

(A) The separation pay plan is 

contained within an agreement that the 

Secretary of Labor determines to be a 

collective bargaining agreement. 

(B) The separation pay provided by 

the collective bargaining agreement was 

the subject of arm’s length negotiations 

between employee representatives and 

one or more employers, and the 

agreement between employee 

representatives and one or more 

employers satisfies section 7701(a)(46). 

(C) The circumstances surrounding 

the agreement evidence good faith 

bargaining between adverse parties over 

the separation pay to be provided under 

the agreement. 

(iii) Separation pay due to 

involuntary separation from service or 

participation in a window program. A 

separation pay plan that is not described 

in paragraph (b)(9)(ii) of this section and 

that provides for separation pay only 

upon an involuntary separation from 

service (as defined in paragraph (n) of 

this section) or pursuant to a window 

program does not provide for a deferral 

of compensation to the extent that the 

separation pay, or portion of the 

separation pay, provided under the plan 

meets the following requirements: 

(A) The separation pay (other than 

amounts described in paragraphs 

(b)(9)(iv) and (v) of this section) does 

not exceed two times the lesser of—

(1) The sum of the service provider’s 

annualized compensation based upon 

the annual rate of pay for services 

provided to the service recipient for the 

taxable year of the service provider 

preceding the taxable year of the service 

provider in which the service provider 

has a separation from service with such 

service recipient (adjusted for any 

increase during that year that was 

expected to continue indefinitely if the 

service provider had not separated from 

service); or 

(2) The maximum amount that may be 

taken into account under a qualified 

plan pursuant to section 401(a)(17) for 

the year in which the service provider 

has a separation from service. 

(B) The plan provides that the 

separation pay described in paragraph 

(b)(9)(iii)(A) of this section must be paid 

no later than the last day of the second 

taxable year of the service provider 

following the taxable year of the service 

provider in which occurs the separation 

from service. 

(iv) Foreign separation pay plans. A 

separation pay plan (including a plan 

providing payments upon a voluntary 

separation from service) does not 

provide for deferred compensation to 

the extent the plan provides for amounts 

of separation pay required to be 

provided under the applicable law of a 

foreign jurisdiction. For this purpose, a 

provision of foreign law shall be 

considered applicable only to foreign 

earned income (as defined under section 

911(b)(1) without regard to section 

911(b)(1)(B)(iv) and without regard to 

the requirement that the income be 

attributable to services performed 

during the period described in section 

911(d)(1)(A) or (B)) from sources within 

the foreign country that promulgated 

such law. 

(v) Reimbursements and certain other 

separation payments—(A) In general. 

To the extent a separation pay plan 

(including a plan providing payments 

upon a voluntary separation from 

service) entitles a service provider to 

payment by the service recipient of 

reimbursements that are not otherwise 

excludible from gross income, for 

expenses that the service provider could 

otherwise deduct under section 162 or 

section 167 as business expenses 

incurred in connection with the 

performance of services (ignoring any 

applicable limitation based on adjusted 

gross income), or of reasonable 

outplacement expenses and reasonable 

moving expenses actually incurred by 

the service provider and directly related 


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to the termination of services for the 

service recipient, such plan does not 

provide for a deferral of compensation 

to the extent such rights apply during a 

limited period of time (regardless of 

whether such rights extend beyond the 

limited period of time). For purposes of 

this paragraph (b)(9)(v)(A), the 

reimbursement of reasonable moving 

expenses includes the reimbursement of 

all or part of any loss the service 

provider actually incurs due to the sale 

of a primary residence in connection 

with a separation from service. 

(B) Medical benefits. To the extent a 

separation pay plan (including a plan 

providing payments due to a voluntary 

separation from service) entitles a 

service provider to reimbursement by 

the service recipient of payments of 

medical expenses incurred and paid by 

the service provider but not reimbursed 

by a person other than the service 

recipient and allowable as a deduction 

under section 213 (disregarding the 

requirement of section 213(a) that the 

deduction is available only to the extent 

that such expenses exceed 7.5 percent of 

adjusted gross income), such plan does 

not provide for a deferral of 

compensation to the extent such rights 

apply during the period of time during 

which the service provider would be 

entitled (or would, but for such plan, be 

entitled) to continuation coverage under 

a group health plan of the service 

recipient under section 4980B (COBRA) 

if the service provider elected such 

coverage and paid the applicable 

premiums. 

(C) In-kind benefits and direct service 

recipient payments. A service provider’s 

entitlement 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, is treated as not 

providing for a deferral of compensation 

for purposes of this paragraph (b), if a 

right to reimbursement by the service 

recipient for a payment for such 

benefits, goods, or services by the 

service provider would not be treated as 

providing for a deferral of compensation 

under this paragraph (b)(9)(v). 

(D) Limited payments. If not 

otherwise excluded, a taxpayer may 

treat a right or rights under a separation 

pay plan to a payment or payments as 

not providing for a deferral of 

compensation to the extent such 

payments in the aggregate do not exceed 

the applicable dollar amount under 

section 402(g)(1)(B) for the year of the 

separation from service. 

(E) Limited period of time. For 

purposes of paragraphs (b)(9)(v)(A) and 

(C) of this section, a limited period of 

time in which expenses may be 

incurred, or in which in-kind benefits 

may be provided by the service 

recipient or a third party that the service 

recipient will pay, does not include 

periods beyond the last day of the 

second taxable year of the service 

provider following the taxable year of 

the service provider in which the 

separation from service occurred, 

provided that the period during which 

the reimbursements for such expenses 

must be paid may not extend beyond 

the third taxable year of the service 

provider following the taxable year of 

the service provider in which the 

separation from service occurred. 

(vi) Window programs—definition. 

The term window program refers to a 

program established by a service 

recipient in connection with an 

impending separation from service to 

provide separation pay, where such 

program is made available by the service 

recipient for a limited period of time (no 

longer than 12 months) to service 

providers who separate from service 

during that period or to service 

providers who separate from service 

during that period under specified 

circumstances. A program will not be 

considered a window program if a 

service recipient establishes a pattern of 

repeatedly providing for similar 

separation pay in similar situations for 

substantially consecutive, limited 

periods of time. Whether the recurrence 

of these programs constitutes a pattern 

is determined based on the facts and 

circumstances. Although no one factor 

is determinative, relevant factors 

include whether the benefits are on 

account of a specific business event or 

condition, the degree to which the 

separation pay relates to the event or 

condition, and whether the event or 

condition is temporary or discrete or is 

a permanent aspect of the employer’s 

business. 

(10) Certain indemnification and 

liability insurance plans. A plan in 

which a service provider participates 

does not provide for a deferral of 

compensation for purposes of this 

paragraph (b) to the extent that the plan 

provides (to the extent permissible 

under applicable law), for the 

indemnification of, or the purchase of 

an insurance policy providing for 

payments of, all or part of the expenses 

incurred or damages paid or payable by 

a service provider with respect to a bona 

fide claim against the service provider 

or service recipient, including amounts 

paid or payable by the service provider 

upon the settlement of a bona fide claim 

against the service provider or service 

recipient, where such claim is based on 

actions or failures to act by the service 

provider in his or her capacity as a 

service provider of the service recipient. 

(11) Legal settlements. An agreement 

to which a service provider is a party 

does not provide for a deferral of 

compensation for purposes of this 

paragraph (b) to the extent that the 

agreement provides for amounts paid as 

settlements or awards resolving bona 

fide legal claims based on wrongful 

termination, employment 

discrimination, the Fair Labor Standards 

Act, or worker’s compensation statutes, 

including claims under applicable 

Federal, state, local, or foreign laws, or 

for reimbursements or payments of 

reasonable attorneys fees or other 

reasonable expenses incurred by the 

service provider related to such bona 

fide legal claims, regardless of whether 

such settlements, awards, or 

reimbursement or payment of expenses 

pursuant to such claims are treated as 

compensation or wages for Federal tax 

purposes. Whether the execution of a 

waiver of any or all of such types of 

claims indicates that the amounts are 

paid as an award or settlement of an 

actual bona fide claim for damages 

under applicable law is determined 

based on the facts and circumstances. 

This paragraph (b)(11) does not apply to 

any deferred amounts that did not arise 

as a result of an actual bona fide claim 

for damages under applicable law, such 

as amounts that would have been 

deferred or paid regardless of the 

existence of such claim, even if such 

amounts are paid or modified as part of 

a settlement or award resolving an 

actual bona fide claim. For this purpose, 

a provision of foreign law shall be 

considered applicable only to foreign 

earned income (as defined under section 

911(b)(1) without regard to section 

911(b)(1)(B)(iv) and without regard to 

the requirement that the income be 

attributable to services performed 

during the period described in section 

911(d)(1)(A) or (B)) from sources within 

the foreign country that promulgated 

such law. 

(12) Certain educational benefits. A 

plan in which a service provider 

participates does not provide for a 

deferral of compensation to the extent 

the plan provides for taxable 

educational benefits. For purposes of 

this paragraph (b)(12), the term 

educational benefits refers solely to 

benefits provided to a service provider, 

consisting solely of educational 

assistance for the education of the 

service provider, as defined in section 

127(c) and the accompanying 

regulations, and does not refer to any 

benefits provided for the education of 

any other person, including any spouse, 


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child, or other family member of the 

service provider. 

(c) Plan—(1) In general. The term 

plan includes any agreement, method, 

program, or other arrangement, 

including an agreement, method, 

program, or other arrangement that 

applies to one person or individual. A 

plan may be adopted unilaterally by the 

service recipient or may be negotiated or 

agreed to by the service recipient and 

one or more service providers or service 

provider representatives. An agreement, 

method, program, or other arrangement 

may constitute a plan regardless of 

whether it is an employee benefit plan 

under section 3(3) of ERISA, as 

amended (29 U.S.C. 1002(3)). The 

requirements of section 409A are 

applied as if a separate plan or plans is 

maintained for each service provider. 

For purposes of determining the terms 

of a plan, general provisions of the plan 

that purport to nullify noncompliant 

plan terms, or to supply any specific 

plan terms required by this section, 

§ 1.409A–2 or § 1.409A–3, are 

disregarded. 

(2) Plan aggregation rules—(i) In 

general. Except as otherwise provided, 

the following rules apply with respect to 

the application of this section and 

§§ 1.409A–2 through 1.409A–6 to 

deferrals of compensation with respect 

to a service provider: 

(A) All deferrals of compensation at 

the election of that service provider 

under all plans of the service recipient 

that are account balance plans, except to 

the extent that the plan is described in 

paragraph (c)(2)(i)(D), (E), (F), (G), or (H) 

of this section, are treated as deferred 

under a single plan. For purposes of this 

paragraph, the term account balance 

plan means—

(1) An agreement, method, program, 

or other arrangement that is an account 

balance plan as defined in 

§ 31.3121(v)(2)–1(c)(1)(ii)(A) of this 

chapter, including mandatorily 

bifurcating the agreement, method, 

program, or other arrangement in 

accordance with the rules provided in 

§ 31.3121(v)–1(c)(1)(iii)(B) of this 

chapter; or 

(2) An agreement, method, program, 

or other arrangement that would be 

described in paragraph (c)(2)(i)(A)(1) of 

this section if the service provider were 

an employee. 

(B) All deferrals of compensation 

other than at the election of that service 

provider, including deferrals reflecting 

matching by the service recipient with 

respect to amounts a service provider 

elects to defer, under all plans of the 

service recipient that are account 

balance plans, except to the extent the 

plan is described in paragraph 

(c)(2)(i)(D), (E), (F), (G), or (H) of this 

section, are treated as deferred under a 

single plan. For purposes of this 

paragraph (c)(2)(i)(B), the term ‘‘account 

balance plan’’ has the same meaning as 

provided in paragraph (c)(2)(i)(A) of this 

section. 

(C) All deferrals of compensation with 

respect to that service provider under all 

plans of the service recipient that are 

nonaccount balance plans, except to the 

extent such plan is described in 

paragraph (c)(2)(i)(D), (E), (F), (G), or (H) 

of this section, are treated as deferred 

under a single plan. For purposes of this 

paragraph (c)(2)(i)(C), the term 

nonaccount balance plan means—

(1) An agreement, method, program, 

or other arrangement that is a 

nonaccount balance plan as defined in 

§ 31.3121(v)(2)–1(c)(2)(i) of this chapter, 

including mandatorily bifurcating the 

agreement, method, program, or other 

arrangement in accordance with the 

rules provided in § 31.3121(v)–

1(c)(1)(iii)(B) of this chapter; or 

(2) An agreement, method, program, 

or other arrangement that would be 

described in paragraph (c)(2)(i)(C)(1) of 

this section if the service provider were 

an employee. 

(D) All deferrals of compensation with 

respect to that service provider under all 

separation pay plans (as defined in 

paragraph (m) of this section) of the 

service recipient to the extent an 

amount deferred under the plans is not 

described in paragraph (c)(2)(i)(E) of this 

section and is payable solely upon an 

involuntary separation from service 

within the meaning of paragraph (n) of 

this section or as a result of 

participation in a window program, are 

treated as deferred under a single plan. 

(E) All deferrals of compensation with 

respect to that service provider under all 

plans of the service recipient to the 

extent such amounts deferred consist of 

rights to in-kind benefits or 

reimbursements of expenses, such as 

membership fees, or expenses related to 

aircraft or vehicle usage, to the extent 

that the right to the in-kind benefit or 

reimbursement, separately or in the 

aggregate, does not 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, are treated as 

deferred under a single plan. 

(F) All deferrals of compensation with 

respect to that service provider under all 

plans of the service recipient to the 

extent that the taxation of such 

compensation is governed by § 1.61–22 

or § 1.7872–15 (split-dollar life 

insurance arrangements), or the taxation 

of such compensation would be 

governed by § 1.61–22 or § 1.7872–15 

but for the operation of § 1.61–22(j) 

(effective date provisions), are treated as 

deferred under a single plan. 

(G) All deferrals of compensation with 

respect to that service provider under all 

agreements, methods, programs, or other 

arrangements of the service recipient to 

the extent the deferrals under the 

agreements, methods, programs, or other 

arrangements are deferrals of amounts 

that would be treated as modified 

foreign earned income (meaning foreign 

earned income as defined under section 

911(b)(1) without regard to section 

911(b)(1)(B)(iv) and without regard to 

the requirement that the income be 

attributable to services performed 

during the period described in section 

911(d)(1)(A) or (B)) if paid to the service 

provider at the time the amount is first 

deferred, and provided further that 

substantially all the participants in such 

agreements, methods, programs, or other 

arrangements and any substantially 

similar agreements, methods, programs, 

or other arrangements are nonresident 

aliens and that the service provider does 

not participate in a substantially 

identical agreement, method, program, 

or other arrangement that does not meet 

the requirements of this paragraph 

(c)(2)(i)(G) (a domestic arrangement), are 

treated as deferred under a single plan. 

(H) All deferrals of compensation 

with respect to that service provider 

under all plans of the service provider 

to the extent such plans are stock rights 

(as defined in paragraph (c)(2)(l) of this 

section) subject to section 409A, are 

treated as deferred under a single plan. 

(I) All deferrals of compensation with 

respect to that service provider under all 

plans of the service recipient to the 

extent such plans are not described in 

paragraph (c)(2)(i)(A), (B), (C), (D), (E), 

(F), (G), or (H) of this section are treated 

as deferred under a single plan. 

(ii) Dual status. Agreements, methods, 

programs, and other arrangements in 

which a service provider participates 

are not aggregated with other 

agreements, methods, programs, and 

other arrangements to the extent the 

service provider participates in one set 

of agreements, methods, programs, and 

other arrangements due to status as an 

employee of the service recipient 

(employee arrangements) and another 

set of agreements, methods, programs, 

and other arrangements due to status as 

an independent contractor of the service 

recipient (independent contractor 

arrangements). For example, where a 

service provider deferred amounts 

under an independent contractor 

arrangement while providing services as 

an independent contractor, and then 


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becomes eligible for and defers amounts 

under a separate employee arrangement 

after being hired as an employee, the 

two arrangements will not be aggregated 

for purposes of this paragraph (c)(2). 

Where an employee also is a member of 

the board of directors of the service 

recipient (or a similar position with 

respect to a non-corporate service 

recipient), the arrangements under 

which the employee participates as a 

director (director arrangements) are not 

aggregated with employee arrangements, 

provided that the director arrangements 

are substantially similar to arrangements 

provided to service providers providing 

services only as directors (or similar 

positions with respect to non-corporate 

service recipients). For example, an 

employee director who participates in 

an employee arrangement and a director 

arrangement generally may treat the two 

arrangements as separate plans, 

provided that the director arrangement 

is substantially similar to arrangements 

providing benefits to non-employee 

directors. To the extent a plan in which 

an employee director participates is not 

substantially similar to arrangements in 

which non-employee directors 

participate, such plan is treated as an 

employee plan for purposes of this 

paragraph (c)(2). Director plans and 

independent contractor plans are 

aggregated for purposes of this 

paragraph (c)(2). 

(3) Establishment of plan—(i) In 

general. A plan does not satisfy the 

requirements of section 409A and this 

section and §§ 1.409A–2 through 

1.409A–3 and §§ 1.409A–5 through 

1.409A–6, unless the plan is established 

and maintained by a service recipient in 

accordance with the requirements of 

this section, §§ 1.409A–2 through 

1.409A–3 and §§ 1.409A–5 through 

1.409A–6. For purposes of this 

paragraph (c)(3), a plan is established on 

the latest of the date on which it is 

adopted, the date on which it is 

effective, and the date on which the 

material terms of the plan are set forth 

in writing. The material terms of the 

plan may be set forth in writing in one 

or more documents. For purposes of this 

paragraph (c)(3)(i), a plan will be 

deemed to be set forth in writing if it is 

set forth in any other form that is 

approved by the Commissioner. The 

material terms of the plan include the 

amount (or the method or formula for 

determining the amount) of deferred 

compensation to be provided under the 

plan and the time and form of payment. 

Notwithstanding the foregoing, a plan 

will be deemed to be established as of 

the date the participant obtains a legally 

binding right to a deferral of 

compensation, provided that the plan is 

otherwise established under the rules of 

this paragraph (c)(3)(i) by the end of the 

taxable year of the service provider in 

which the legally binding right arises, or 

with respect to an amount not payable 

in the year immediately following the 

taxable year of the service provider in 

which the legally binding right arises 

(the subsequent year), the 15th day of 

the third month of the subsequent year. 

(ii) Initial deferral election provisions. 

If a plan provides a service provider or 

a service recipient with an initial 

deferral election, the plan satisfies the 

requirements of this paragraph (c)(3) if 

the plan sets forth in writing, on or 

before the date the applicable election is 

required to be irrevocable to satisfy the 

requirements of § 1.409A–2(a), the 

conditions under which such election 

may be made. 

(iii) Subsequent deferral election 

provisions. If a plan permits a 

subsequent deferral election described 

in § 1.409A–2(b), the plan satisfies the 

requirements of this paragraph (c)(3) if 

the plan sets forth in writing, on or 

before the date the election is required 

to be irrevocable to meet the 

requirements of § 1.409A–2(b), the 

conditions under which such election 

may be made. 

(iv) Payment accelerations. Except as 

explicitly provided in § 1.409A–3, a 

plan is not required to set forth in 

writing the conditions under which a 

payment may be accelerated if such 

acceleration is permitted under 

§ 1.409A–3(j)(4). 

(v) Six-month delay for specified 

employees. A plan must provide that 

distributions to a specified employee 

may not be made before the date that is 

six months after the date of separation 

from service or, if earlier, the date of 

death (the six-month delay rule). The 

six-month delay rule, required for 

payments due to the separation from 

service of a specified employee, must be 

written in the plan. A plan does not fail 

to be established and maintained merely 

because it does not contain the sixmonth delay rule when the service 

provider who has a right to 

compensation deferred under such plan 

is not a specified employee. However, 

such provision must be set forth in 

writing on or before the date such 

service provider first becomes a 

specified employee. In general, this 

means the provision must be set forth in 

writing on or before the specified 

employee effective date (as defined in 

paragraph (i)(3) of this section) for the 

first list of specified employees that 

includes such service provider. 

(vi) Plan amendments. In the case of 

an amendment that increases the 

amount deferred under a nonqualified 

deferred compensation plan, the plan is 

not considered established with respect 

to the additional amount deferred until 

the plan, as amended, is established in 

accordance with paragraph (c)(3)(i) of 

this section. 

(vii) Transition rule for written plan 

requirement. For purposes of this 

paragraph (c)(3), a legally enforceable 

unwritten plan that was adopted and 

effective before December 31, 2007, is 

treated as established under this section 

as of the later of the date on which it 

was adopted or became effective, 

provided that the material terms of the 

plan are set forth in writing on or before 

December 31, 2007. 

(viii) Plan aggregation rules. The plan 

aggregation rules of paragraph (c)(2)(i) of 

this section do not apply to the 

requirements of this paragraph (c)(3). 

Accordingly, deferrals of compensation 

under an agreement, method, program, 

or other arrangement that fails to meet 

the requirements of section 409A solely 

due to a failure to meet the requirements 

of this paragraph (c)(3) are not 

aggregated with deferrals of 

compensation under other agreements, 

methods, programs, or other 

arrangements that meet such 

requirements. 

(d) Substantial risk of forfeiture—(1) 

In general. Compensation is subject to a 

substantial risk of forfeiture if 

entitlement to the amount is 

conditioned on the performance of 

substantial future services by any 

person or the occurrence of a condition 

related to a purpose of the 

compensation, and the possibility of 

forfeiture is substantial. For purposes of 

this paragraph (d), a condition related to 

a purpose of the compensation must 

relate to the service provider’s 

performance for the service recipient or 

the service recipient’s business 

activities or organizational goals (for 

example, the attainment of a prescribed 

level of earnings or equity value or 

completion of an initial public offering). 

For purposes of this paragraph (d), if a 

service provider’s entitlement to the 

amount is conditioned on the 

occurrence of the service provider’s 

involuntary separation from service 

without cause, the right is subject to a 

substantial risk of forfeiture if the 

possibility of forfeiture is substantial. 

An amount is not subject to a 

substantial risk of forfeiture merely 

because the right to the amount is 

conditioned, directly or indirectly, upon 

the refraining from the performance of 

services. Except as provided with 

respect to certain transaction-based 

compensation under § 1.409A–

3(i)(5)(iv), the addition of any risk of 


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forfeiture after the legally binding right 

to the compensation arises, or any 

extension of a period during which 

compensation is subject to a risk of 

forfeiture, is disregarded for purposes of 

determining whether such 

compensation is subject to a substantial 

risk of forfeiture. An amount will not be 

considered subject to a substantial risk 

of forfeiture beyond the date or time at 

which the recipient otherwise could 

have elected to receive the amount of 

compensation, unless the present value 

of the amount subject to a substantial 

risk of forfeiture (disregarding, in 

determining the present value, the risk 

of forfeiture) is materially greater than 

the present value of the amount the 

recipient otherwise could have elected 

to receive absent such risk of forfeiture. 

For this purpose, compensation that the 

service provider would receive for 

continuing to perform services 

regardless of whether the service 

provider elected to receive the amount 

that is subject to a substantial risk of 

forfeiture is not taken into account in 

determining whether the present value 

of the right to the amount subject to a 

substantial risk of forfeiture is 

materially greater than the amount the 

recipient otherwise could have elected 

to receive absent such risk of forfeiture. 

For example, a salary deferral generally 

may not be made subject to a substantial 

risk of forfeiture. But, for example, 

where a bonus plan provides an election 

between a cash payment or restricted 

stock units with a present value that is 

materially greater (disregarding the risk 

of forfeiture) than the present value of 

such cash payment and that will be 

forfeited absent continued services for a 

period of years, the right to the 

restricted stock units generally will be 

treated as subject to a substantial risk of 

forfeiture. 

(2) Stock rights. A stock right is not 

subject to a substantial risk of forfeiture 

at the earlier of the first date the holder 

may exercise the stock right and receive 

cash or property that is substantially 

vested (as defined in § 1.83–3(b)) or the 

first date that the stock right is not 

subject to a forfeiture condition that 

would constitute a substantial risk of 

forfeiture. Accordingly, a stock option 

that the service provider may exercise 

immediately and receive substantially 

vested stock is not subject to a 

substantial risk of forfeiture, even if the 

stock option automatically terminates 

upon the service provider’s separation 

from service. 

(3) Enforcement of forfeiture 

condition—(i) In general. In determining 

whether the possibility of forfeiture is 

substantial in the case of rights to 

compensation granted by a service 

recipient to a service provider that owns 

a significant amount of the total 

combined voting power or value of all 

classes of equity of the service recipient 

(where the service provider’s ownership 

is determined with application of the 

attribution rules under section 318 if the 

service recipient is a corporation, or if 

the service recipient is an entity that is 

not a corporation, with application by 

analogy of the attribution rules under 

section 318), all relevant facts and 

circumstances will be taken into 

account in determining whether the 

probability of the service recipient 

enforcing such condition is substantial, 

including—

(A) The service provider’s 

relationship to other equity holders and 

the extent of their control, potential 

control and possible loss of control of 

the service recipient; 

(B) The position of the service 

provider in the service recipient and the 

extent to which the service provider is 

subordinate to other service providers; 

(C) The service provider’s relationship 

to the officers and directors of the 

service recipient (or similar positions 

with respect to a noncorporate service 

recipient); 

(D) The person or persons who must 

approve the service provider’s 

discharge; and 

(E) Past actions of the service 

recipient in enforcing the restrictions. 

(ii) Examples. The following 

examples illustrate the rules of 

paragraph (d)(3)(i) of this section: 

Example 1. A service provider would be 

considered as having deferred compensation 

subject to a substantial risk of forfeiture, but 

for the fact that the service provider owns 20 

percent of the single class of stock in the 

transferor corporation. If the remaining 80 

percent of the class of stock is owned by an 

unrelated individual (or members of such an 

individual’s family) so that the possibility of 

the corporation enforcing a restriction on 

such rights is substantial, then such rights are 

subject to a substantial risk of forfeiture. 

Example 2. A service provider would be 

considered as having deferred compensation 

subject to a substantial risk of forfeiture, but 

for the fact that the service provider, who is 

president of the corporation, also owns 4 

percent of the voting power of all the stock 

of a corporation. If the remaining stock is so 

diversely held by the public that the 

president, in effect, controls the corporation, 

then the possibility of the corporation 

enforcing a restriction on the right to deferred 

compensation of the president is not 

substantial, and such rights are not subject to 

a substantial risk of forfeiture. 

(e) Performance-based 

compensation—(1) In general. The term 

performance-based compensation 

means compensation the amount of 

which, or the entitlement to which, is 

contingent on the satisfaction of 

preestablished organizational or 

individual performance criteria relating 

to a performance period of at least 12 

consecutive months. Organizational or 

individual performance criteria are 

considered preestablished if established 

in writing by not later than 90 days after 

the commencement of the period of 

service to which the criteria relates, 

provided that the outcome is 

substantially uncertain at the time the 

criteria are established. Performancebased compensation may include 

payments based on performance criteria 

that are not approved by a 

compensation committee of the board of 

directors (or similar entity in the case of 

a non-corporate service recipient) or by 

the stockholders or members of the 

service recipient. Performance-based 

compensation does not include any 

amount or portion of any amount that 

will be paid either regardless of 

performance, or based upon a level of 

performance that is substantially certain 

to be met at the time the criteria is 

established. In addition, except as 

provided in paragraph (e)(3) of this 

section, compensation is not 

performance-based compensation 

merely because the amount of such 

compensation is determined by 

reference to the value of the service 

recipient or the stock of the service 

recipient. Where a portion of an amount 

of compensation would qualify as 

performance-based compensation if the 

portion were the sole amount available 

under the plan, that portion of the 

award will not fail to qualify as 

performance-based compensation if that 

portion is designated separately or 

otherwise separately identifiable under 

the terms of the plan, and the amount 

of each portion is determined 

independently of the other. 

Compensation may be performancebased compensation where the amount 

will be paid regardless of satisfaction of 

the performance criteria due to the 

service provider’s death, disability, or a 

change in control event (as defined in 

§ 1.409A–3(i)(5)(i)), provided that a 

payment made under such 

circumstances without regard to the 

satisfaction of the performance criteria 

will not constitute performance-based 

compensation. For purposes of this 

paragraph (e)(1), a disability refers to 

any medically determinable physical or 

mental impairment resulting in the 

service provider’s inability to perform 

the duties of his or her position or any 

substantially similar position, where 

such impairment can be expected to 

result in death or can be expected to last 


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for a continuous period of not less than 

six months. 

(2) Payments based upon subjective 

performance criteria. The term 

performance-based compensation 

includes payments based upon 

subjective performance criteria, 

provided that—

(i) The subjective performance criteria 

are bona fide and relate to the 

performance of the participant service 

provider, a group of service providers 

that includes the participant service 

provider, or a business unit for which 

the participant service provider 

provides services (which may include 

the entire organization); and 

(ii) The determination that any 

subjective performance criteria have 

been met is not made by the participant 

service provider or a family member of 

the participant service provider (as 

defined in section 267(c)(4) applied as 

if the family of an individual includes 

the spouse of any member of the 

family), or a person under the effective 

control of the participant service 

provider or such a family member, and 

no amount of the compensation of the 

person making such determination is 

effectively controlled in whole or in part 

by the service provider or such a family 

member. 

(3) Equity-based compensation. 

Compensation is performance-based 

compensation if it is based solely on an 

increase in the value of the service 

recipient, or a share of stock in the 

service recipient, after the date of a 

grant or award. However, compensation 

payable for a service period that is equal 

to the value of a predetermined number 

of shares of stock, and is variable only 

to the extent that the value of such 

shares appreciates or depreciates, 

generally will not be performance-based 

compensation. Notwithstanding the 

foregoing, the attainment of a prescribed 

value for the service recipient (or a 

portion thereof), or a share of stock in 

the service recipient, may be used as a 

preestablished organizational criterion 

for purposes of providing performancebased compensation, provided that the 

other requirements of paragraph (e)(1) of 

this section are satisfied. In addition, an 

award of equity-based compensation 

may constitute performance-based 

compensation if entitlement to the 

compensation is subject to a condition 

that would cause the award to otherwise 

qualify as performance-based 

compensation, such as a performancebased vesting condition. A provision 

that allows a service provider to defer 

compensation that would be realized 

upon the exercise of a stock right 

generally constitutes an additional 

deferral feature for purposes of the 

definition of a deferral of compensation 

under paragraph (b)(5) of this section. 

(f) Service provider—(1) In general. 

The term service provider includes an 

individual, corporation, subchapter S 

corporation, partnership, personal 

service corporation (as defined in 

section 269A(b)(1)), noncorporate entity 

that would be a personal service 

corporation if it were a corporation, 

qualified personal service corporation 

(as defined in section 448(d)(2)), and 

noncorporate entity that would be a 

qualified personal service corporation if 

it were a corporation, for any taxable 

year in which such individual, 

corporation, subchapter S corporation, 

partnership, or other entity accounts for 

gross income from the performance of 

services under the cash receipts and 

disbursements method of accounting. 

The term service provider generally 

includes a person who has separated 

from service (a former service provider). 

(2) Independent contractors—(i) In 

general. Except as otherwise provided 

in paragraph (f)(2)(iv) of this section, 

section 409A does not apply to an 

amount deferred under a plan between 

a service provider and service recipient 

with respect to a particular trade or 

business in which the service provider 

participates, including earnings credited 

to such deferred amount, if during the 

service provider’s taxable year in which 

the service provider obtains a legally 

binding right to the payment of the 

amount deferred each of the following 

applies: 

(A) The service provider is actively 

engaged in the trade or business of 

providing services, other than as an 

employee or as a member of the board 

of directors of a corporation (or similar 

position with respect to an entity that is 

not a corporation). 

(B) The service provider provides 

significant services to two or more 

service recipients to which the service 

provider is not related and that are not 

related to one another (as defined in 

paragraph (f)(2)(ii) of this section). 

(C) The service provider is not related 

to the service recipient, applying the 

definition of related person contained in 

paragraph (f)(2)(ii) of this section subject 

to the modification that the language 

‘‘20 percent’’ is not used instead of ‘‘50 

percent’’ each place ‘‘50 percent’’

appears in sections 267(b) and 707(b)(1). 

(ii) Related person. For purposes of 

this paragraph (f)(2), a person is related 

to another person if the persons bear a 

relationship to each other that is 

specified in section 267(b) or 707(b)(1), 

subject to the modifications that the 

language ‘‘20 percent’’ is used instead of 

‘‘50 percent’’ each place it appears in 

sections 267(b) and 707(b)(1), and 

section 267(c)(4) is applied as if the 

family of an individual includes the 

spouse of any member of the family; or 

the persons are engaged in trades or 

businesses under common control 

(within the meaning of section 52(a) and 

(b)). In addition, an individual is related 

to an entity if the individual is an officer 

of an entity that is a corporation, or 

holds a position substantially similar to 

an officer of a corporation with an entity 

that is not a corporation. 

(iii) Significant services. Whether a 

service provider is providing significant 

services depends on the facts and 

circumstances of each case. However, 

for purposes of paragraph (f)(2)(i) of this 

section, a service provider who provides 

services to two or more service 

recipients to which the service provider 

is not related and that are not related to 

one another is deemed to be providing 

significant services to two or more of 

such service recipients for a given 

taxable year, if the revenues generated 

from the services provided to any 

service recipient or group of related 

service recipients during such taxable 

year do not exceed 70 percent of the 

total revenue generated by the service 

provider from the trade or business of 

providing such services. In addition, in 

the case of a service provider who has 

been providing services in a trade or 

business for a period of not less than 

three consecutive years, for purposes of 

paragraph (f)(2)(i) of this section, a 

service provider who provides services 

to two or more service recipients to 

which the service provider is not related 

and that are not related to one another 

is deemed to be providing significant 

services to two or more of such service 

recipients for a given taxable year if in 

each of the prior three taxable years the 

revenues generated from the services 

provided to any service recipient or 

group of related service recipients 

during such prior taxable years did not 

exceed 70 percent of the total revenue 

generated by the service provider from 

the trade or business of providing such 

services and, at the time an amount is 

deferred, the service provider does not 

know or have reason to anticipate that 

the revenues generated from the services 

provided to any service recipient or 

group of related service recipients 

during the current year will exceed 70 

percent of the total revenue generated 

by the service provider from the trade or 

business of providing such services. 

(iv) Management services. This 

paragraph (f)(2) does not apply to a 

service provider to the extent the service 

provider provides management services 

to a service recipient. For purposes of 

this paragraph (f)(2)(iv), the term 

management services means services 


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that involve the actual or de facto 

direction or control of the financial or 

operational aspects of a trade or 

business of the service recipient, or 

investment management or advisory 

services provided to a service recipient 

whose primary trade or business 

includes the investment of financial 

assets (including investments in real 

estate), such as a hedge fund or a real 

estate investment trust. 

(v) Services provided to related 

persons. Section 409A does not apply to 

an amount deferred under a plan that is 

a bona fide agreement, method, 

program, or other arrangement between 

a service provider and a related service 

recipient arising in the ordinary course 

of a particular trade or business in 

which the service provider is engaged to 

the extent that—

(A) The service provider provides 

services to the service recipient as an 

independent contractor; 

(B) During the service provider’s 

taxable year in which the amount is 

deferred, the service provider qualifies 

for the safe harbor provided in 

paragraph (f)(2)(iii) of this section with 

respect to such trade or business; and 

(C) Such agreement, method, program, 

or other arrangement and the practices 

thereunder (including billing and 

collection practices), are substantially 

similar to the agreements, methods, 

programs, or other arrangements and 

practices applicable to one or more 

unrelated service recipients to whom 

the service provider provides 

substantial services and that produce a 

majority of the total revenue that the 

service provider earns from the trade or 

business of providing such services 

during the taxable year. 

(g) Service recipient. Except as 

otherwise specifically provided in these 

regulations, the term service recipient 

means the person for whom the services 

are performed and with respect to 

whom the legally binding right to 

compensation arises, and all persons 

with whom such person would be 

considered a single employer under 

section 414(b) (employees of controlled 

group of corporations), and all persons 

with whom such person would be 

considered a single employer under 

section 414(c) (employees of 

partnerships, proprietorships, etc., 

under common control). For example, if 

the service provider is an employee, the 

service recipient generally is the 

employer (including all persons treated 

as a single employer under section 

414(b) or (c)). Notwithstanding the 

foregoing, section 409A applies to a 

plan that provides for the deferral of 

compensation, even if the payment of 

the compensation is not made by the 

person for whom services are 

performed. 

(h) Separation from service—(1) 

Employees—(i) In general. An employee 

separates from service with the 

employer if the employee dies, retires, 

or otherwise has a termination of 

employment with the employer. 

However, for purposes of this paragraph 

(h)(1), the employment relationship is 

treated as continuing intact while the 

individual is on military leave, sick 

leave, or other bona fide leave of 

absence if the period of such leave does 

not exceed six months, or if longer, so 

long as the individual retains a right to 

reemployment with the service recipient 

under an applicable statute or by 

contract. For purposes of this paragraph 

(h)(1), a leave of absence constitutes a 

bona fide leave of absence only if there 

is a reasonable expectation that the 

employee will return to perform 

services for the employer. If the period 

of leave exceeds six months and the 

individual does not retain a right to 

reemployment under an applicable 

statute or by contract, the employment 

relationship is deemed to terminate on 

the first date immediately following 

such six-month period. Notwithstanding 

the foregoing, where a leave of absence 

is due to any medically determinable 

physical or mental impairment that can 

be expected to result in death or can be 

expected to last for a continuous period 

of not less than six months, where such 

impairment causes the employee to be 

unable to perform the duties of his or 

her position of employment or any 

substantially similar position of 

employment, a 29-month period of 

absence may be substituted for such sixmonth period. 

(ii) Termination of employment. 

Whether a termination of employment 

has occurred is determined based on 

whether the facts and circumstances 

indicate that the employer and 

employee reasonably anticipated that no 

further services would be performed 

after a certain date or that the level of 

bona fide services the employee would 

perform after such date (whether as an 

employee or as an independent 

contractor) would permanently decrease 

to no more than 20 percent of the 

average level of bona fide services 

performed (whether as an employee or 

an independent contractor) over the 

immediately preceding 36-month period 

(or the full period of services to the 

employer if the employee has been 

providing services to the employer less 

than 36 months). Facts and 

circumstances to be considered in 

making this determination include, but 

are not limited to, whether the 

employee continues to be treated as an 

employee for other purposes (such as 

continuation of salary and participation 

in employee benefit programs), whether 

similarly situated service providers have 

been treated consistently, and whether 

the employee is permitted, and 

realistically available, to perform 

services for other service recipients in 

the same line of business. An employee 

is presumed to have separated from 

service where the level of bona fide 

services performed decreases to a level 

equal to 20 percent or less of the average 

level of services performed by the 

employee during the immediately 

preceding 36-month period. An 

employee will be presumed not to have 

separated from service where the level 

of bona fide services performed 

continues at a level that is 50 percent or 

more of the average level of service 

performed by the employee during the 

immediately preceding 36-month 

period. No presumption applies to a 

decrease in the level of bona fide 

services performed to a level that is 

more than 20 percent and less than 50 

percent of the average level of bona fide 

services performed during the 

immediately preceding 36-month 

period. The presumption is rebuttable 

by demonstrating that the employer and 

the employee reasonably anticipated 

that as of a certain date the level of bona 

fide services would be reduced 

permanently to a level less than or equal 

to 20 percent of the average level of 

bona fide services provided during the 

immediately preceding 36-month period 

or full period of services provided to the 

employer if the employee has been 

providing services to the service 

recipient for a period of less than 36 

months (or that the level of bona fide 

services would not be so reduced). For 

example, an employee may demonstrate 

that the employer and employee 

reasonably anticipated that the 

employee would cease providing 

services, but that, after the original 

cessation of services, business 

circumstances such as termination of 

the employee’s replacement caused the 

employee to return to employment. 

Although the employee’s return to 

employment may cause the employee to 

be presumed to have continued in 

employment because the employee is 

providing services at a rate equal to the 

rate at which the employee was 

providing services before the 

termination of employment, the facts 

and circumstances in this case would 

demonstrate that at the time the 

employee originally ceased to provide 

services, the employee and the service 

recipient reasonably anticipated that the 

employee would not provide services in 


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the future. Notwithstanding the 

foregoing provisions of this paragraph 

(h)(1)(ii), a plan may treat another level 

of reasonably anticipated permanent 

reduction in the level of bona fide 

services as a separation from service, 

provided that the level of reduction 

required must be designated in writing 

as a specific percentage, and the 

reasonably anticipated reduced level of 

bona fide services must be greater than 

20 percent but less than 50 percent of 

the average level of bona fide services 

provided in the immediately preceding 

12 months. The plan must specify the 

definition of separation from service on 

or before the date on which a separation 

from service is designated as a time of 

payment of the applicable amount 

deferred, and once designated, any 

change to the definition of separation 

from service with respect to such 

amount deferred will be subject to the 

rules regarding subsequent deferrals and 

the acceleration of payments. For 

purposes of this paragraph (h)(1)(ii), for 

periods during which an employee is on 

a paid bona fide leave of absence (as 

defined in paragraph (h)(1)(i) of this 

section) and has not otherwise 

terminated employment pursuant to 

paragraph (h)(1)(i) of this section, the 

employee is treated as providing bona 

fide services at a level equal to the level 

of services that the employee would 

have been required to perform to receive 

the compensation paid with respect to 

such leave of absence. Periods during 

which an employee is on an unpaid 

bona fide leave of absence (as defined in 

paragraph (h)(1)(i) of this section) and 

has not otherwise terminated 

employment pursuant to paragraph 

(h)(1)(i) of this section, are disregarded 

for purposes of this paragraph (h)(1)(ii) 

(including for purposes of determining 

the applicable 36-month (or shorter) 

period). 

(2) Independent contractors—(i) In 

general. An independent contractor is 

considered to have a separation from 

service with the service recipient upon 

the expiration of the contract (or in the 

case of more than one contract, all 

contracts) under which services are 

performed for the service recipient if the 

expiration constitutes a good-faith and 

complete termination of the contractual 

relationship. An expiration does not 

constitute a good faith and complete 

termination of the contractual 

relationship if the service recipient 

anticipates a renewal of a contractual 

relationship or the independent 

contractor becoming an employee. For 

this purpose, a service recipient is 

considered to anticipate the renewal of 

the contractual relationship with an 

independent contractor if it intends to 

contract again for the services provided 

under the expired contract, and neither 

the service recipient nor the 

independent contractor has eliminated 

the independent contractor as a possible 

provider of services under any such new 

contract. Further, a service recipient is 

considered to intend to contract again 

for the services provided under an 

expired contract if the service 

recipient’s doing so is conditioned only 

upon incurring a need for the services, 

the availability of funds, or both. 

(ii) Special rule. Notwithstanding 

paragraph (h)(2)(i) of this section, a plan 

is considered to satisfy the requirement 

described in § 1.409A–3(a)(1) with 

respect to an amount payable upon a 

separation from service if, with respect 

to amounts payable to a service provider 

who is an independent contractor, the 

plan provides that—

(A) No amount will be paid to the 

service provider before a date at least 12 

months after the day on which the 

contract expires under which the 

service provider performs services for 

the service recipient (or, in the case of 

more than one contract, all such 

contracts expire); and 

(B) No amount payable to the service 

provider on that date will be paid to the 

service provider if, after the expiration 

of the contract (or contracts) and before 

that date, the service provider performs 

services for the service recipient as an 

independent contractor or an employee. 

(3) Definition of service recipient and 

employer. For purposes of this 

paragraph (h), the term service recipient 

or employer means the service recipient 

as defined in paragraph (g) of this 

section, provided that in applying 

section 1563(a)(1), (2), and (3) for 

purposes of determining a controlled 

group of corporations under section 

414(b), the language ‘‘at least 50 

percent’’ is used instead of ‘‘at least 80 

percent’’ each place it appears in section 

1563(a)(1), (2), and (3), and in applying 

§ 1.414(c)–2 for purposes of determining 

trades or businesses (whether or not 

incorporated) that are under common 

control for purposes of section 414(c), 

‘‘at least 50 percent’’ is used instead of 

‘‘at least 80 percent’’ each place it 

appears in § 1.414(c)–2. A plan may 

provide with respect to a deferral of 

compensation under the plan that in 

applying sections 1563(a)(1), (2), and (3) 

for purposes of determining a controlled 

group of corporations under section 

414(b), another defined percentage 

greater than 50 percent, but not greater 

than 80 percent, is used instead of ‘‘at 

least 80 percent’’ at each place it 

appears in sections 1563(a)(1), (2), and 

(3), and in applying § 1.414(c)–2 for 

purposes of determining trades or 

businesses (whether or not 

incorporated) that are under common 

control for purposes of section 414(c), 

another defined percentage greater than 

50 percent, but not greater than 80 

percent, is used instead of ‘‘at least 80 

percent’’ at each place it appears in 

§ 1.414(c)–2. In addition, where the use 

of such definition of service recipient 

for purposes of determining a separation 

from service is based upon legitimate 

business criteria, the plan may provide 

that for purposes of a deferral of 

compensation under the plan that in 

applying sections 1563(a)(1), (2), and (3) 

for purposes of determining a controlled 

group of corporations under section 

414(b), the language ‘‘at least 20 

percent’’ or another defined percentage 

not less than 20 percent but not greater 

than 50 percent is used instead of ‘‘at 

least 80 percent’’ at each place it 

appears in sections 1563(a)(1), (2), and 

(3), and in applying § 1.414(c)–2 for 

purposes of determining trades or 

businesses (whether or not 

incorporated) that are under common 

control for purposes of section 414(c), 

the language ‘‘at least 20 percent’’ or 

another defined percentage not less than 

20 percent but not greater than 50 

percent is used instead of ‘‘at least 80 

percent’’ at each place it appears in 

§ 1.414(c)–2. Where a definition of 

service recipient or employer other than 

the definition provided in the first 

sentence of this paragraph (h)(3) (the 50 

percent standard) is used, the plan must 

designate in writing the alternate 

definition no later than the last date at 

which the time and form of payment of 

the applicable amount deferred must be 

elected in accordance with § 1.409A–

2(a), and any change in the definition 

for such amounts deferred will 

constitute a change in the time and form 

of payment subject to the rules 

governing subsequent deferral elections 

under § 1.409A–2(b) and the 

acceleration of payments under 

§ 1.409A–3(j). 

(4) Asset purchase transactions. 

Where as part of a sale or other 

disposition of assets by one service 

recipient (seller) to an unrelated service 

recipient (buyer), a service provider of 

the seller would otherwise experience a 

separation from service with the seller, 

the seller and the buyer may retain the 

discretion to specify, and may specify, 

whether a service provider providing 

services to the seller immediately before 

the asset purchase transaction and 

providing services to the buyer after and 

in connection with the asset purchase 

transaction has experienced a separation 

from service for purposes of this 


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paragraph (h), provided that the asset 

purchase transaction results from bona 

fide, arm’s length negotiations, all 

service providers providing services to 

the seller immediately before the asset 

purchase transaction and providing 

services to the buyer after and in 

connection with the asset purchase 

transaction are treated consistently 

(regardless of position at the seller) for 

purposes of applying the provisions of 

any nonqualified deferred compensation 

plan, and such treatment is specified in 

writing no later than the closing date of 

the asset purchase transaction. For 

purposes of this paragraph (h)(4), 

references to a sale or other disposition 

of assets, or an asset purchase 

transaction, refer only to a transfer of 

substantial assets, such as a plant or 

division or substantially all the assets of 

a trade or business. For purposes of this 

paragraph (h)(4), whether a service 

recipient is related to another service 

recipient is determined under the rules 

provided in paragraph (f)(2)(ii) of this 

section. 

(5) Dual status. If a service provider 

provides services both as an employee 

of a service recipient and as an 

independent contractor of a service 

recipient, the service provider must 

separate from service both as an 

employee and as an independent 

contractor to be treated as having 

separated from service. If a service 

provider ceases providing services as an 

independent contractor and begins 

providing services as an employee, or 

ceases providing services as an 

employee and begins providing services 

as an independent contractor, the 

service provider will not be considered 

to have a separation from service until 

the service provider has ceased 

providing services in both capacities. 

Notwithstanding the foregoing, if a 

service provider provides services both 

as an employee of a service recipient 

and a member of the board of directors 

of a corporate service recipient (or an 

analogous position with respect to a 

non-corporate service recipient), the 

services provided as a director are not 

taken into account in determining 

whether the service provider has a 

separation from service as an employee 

for purposes of a nonqualified deferred 

compensation plan in which the service 

provider participates as an employee 

that is not aggregated with any plan in 

which the service provider participates 

as a director under paragraph (c)(2)(ii) of 

this section. In addition, if a service 

provider provides services both as an 

employee of a service recipient and a 

member of the board of directors of a 

corporate service recipient (or an 

analogous position with respect to a 

non-corporate service recipient), the 

services provided as an employee are 

not taken into account in determining 

whether the service provider has a 

separation from service as a director for 

purposes of a nonqualified deferred 

compensation plan in which the service 

provider participates as a director that is 

not aggregated with any plan in which 

the service provider participates as an 

employee under paragraph (c)(2)(ii) of 

this section. 

(6) Collectively bargained plans 

covering multiple employers. 

Notwithstanding the foregoing 

provisions of this paragraph (h), to the 

extent a plan is established pursuant to 

a bona fide collective bargaining 

agreement covering services performed 

by employees for multiple employers, 

such plan may define a separation from 

service in a reasonable manner that 

treats the employee as not having 

separated from service during periods in 

which the employee is not providing 

services but is available to perform 

services covered by the collective 

bargaining agreement for one or more 

employers, provided that the definition 

also provides that the employee must be 

deemed to have separated from service 

at a specified date not later than the end 

of any period of at least 12 consecutive 

months during which the employee has 

not provided any services covered by 

the collective bargaining agreement to 

any participating employer. This 

paragraph (h)(6) applies only if the 

definition of separation from service 

provided by the collective bargaining 

agreement was the subject of arm’s 

length negotiations between employee 

representatives and two or more 

employers, the agreement between 

employee representatives and such 

employers satisfies section 7701(a)(46), 

and the circumstances surrounding the 

agreement evidence good faith 

bargaining between adverse parties over 

such definition. 

(i) Specified employee—(1) In general. 

The term specified employee means a 

service provider who, as of the date of 

the service provider’s separation from 

service, is a key employee of a service 

recipient any stock of which is publicly 

traded on an established securities 

market or otherwise. For purposes of 

this paragraph (i)(1), a service provider 

is a key employee if the service provider 

meets the requirements of section 

416(i)(1)(A)(i), (ii), or (iii) (applied in 

accordance with the regulations 

thereunder and disregarding section 

416(i)(5)) at any time during the 12- 

month period ending on a specified 

employee identification date. If a service 

provider is a key employee as of a 

specified employee identification date, 

the service provider is treated as a key 

employee for purposes of this paragraph 

(i) for the entire 12-month period 

beginning on the specified employee 

effective date. 

(2) Definition of compensation. For 

purposes of identifying a specified 

employee by applying the requirements 

of section 416(i)(1)(A)(i), (ii), and (iii), 

the definition of compensation under 

§ 1.415(c)–2(a) is used, applied as if the 

service recipient were not using any safe 

harbor provided in § 1.415(c)–2(d), were 

not using any of the special timing rules 

provided in § 1.415(c)–2(e), and were 

not using any of the special rules 

provided in § 1.415(c)–2(g). 

Notwithstanding the foregoing, a service 

recipient may elect to use any available 

definition of compensation under 

section 415 and the regulations 

thereunder in accordance with the 

election requirements set forth in 

paragraph (i)(8) of this section, 

including any available safe harbor and 

any available election under the timing 

rules or special rules, provided that the 

definition is applied consistently to all 

employees of the service recipient for 

purposes of identifying specified 

employees. A service recipient may 

elect to use such an alternative 

definition regardless of whether another 

definition of compensation is being 

used for purposes of a qualified plan 

sponsored by the service recipient. 

However, once a list of specified 

employees has become effective, the 

service recipient cannot change the 

definition of compensation for purposes 

of identifying specified employees for 

the period with respect to which such 

list is effective. 

(3) Specified employee identification 

date. Unless another date is designated 

in accordance with the requirements of 

this paragraph (i)(3) and paragraph (i)(8) 

of this section, the specified employee 

identification date is December 31. A 

service recipient may designate in 

accordance with the requirements of 

paragraph (i)(8) of this section any other 

date as the specified employee 

identification date, provided that a 

service recipient must use the same 

specified employee identification date 

with respect to all nonqualified deferred 

compensation plans, and any change to 

the specified employee identification 

date may not be effective for a period of 

at least 12 months. The service recipient 

may designate a specified employee 

identification date in each plan or in a 

separate document applicable to all 

plans, provided that the service 

recipient will not be treated as having 

designated a specified employee 

identification date before the 


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designation is legally binding on the 

service recipient and all affected service 

providers. Any designation of a 

specified employee identification date 

made on or before December 31, 2007, 

may be applied to any separation from 

service occurring on or after January 1, 

2005, unless and until subsequently 

changed pursuant to this paragraph 

(i)(3). 

(4) Specified employee effective date. 

Unless another date is designated in 

accordance with the requirements of 

this paragraph (i)(4) and paragraph (i)(8) 

of this section, the specified employee 

effective date is the first day of the 

fourth month following the specified 

employee identification date. A service 

recipient may designate in accordance 

with the requirements of paragraph 

(i)(8) of this section any date following 

the specified employee identification 

date as the specified employee effective 

date, provided that such date may not 

be later than the first day of the fourth 

month following the specified employee 

identification date, and provided further 

that a service recipient must use the 

same specified employee effective date 

with respect to all nonqualified deferred 

compensation plans, and any change to 

the specified employee effective date 

may not be effective for a period of at 

least 12 months. The service recipient 

may designate a specified employee 

effective date through inclusion in each 

plan document or through a separate 

document applicable to all plans, 

provided that the service recipient will 

not be treated as having designated a 

specified employee effective date on any 

date before the designation is legally 

binding on the service recipient and all 

affected service providers. Any 

designation of a specified employee 

effective date made on or before 

December 31, 2007, may be applied to 

any separation from service occurring 

on or after January 1, 2005, unless and 

until subsequently changed pursuant to 

this paragraph (i)(4). 

(5) Alternative methods of satisfying 

the six-month delay rule. A plan may 

provide, in accordance with the 

requirements of paragraph (i)(8) of this 

section, for an alternative method to 

identify service providers who will be 

subject to the six-month delay rule 

provided in section 409A(a)(2)(B)(i), 

provided that the alternative method is 

reasonably designed to include all 

specified employees (determined 

without respect to any available service 

recipient elections), the alternative 

method is an objectively determinable 

standard providing no direct or indirect 

election to any service provider 

regarding its application, and the 

alternative method results in either all 

service providers or no more than 200 

service providers being identified in the 

class as of any date. Use of such an 

alternative method will not be treated as 

a change in the time and form of 

payment for purposes of § 1.409A–2(b) 

(the subsequent deferral rules), even if 

the service provider is not a specified 

employee when the payment is delayed. 

(6) Corporate transactions—(i) 

Mergers and acquisitions of public 

service recipients. If as a result of a 

corporate transaction, two or more 

separate service recipients, more than 

one of which has stock outstanding that 

is publicly traded on an established 

securities market or otherwise 

immediately before the transaction, 

become one service recipient, any stock 

of which is publicly traded on an 

established securities market or 

otherwise immediately after the 

transaction (resulting public service 

recipient), the resulting public service 

recipient’s next specified employee 

identification date and specified 

employee effective date following the 

corporate transaction are the specified 

employee identification date and 

specified employee effective date that 

the acquiring service recipient would 

have been required to use absent such 

transaction. For this purpose, in the case 

of a corporate merger, the acquiring 

service recipient is the service recipient 

that included the surviving corporation 

in such merger, in the case of an 

acquisition by a corporation of the stock 

of another corporation, the acquiring 

service recipient is the service recipient 

that included the corporation that 

acquired such stock, and in all other 

cases, the surviving service recipient is 

determined on the basis of all of the 

facts and circumstances. For the period 

between the transaction and the next 

specified employee effective date, the 

list of specified employees of the 

resulting public service recipient is 

determined by combining the lists of 

specified employees of all service 

recipients participating in the 

transaction that were in effect at the 

date of the corporate transaction, 

ranking such specified employees in 

order of the amount of compensation 

used to determine each specified 

employee’s status as a specified 

employee, and treating the top 50 of 

such specified employees, plus any 

employees described in section 

416(i)(1)(ii) or section 416(i)(1)(iii) and 

the regulations thereunder (relating to 1- 

percent and 5-percent owners) who are 

not included in such top 50 specified 

employees, as specified employees for 

the period between the corporate 

transaction and the next specified 

employee effective date. Alternatively, 

the resulting service recipient may elect 

in accordance with the requirements of 

paragraph (i)(8) of this section to use 

any reasonable method to determine the 

specified employees of the resulting 

service recipient, including the use of 

an alternative method of compliance 

described in paragraph (i)(5) of this 

section, provided that such method is 

adopted no later than 90 days after the 

corporate transaction and applied 

prospectively from the date the method 

is adopted. 

(ii) Mergers and acquisitions of 

nonpublic service recipients. If as part of 

a corporate transaction a service 

recipient that does not have outstanding 

stock that is publicly traded on an 

established securities market or 

otherwise immediately before the 

transaction (initial private service 

recipient), and a service recipient with 

stock outstanding that is publicly traded 

on an established securities market or 

otherwise immediately before the 

transaction (initial public service 

recipient), become a single service 

recipient having stock that is publicly 

traded on an established securities 

market or otherwise immediately after 

the transaction (resulting public service 

recipient), the resulting public service 

recipient’s next specified employee 

identification date and specified 

employee effective date following the 

corporate transaction are the specified 

employee identification date and 

specified employee effective date that 

the initial public service recipient 

would have been required to use absent 

such transaction. For the period after 

the date of the corporate transaction and 

before the next specified employee 

effective date, the specified employees 

of the initial public service recipient 

immediately before the transaction 

continue to be the specified employees 

of the resulting public service recipient, 

and no service providers of the initial 

private service recipient are required to 

be treated as specified employees. 

(iii) Spinoffs. If as part of a corporate 

transaction, a service recipient with 

stock outstanding that is publicly traded 

on an established securities market or 

otherwise immediately before the 

transaction (initial public service 

recipient), becomes two or more 

separate service recipients, each with 

stock outstanding that is publicly traded 

on an established securities market or 

otherwise immediately after the 

transaction (post-transaction public 

service recipients), the next specified 

employee identification date of each of 

the post-transaction public service 

recipients is the specified employee 

identification date that the initial public 


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service recipient would have been 

required to use absent such transaction. 

For the period after the date of the 

corporate transaction and before the 

next specified employee effective date, 

the specified employees of the initial 

public service recipient immediately 

before the transaction continue to be the 

specified employees of the posttransaction public service recipients. 

(iv) Public offerings and other 

corporate transactions. If as part of an 

initial public offering or corporate 

transaction not described in paragraph 

(i)(6)(ii) or (iii) of this section, a service 

recipient with no outstanding stock that 

is publicly traded on an established 

securities market or otherwise 

immediately before such offering or 

other transaction (initial private service 

recipient), becomes one or more service 

recipients with stock outstanding that is 

publicly traded on an established 

securities market or otherwise 

immediately after such offering or other 

transaction (post-transaction public 

service recipient), each post-transaction 

public service recipient has a specified 

employee identification date of 

December 31 and a specified employee 

effective date of April 1, effective 

retroactively to the December 31 and 

April 1 next preceding the offering or 

other transaction for purposes of 

identifying the specified employees 

between the corporation transaction and 

the next December 31. Alternatively, a 

post-transaction public service recipient 

may elect in accordance with the 

requirements of paragraph (i)(8) of this 

section, a specified employee 

identification date and specified 

employee effective date on or before the 

date of the offering or other transaction. 

If a public service recipient makes such 

an election, for the period after the 

offering or other transaction and before 

the next specified employee effective 

date, the specified employees of the 

post-transaction public service recipient 

consist of the service providers that at 

the time of the offering or other 

transaction would have been classified 

as specified employees of the initial 

private service recipient, had the initial 

private service recipient elected the 

same specified employee identification 

date and specified employee effective 

date as selected by the post-transaction 

public service recipient, and had such 

initial private service recipient had 

stock publicly traded on an established 

securities market or otherwise as of the 

specified employee identification date 

preceding the transaction. 

(v) Alternative methods of 

compliance. For purposes of this 

paragraph (i)(6), references to specified 

employees as of a corporate transaction 

or offering include any specified 

employees identified through the use of 

an alternative method described in 

paragraph (i)(5) of this section, where 

the use of such alternative method was 

established and effective at the time of 

the corporate transaction or offering. 

(7) Nonresident alien employees. For 

purposes of determining whether an 

employee meets the requirements of 

section 416(i)(1)(A)(i), (ii), or (iii) 

(applied in accordance with the 

regulations thereunder and disregarding 

section 416(i)(5)), and therefore is a key 

employee, the incorporation of the rules 

of § 1.415(c)–2(g)(5) regarding the 

definition of compensation applies. 

Accordingly, the rule of § 1.415(c)–

2(g)(5)(i), generally requiring the 

treatment as compensation of certain 

compensation excludible from an 

employee’s gross income due to the 

location of the services or the identity 

of the employer, applies. In addition, a 

service recipient may elect in 

accordance with paragraph (i)(8) of this 

section to apply the rule of § 1.415(c)–

2(g)(5)(ii) to not treat as compensation 

certain compensation excludible from 

an employee’s gross income on account 

of the location of the services or the 

identity of the employer that is not 

effectively connected with the conduct 

of a trade or business within the United 

States. A service recipient may elect to 

apply the rule of § 1.415–2(g)(5)(ii) 

regardless of whether the service 

recipient has elected to apply the rule 

to a qualified plan sponsored by the 

service recipient; however, once a list of 

specified employees has become 

effective, any election of the rule for that 

period may not be changed. 

Notwithstanding the foregoing, any 

election of the rule made before January 

1, 2008, may be effective with respect to 

any specified employee identification 

date on or before December 31, 2007. 

(8) Elections affecting the 

identification of specified employees. 

The elections described in paragraphs 

(i)(2) through (7) of this section are 

effective only as of the date that all 

necessary corporate action has been 

taken to make such elections binding for 

purposes of all affected nonqualified 

deferred compensation plans in which 

the service providers of the service 

recipient that would become a specified 

employee due to the application of such 

election participate. Where a taxpayer 

attempts to make an election under 

paragraph (i)(2), (3), (4), (5), (6), or (7) 

of this section but such election is not 

binding on all the affected nonqualified 

deferred compensation plans and 

applied consistently to all such service 

providers, the election is not effective 

and the rule under paragraph (i)(2), (3), 

(4), (5), (6), or (7) of this section, as 

applicable, that would apply absent an 

election is applicable for identifying 

specified employees. 

(j) Nonresident alien. (1) Except as 

provided in paragraph (j)(2) of this 

section, the term nonresident alien 

means an individual who is—

(i) A nonresident alien within the 

meaning of section 7701(b)(1)(B); or 

(ii) A dual resident taxpayer within 

the meaning of § 301.7701(b)–7(a)(1) of 

this chapter with respect to any taxable 

year in which such individual is treated 

as a nonresident alien for purposes of 

computing the individual’s U.S. income 

tax liability. 

(2) The term nonresident alien does 

not include—

(i) A nonresident alien with respect to 

whom an election is in effect for the 

taxable year under section 6013(g) to be 

treated as a resident of the United 

States; 

(ii) A former citizen or long-term 

resident (within the meaning of section 

877(e)(2)) who expatriated after June 3, 

2004, and has not complied with the 

requirements of section 7701(n); or 

(iii) An individual who is treated as 

a citizen or resident of the United States 

for the taxable year under section 

877(g). 

(k) Established securities market. The 

term established securities market 

means an established securities market 

within the meaning of § 1.897–1(m). 

(l) Stock right. The term stock right 

means a stock option (other than an 

incentive stock option described in 

section 422 or an option granted 

pursuant to an employee stock purchase 

plan described in section 423) or a stock 

appreciation right. 

(m) Separation pay plan. The term 

separation pay plan means any plan 

that provides separation pay or, where 

a plan provides both amounts that are 

separation pay and that are not 

separation pay, that portion of the plan 

that provides separation pay. The term 

separation pay means any deferral of 

compensation (before the application of 

the exclusions from the definition of a 

deferral of compensation set forth in 

paragraph (b)(9) of this section) that will 

not be paid under any circumstances 

unless the service provider has had a 

separation from service, whether 

voluntary or involuntary, including 

payments in the form of reimbursements 

of expenses incurred, and the provision 

of in-kind benefits. A deferral of 

compensation that the service provider 

may receive without a separation from 

service does not become separation pay 

merely because the service provider 

elects to receive or receives the payment 

after or upon a separation from service. 


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A deferral of compensation does not fail 

to be separation pay merely because the 

payment is conditioned upon the 

execution of a release of claims, 

noncompetition or nondisclosure 

provisions, or other similar 

requirements. Notwithstanding the 

foregoing, any amount, or entitlement to 

any amount, that acts as a substitute for, 

or replacement of, amounts deferred by 

the service recipient under a 

nonqualified deferred compensation 

plan constitutes a payment of 

compensation or deferral of 

compensation under such nonqualified 

deferred compensation plan. 

(n) Involuntary separation from 

service—(1) In general. An involuntary 

separation from service means a 

separation from service due to the 

independent exercise of the unilateral 

authority of the service recipient to 

terminate the service provider’s 

services, other than due to the service 

provider’s implicit or explicit request, 

where the service provider was willing 

and able to continue performing 

services. An involuntary separation 

from service may include the service 

recipient’s failure to renew a contract at 

the time such contract expires, provided 

that the service provider was willing 

and able to execute a new contract 

providing terms and conditions 

substantially similar to those in the 

expiring contract and to continue 

providing such services. The 

determination of whether a separation 

from service is involuntary is based on 

all the facts and circumstances. Any 

characterization of the separation from 

service as voluntary or involuntary by 

the service provider and the service 

recipient in the documentation of the 

separation from service is presumed to 

properly characterize the nature of the 

separation from service. However, the 

presumption may be rebutted where the 

facts and circumstances indicate 

otherwise. For example, if a separation 

from service is designated as a voluntary 

separation from service or resignation, 

but the facts and circumstances indicate 

that absent such voluntary separation 

from service the service recipient would 

have terminated the service provider’s 

services, and that the service provider 

had knowledge that the service provider 

would be so terminated, the separation 

from service is involuntary. 

(2) Separations from service for good 

reason—(i) In general. Notwithstanding 

paragraph (n)(1) of this section, a service 

provider’s voluntary separation from 

service will be treated for purposes of 

this section and §§ 1.409A–2 through 

1.409A–6 as an involuntary separation 

from service if the separation from 

service occurs under certain limited 

bona fide conditions, where the 

avoidance of the requirements of section 

409A is not a purpose of the inclusion 

of these conditions in the plan or of the 

actions by the service recipient in 

connection with the satisfaction of these 

conditions, and a voluntary separation 

from service under such conditions 

effectively constitutes an involuntary 

separation from service. Generally such 

conditions will be prespecified under an 

agreement to provide compensation 

upon a separation from service for good 

reason. Such a good reason (or a similar 

condition) must be defined to require 

actions taken by the service recipient 

resulting in a material negative change 

to the service provider in the service 

relationship, such as the duties to be 

performed, the conditions under which 

such duties are to be performed, or the 

compensation to be received for 

performing such services. Other factors 

taken into account in determining 

whether a separation from service for 

good reason effectively constitutes an 

involuntary separation from service 

include the extent to which the 

payments upon a separation from 

service for good reason are in the same 

amount and are to be made at the same 

time and in the same form as payments 

available upon an actual involuntary 

separation from service, and whether 

the service provider is required to give 

the service recipient notice of the 

existence of the condition that would 

result in treatment as a separation from 

service for good reason and a reasonable 

opportunity to remedy the condition. 

(ii) Safe harbor. For purposes of this 

section and §§ 1.409A–2 through 

1.409A–6, if a plan provides that a 

voluntary separation from service will 

be treated as an involuntary separation 

from service if the separation from 

service occurs under certain express 

conditions, a separation from service 

satisfying the conditions set forth in the 

plan will be treated as an involuntary 

separation from the service if the 

necessary conditions (or set of 

conditions) require the following: 

(A) The separation from service must 

occur during a pre-determined limited 

period of time not to exceed two years 

following the initial existence of one or 

more of the following conditions arising 

without the consent of the service 

provider: 

(1) A material diminution in the 

service provider’s base compensation. 

(2) A material diminution in the 

service provider’s authority, duties, or 

responsibilities. 

(3) A material diminution in the 

authority, duties, or responsibilities of 

the supervisor to whom the service 

provider is required to report, including 

a requirement that a service provider 

report to a corporate officer or employee 

instead of reporting directly to the board 

of directors of a corporation (or similar 

governing body with respect to an entity 

other than a corporation). 

(4) A material diminution in the 

budget over which the service provider 

retains authority. 

(5) A material change in the 

geographic location at which the service 

provider must perform the services. 

(6) Any other action or inaction that 

constitutes a material breach by the 

service recipient of the agreement under 

which the service provider provides 

services. 

(B) The amount, time, and form of 

payment upon the separation from 

service must be substantially identical 

to the amount, time and form of 

payment payable due to an actual 

involuntary separation from service, to 

the extent such a right exists. 

(C) The service provider must be 

required to provide notice to the service 

recipient of the existence of the 

condition described in paragraph 

(n)(2)(ii)(A) of this section within a 

period not to exceed 90 days of the 

initial existence of the condition, upon 

the notice of which the service recipient 

must be provided a period of at least 30 

days during which it may remedy the 

condition and not be required to pay the 

amount. 

(3) Special rule for certain collectively 

bargained plans. Notwithstanding the 

foregoing, for purposes of this paragraph 

(n), to the extent a plan is subject to a 

bona fide collective bargaining 

agreement covering services performed 

for multiple employers under which an 

employee must separate from service 

with all such employers in order to 

receive a payment, such plan may use 

any reasonable definition of involuntary 

separation from service, provided that 

such definition is consistent with any 

definition of a separation from service 

adopted under paragraph (h)(6) of this 

section, and provided further that the 

definition of an involuntary separation 

from service provided by the collective 

bargaining agreement was the subject of 

arm’s length negotiations between 

employee representatives and two or 

more employers, the agreement between 

employee representatives and such 

employers satisfies section 7701(a)(46), 

and the circumstances surrounding the 

agreement evidence good faith 

bargaining between adverse parties over 

such definition. 

(o) Earnings. Whether a deferred 

amount constitutes earnings on an 

amount deferred, or actual or notional 

income attributable to an amount 

deferred, is determined under the 


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principles defining income attributable 

to the amount taken into account under 

§ 31.3121(v)(2)–1(d)(2) of this chapter. 

Accordingly, with respect to an account 

balance plan, earnings on an amount 

deferred generally include an amount 

credited on behalf of a service provider 

under the terms of the plan that reflects 

a rate of return that does not exceed 

either the rate of return on a 

predetermined actual investment or, if 

the income does not reflect the rate of 

return on a predetermined actual 

investment, a reasonable rate of interest. 

With respect to nonaccount balance 

plans, earnings on an amount deferred 

generally include an increase, due 

solely to the passage of time, in the 

present value of the future payments to 

which the service provider has obtained 

a legally binding right, the present value 

of which constituted the amount 

deferred (determined as of the date such 

amount was deferred), but only if the 

amount deferred was determined using 

reasonable actuarial assumptions and 

methods. A right to earnings on an 

amount deferred generally is treated as 

a right to a deferral of compensation for 

purposes of this section and §§ 1.409A–

2 through 1.409A–6. However, for 

purposes of any provision of this section 

and §§ 1.409A–2 through 1.409A–6 

referring to earnings on deferred 

compensation (or similar terms), the use 

of an unreasonable rate of return, or 

unreasonable actuarial assumptions and 

methods, generally will result in the 

treatment of some or all of such a right 

to deferred compensation as a right only 

to deferred compensation, and not a 

right to earnings on deferred 

compensation, so that the provision will 

not be applicable. With respect to plans 

that are neither account balance plans 

nor nonaccount balance plans, these 

rules apply by analogy. 

(p) In-kind benefits. The term in-kind 

benefits refers to services provided to or 

on behalf of a service provider, such as 

financial planning services, or tangible 

personal or real property made available 

for use by or on behalf of the service 

provider, such as the use of an aircraft 

or vehicle, and does not refer to a 

transfer of property within the meaning 

of section 83 and the regulations 

thereunder, or a promise to transfer, or 

an option to purchase or receive, 

property in the future. 

(q) Application of definitions and 

rules. The definitions and rules set forth 

in paragraphs (a) through (p) of this 

section apply for purposes of section 

409A, this section, and §§ 1.409A–2 

through 1.409A–6. 

§ 1.409A–2 Deferral elections. 

(a) Initial elections as to the time and 

form of payment—(1) In general. A plan 

that is, or constitutes part of, a 

nonqualified deferred compensation 

plan meets the requirements of section 

409A(a)(4)(B) only if under the terms of 

the plan, compensation for services 

performed during a service provider’s 

taxable year (the service year) may be 

deferred at the service provider’s 

election only if the election to defer 

such compensation is made and 

becomes irrevocable not later than the 

latest date permitted in this paragraph 

(a). An election will not be considered 

to be revocable merely because the 

service provider or service recipient 

may make an election to change the 

time and form of payment pursuant to 

paragraph (b) of this section, or the 

service recipient may accelerate the 

time of payment pursuant to § 1.409A–

3(j)(4) (exceptions to prohibition on 

accelerated payments). Whether a plan 

provides a service provider an 

opportunity to elect the time or form of 

payment of compensation is determined 

based upon all the facts and 

circumstances surrounding the 

determination of the time and form of 

payment of the compensation. For 

purposes of this section, an election to 

defer includes an election as to the time 

of the payment, an election as to the 

form of the payment or an election as to 

both the time and the form of the 

payment, but does not include an 

election as to the medium of payment 

(for example, an election between a 

payment of cash or a payment of 

property). Except as otherwise expressly 

provided in this section, an election will 

not be considered made until such 

election becomes irrevocable under the 

terms of the applicable plan. 

Accordingly, a plan may provide that an 

election to defer may be changed at any 

time before the last permissible date for 

making such an election. Where a plan 

provides the service provider a right to 

make an initial deferral election, and 

further provides that the election 

remains in effect until terminated or 

modified by the service provider, the 

election will be treated as made as of the 

date such election becomes irrevocable 

as to compensation for services 

performed during the relevant service 

year. For example, where a plan 

provides that a service provider’s 

election to defer a set percentage will 

remain in effect until changed or 

revoked, but that as of each December 

31 the election becomes irrevocable 

with respect to salary payable in 

connection with services performed in 

the immediately following year, the 

initial deferral election with respect to 

salary payable with respect to services 

performed in the immediately following 

year will be deemed to have been made 

as of the December 31 upon which the 

election became irrevocable. For 

purposes of this paragraph (a), the 

reference to a service period or a 

performance period refers to the period 

of service for which the right to the 

compensation arises, and may include 

periods before the grant of a legally 

binding right to the compensation. For 

example, where a service recipient 

grants a bonus based upon services 

performed in the calendar year 2010, 

but retains the discretion to rescind the 

bonus until 2011 such that the promise 

of the bonus is not a legally binding 

right, the period of service or 

performance period to which the 

compensation relates is the calendar 

year 2010. 

(2) Service recipient elections. A plan 

that provides for a deferral of 

compensation for services performed 

during a service provider’s taxable year 

that does not provide the service 

provider with an opportunity to elect 

the time or form of payment of such 

compensation must designate the time 

and form of payment by no later than 

the later of the time the service provider 

first has a legally binding right to the 

compensation or, if later, the time the 

service provider would be required 

under this section to make such an 

election if the service provider were 

provided such an election. Such 

designation is treated as an initial 

deferral election for purposes of this 

section. Where a plan permits a service 

recipient to exercise discretion to 

disregard a service provider election as 

to the time or form of a payment, any 

service provider election that is subject 

to such discretion will be treated as 

revocable so long as such discretion 

may be exercised. 

(3) General rule. A plan that is, or 

constitutes part of, a nonqualified 

deferred compensation plan meets the 

requirements of section 409A(a)(4)(B) if 

under the terms of the plan, 

compensation for services performed 

during a service provider’s taxable year 

(the service year) may be deferred at the 

service provider’s election only if the 

election to defer such compensation is 

made not later than the close of the 

service provider’s taxable year next 

preceding the service year. 

(4) Initial deferral election with 

respect to short-term deferrals. If a 

service provider has a legally binding 

right to a payment of compensation in 

a subsequent taxable year that, absent a 

deferral election, would be treated as a 

short-term deferral within the meaning 


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of § 1.409A–1(b)(4), an election to defer 

such compensation may be made in 

accordance with the requirements of 

paragraph (b) of this section, applied as 

if the amount were a deferral of 

compensation and the scheduled 

payment date for the amount were the 

date the substantial risk of forfeiture 

lapses. Notwithstanding the 

requirements of paragraph (b) of this 

section, such a deferral election may 

provide that the deferred amounts will 

be payable upon a change in control 

event (as defined in § 1.409A–3(i)(5)) 

without regard to the five-year 

additional deferral requirement in 

paragraph (b) of this section. 

(5) Initial deferral election with 

respect to certain forfeitable rights. If a 

service provider has a legally binding 

right to a payment in a subsequent year 

that is subject to a condition requiring 

the service provider to continue to 

provide services for a period of at least 

12 months from the date the service 

provider obtains the legally binding 

right to avoid forfeiture of the payment, 

an election to defer such compensation 

may be made on or before the 30th day 

after the service provider obtains the 

legally binding right to the 

compensation, provided that the 

election is made at least 12 months in 

advance of the earliest date at which the 

forfeiture condition could lapse. For 

purposes of this paragraph (a)(5), a 

condition will not be treated as failing 

to require the service provider to 

continue to provide services for a period 

of at least 12 months from the date the 

service provider obtains the legally 

binding right merely because the 

condition immediately lapses upon the 

death or disability (as defined in 

§ 1.409A–3(i)(4)) of the service provider, 

or upon a change in control event (as 

defined in § 1.409A–3(i)(5)), provided 

that if death, disability, or a change in 

control event occurs and the condition 

lapses before the end of such 12-month 

period, a deferral election may be given 

effect only if the deferral election is 

permitted under this section without 

regard to this paragraph (a)(5). 

(6) Initial deferral election with 

respect to fiscal year compensation. In 

the case of a service recipient with a 

taxable year that is not the same as the 

taxable year of the service provider, a 

plan may provide that fiscal year 

compensation may be deferred at the 

service provider’s election only if the 

election to defer such compensation is 

made not later than the close of the 

service recipient’s taxable year 

immediately preceding the first taxable 

year of the service recipient in which 

any services are performed for which 

such compensation is payable. For 

purposes of this paragraph (a)(6), the 

term fiscal year compensation means 

compensation relating to a period of 

service coextensive with one or more 

consecutive taxable years of the service 

recipient, of which no amount is paid or 

payable during the service recipient’s 

taxable year or years constituting the 

period of service. For example, fiscal 

year compensation generally would 

include a bonus to an individual 

employee with a calendar year taxable 

year that is based on a service period 

consisting of the service recipient’s two 

consecutive taxable years ending 

September 30, 2011, where the amount 

will be paid after the end of the second 

of such taxable years, but would not 

include either a bonus based on a 

service period consisting of one or more 

calendar years or salary that would 

otherwise be paid during such taxable 

years of the service recipient. 

(7) First year of eligibility—(i) In 

general. In the case of the first year in 

which a service provider becomes 

eligible to participate in a plan, the 

service provider may make an initial 

deferral election within 30 days after the 

date the service provider becomes 

eligible to participate in such plan, with 

respect to compensation paid for 

services to be performed after the 

election. In the case of a plan that does 

not provide for service provider 

elections with respect to the time or 

form of a payment, the time and form 

of the payment must be specified on or 

before the date that is 30 days after the 

date the service provider first becomes 

eligible to participate in such plan. For 

compensation that is earned based upon 

a specified performance period (for 

example, an annual bonus), where a 

deferral election is made in the first year 

of eligibility but after the beginning of 

the performance period, the election 

must apply only to the compensation 

paid for services performed after the 

election. For this purpose, an election 

will be deemed to apply to 

compensation paid for services 

performed after the election if the 

election applies to no more than an 

amount equal to the total amount of the 

compensation for the performance 

period multiplied by the ratio of the 

number of days remaining in the 

performance period after the election 

over the total number of days in the 

performance period. 

(ii) Eligibility to participate. For 

purposes of this paragraph (a)(7), a 

service provider is eligible to participate 

in a plan at any time during which, 

under the plan’s terms and without 

further amendment or action by the 

service recipient, the service provider is 

eligible to accrue an amount of deferred 

compensation under the plan other than 

earnings on amounts previously 

deferred, even if the service provider 

has elected not to accrue (or has not 

elected to accrue) an amount of deferred 

compensation. Where a service provider 

has been paid all amounts deferred 

under a plan, and on and before the date 

of the last payment was not eligible to 

continue (or to elect to continue) to 

participate in the plan for periods after 

the last payment (other than through an 

election of a different time and form of 

payment with respect to the amounts 

paid), the service provider may be 

treated as initially eligible to participate 

in a plan as of the first date following 

such payment that the service provider 

becomes eligible to accrue an additional 

amount of deferred compensation. 

Where a service provider has ceased 

being eligible to participate in a plan 

(other than the accrual of earnings), 

regardless of whether all amounts 

deferred under the plan have been paid, 

and subsequently becomes eligible to 

participate in the plan again, the service 

provider may be treated as being 

initially eligible to participate in the 

plan if the service provider had not been 

eligible to participate in the plan (other 

than the accrual of earnings) at any time 

during the 24-month period ending on 

the date the service provider again 

becomes eligible to participate in the 

plan. 

(iii) Application to excess benefit 

plans. For purposes of this paragraph 

(a)(7), a service provider is treated as 

initially eligible to participate in an 

excess benefit plan as of the first day of 

the service provider’s taxable year 

immediately following the first year the 

service provider accrues a benefit under 

the excess benefit plan; and any election 

made within 30 days following such 

date is treated as applying to benefits 

accrued under such plan for services 

performed before the election. For 

purposes of this paragraph (a)(7), the 

term excess benefit plan means all 

nonqualified deferred compensation 

plans in which a service provider 

participates, to the extent such plans do 

not provide for an election between 

current compensation (including a 

short-term deferral) and deferred 

compensation and solely provide 

deferred compensation equal to the 

excess of the benefits the service 

provider would have accrued under a 

qualified employer plan (as defined in 

§ 1.409A–1(a)(2)) in which the service 

provider also participates, in the 

absence of one or more of the limits 

incorporated into the plan to reflect one 

or more of the limits on contributions or 

benefits applicable to the qualified 


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employer plan under the Internal 

Revenue Code, over the benefits the 

service provider actually accrues under 

the qualified employer plan. For 

purposes of this paragraph (a)(7), once 

a service provider has accrued a benefit 

or deferred compensation under a plan 

in any year, the service provider will 

not become eligible for an initial 

deferral election based upon an accrual 

or deferral under an excess benefit plan 

in a subsequent year, even if the benefit 

or deferred compensation accrued in a 

previous year is forfeited or eliminated. 

(8) Initial deferral election with 

respect to performance-based 

compensation. In the case of any 

performance-based compensation (as 

defined in § 1.409A–1(e)), an initial 

deferral election may be made with 

respect to such performance-based 

compensation on or before the date that 

is six months before the end of the 

performance period, provided that the 

service provider performs services 

continuously from the later of the 

beginning of the performance period or 

the date the performance criteria are 

established through the date an election 

is made under this paragraph (a)(8), and 

provided further that in no event may 

an election to defer performance-based 

compensation be made after such 

compensation has become readily 

ascertainable. For purposes of this 

paragraph (a)(8), if the performancebased compensation is a specified or 

calculable amount, the compensation is 

readily ascertainable if and when the 

amount is first substantially certain to 

be paid. If the performance-based 

compensation is not a specified or 

calculable amount because, for example, 

the amount may vary based upon the 

level of performance, the compensation, 

or any portion of the compensation, is 

readily ascertainable when the amount 

is first both calculable and substantially 

certain to be paid. For this purpose, the 

performance-based compensation is 

bifurcated between the portion that is 

readily ascertainable and the amount 

that is not readily ascertainable. 

Accordingly, in general any minimum 

amount that is both calculable and 

substantially certain to be paid will be 

treated as readily ascertainable. 

(9) Nonqualified deferred 

compensation plans linked to qualified 

employer plans or certain other 

arrangements. If a nonqualified deferred 

compensation plan provides that the 

amount deferred under the plan is 

determined under the formula for 

determining benefits under a qualified 

employer plan (as defined in § 1.409A–

1(a)(2)) or a broad-based foreign 

retirement plan (as defined in § 1.409A–

1(a)(3)(v)) maintained by the service 

recipient but applied without regard to 

one or more limitations applicable to 

the qualified employer plan under the 

Internal Revenue Code or to the broadbased foreign retirement plan under 

other applicable law, or that the amount 

deferred under the nonqualified 

deferred compensation plan is 

determined as an amount offset by some 

or all of the benefits provided under the 

qualified employer plan or the broadbased foreign retirement plan, an 

increase in amounts deferred under the 

nonqualified deferred compensation 

plan that results directly from changes 

in benefit limitations applicable to the 

qualified employer plan or the broadbased foreign retirement plan under the 

Internal Revenue Code or other 

applicable law does not constitute a 

deferral election under the nonqualified 

deferred compensation plan, provided 

that such operation does not otherwise 

result in a change in the time or form 

of a payment under the nonqualified 

deferred compensation plan, and 

provided further that such change in the 

amounts deferred under the 

nonqualified deferred compensation 

plan does not exceed that change in the 

amounts deferred under the qualified 

employer plan or the broad-based 

foreign retirement plan, as applicable. In 

addition, with respect to such a 

nonqualified deferred compensation 

plan, the following actions or failures to 

act will not constitute a deferral election 

under the nonqualified deferred 

compensation plan even if in 

accordance with the terms of the 

nonqualified deferred compensation 

plan, the actions or inactions result in 

an increase in the amounts deferred 

under the plan, provided that such 

actions or inactions do not otherwise 

affect the time or form of payment under 

the nonqualified deferred compensation 

plan and provided further that with 

respect to actions or inactions described 

in paragraphs (a)(9)(i) or (ii), the change 

in the amount deferred under the 

nonqualified deferred compensation 

plan does not exceed the change in the 

amounts deferred under the qualified 

employer plan or the broad-based 

foreign retirement plan, as applicable: 

(i) A service provider’s action or 

inaction under the qualified employer 

plan or broad-based foreign retirement 

plan with respect to whether to elect to 

receive a subsidized benefit or an 

ancillary benefit under the qualified 

employer plan or broad-based foreign 

retirement plan. 

(ii) The amendment of a qualified 

employer plan or broad-based foreign 

retirement plan to add or remove a 

subsidized benefit or an ancillary 

benefit, or to freeze or limit future 

accruals of benefits under the qualified 

plan or freeze or limit future accruals of 

benefits or reduce existing benefits 

under the broad-based foreign 

retirement plan. 

(iii) A service provider’s action or 

inaction under a qualified employer 

plan with respect to elective deferrals 

and other employee pre-tax 

contributions subject to the contribution 

restrictions under section 401(a)(30) or 

section 402(g), including an adjustment 

to a deferral election under such 

qualified employer plan, provided that 

for any given taxable year, the service 

provider’s action or inaction does not 

result in an increase in the amounts 

deferred under all nonqualified deferred 

compensation plans in which the 

service provider participates (other than 

amounts described in paragraph 

(a)(9)(iv) of this section) in excess of the 

limit with respect to elective deferrals 

under section 402(g)(1)(A), (B), and (C) 

in effect for the taxable year in which 

such action or inaction occurs. 

(iv) A service provider’s action or 

inaction under a qualified employer 

plan with respect to elective deferrals 

and other employee pre-tax 

contributions subject to the contribution 

restrictions under section 401(a)(30) or 

section 402(g), and after-tax 

contributions by the service provider to 

a qualified employer plan that provides 

for such contributions, that affects the 

amounts that are credited under one or 

more nonqualified deferred 

compensation plans as matching 

amounts or other similar amounts 

contingent on such elective deferrals, 

employee pre-tax contributions, or aftertax contributions, provided that the total 

of such matching or contingent 

amounts, as applicable, never exceeds 

100 percent of the matching or 

contingent amounts that would be 

provided under the qualified employer 

plan absent any plan-based restrictions 

that reflect limits on qualified plan 

contributions under the Internal 

Revenue Code. 

(10) Changes in elections under a 

cafeteria plan. A change in an election 

under a cafeteria plan does not 

constitute a deferral election with 

respect to an amount deferred under a 

nonqualified deferred compensation 

plan to the extent that the change in the 

amount deferred under the nonqualified 

deferred compensation plan results 

solely from the application of the 

change in amount eligible to be treated 

as compensation under the terms of the 

nonqualified deferred compensation 

plan resulting from the election change 

under the cafeteria plan, to a benefit 

formula under the nonqualified deferred 

compensation plan based upon the 


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service provider’s eligible 

compensation, and only to the extent 

that such change applies in the same 

manner as any other increase or 

decrease in compensation would apply 

to such benefit formula. 

(11) Initial deferral election with 

respect to certain separation pay. In the 

case of separation pay (as defined in 

§ 1.409A–1(m)), where such separation 

pay is the subject of bona fide, arm’s 

length negotiations at the time of the 

separation from service, an initial 

deferral election may be made at any 

time up to the time the service provider 

obtains a legally binding right to the 

payment. This paragraph (a)(11) does 

not apply to any separation pay to 

which the service provider obtained a 

legally binding right before the 

negotiations at the time of the 

separation from service, including a 

right to a payment subject to a condition 

such as that the service provider 

separate from service other than for 

cause. In the case of separation pay due 

to participation in a window program 

(as defined in § 1.409A–1(b)(9)(vi)), an 

initial deferral election may be made at 

any time before the time the election to 

participate in the window program 

becomes irrevocable. 

(12) Initial deferral election with 

respect to certain commissions—(i) 

Sales commission compensation. For 

purposes of this paragraph (a), a service 

provider earning sales commission 

compensation is treated as providing the 

services to which such compensation 

relates only in the service provider’s 

taxable year in which the customer 

remits payment to the service recipient 

or, if applied consistently to all 

similarly situated service providers, the 

service provider’s taxable year in which 

the sale occurs. For purposes of this 

paragraph (a)(12), the term sales 

commission compensation means 

compensation or portions of 

compensation earned by a service 

provider if a substantial portion of the 

services provided by such service 

provider to a service recipient consist of 

the direct sale of a product or service to 

an unrelated customer, the 

compensation paid by the service 

recipient to the service provider consists 

of either a portion of the purchase price 

for the product or service or an amount 

substantially all of which is calculated 

by reference to the volume of sales, and 

payment of the compensation is either 

contingent upon the service recipient 

receiving payment from an unrelated 

customer for the product or services or, 

if applied consistently to all similarly 

situated service providers, is contingent 

upon the closing of the sales transaction 

and such other requirements as may be 

specified by the service recipient before 

the closing of the sales transaction. For 

this purpose, a customer is treated as an 

unrelated customer only if the customer 

is not related to either the service 

provider or the service recipient. A 

person is treated as related to another 

person if the person would be treated as 

related to the other person under 

§ 1.409A–1(f)(2)(ii) or the person would 

be treated as providing management 

services to the other person under 

§ 1.409A–1(f)(2)(iv). 

(ii) Investment commission 

compensation. For purposes of this 

paragraph (a), a service provider earning 

investment commission compensation 

is treated as providing the services to 

which such compensation relates over 

the 12 months preceding the date as of 

which the overall value of the assets or 

asset accounts is determined for 

purposes of the calculation of the 

investment commission compensation. 

For purposes of this paragraph (a)(12), 

the term investment commission 

compensation means the compensation 

or the portion of compensation earned 

by a service provider if a substantial 

portion of the services provided by such 

service provider to a service recipient to 

which such compensation relates 

consists of sales of financial products or 

other direct customer services to an 

unrelated customer with respect to 

customer assets or customer asset 

accounts, the customer retains the right 

to terminate the customer relationship 

and may move or liquidate the assets or 

asset accounts without undue delay 

(which may be subject to a reasonable 

notice period), such compensation 

consists of a portion of the value of the 

overall assets or asset account balance, 

an amount substantially all of which is 

calculated by reference to the increase 

in the value of the overall assets or 

account balance during a specified 

period, or both, and the value of the 

overall assets or account balance and 

investment commission compensation 

is determined at least annually. For this 

purpose, a customer is treated as an 

unrelated customer only if the customer 

is not related to either the service 

provider or the service recipient. A 

person is treated as related to another 

person if the person would be treated as 

related to the other person under 

§ 1.409A–1(f)(2)(ii) or the person would 

be treated as providing management 

services to the other person under 

§ 1.409A–1(f)(2)(iv). 

(iii) Commission compensation and 

related persons. The rules of paragraphs 

(a)(12)(i) and (ii) of this section apply to 

sales commission compensation and 

investment commission compensation 

involving a related customer, provided 

that substantial sales from which 

commission compensation arises are 

made, or substantial services from 

which commission compensation arises 

are provided, to unrelated customers by 

the service recipient, the sales and 

service arrangement and the 

commission arrangement with respect to 

the related customer are bona fide, arise 

from the service recipient’s ordinary 

course of business, and are substantially 

the same, both in terms and in practice, 

as the terms and practices applicable to 

unrelated customers (as defined in such 

paragraphs) to which individually or in 

the aggregate substantial sales are made 

or substantial services provided by the 

service recipient. 

(13) Initial deferral election with 

respect to compensation paid for final 

payroll period—(i) In general. Unless a 

plan provides otherwise, compensation 

payable after the last day of the service 

provider’s taxable year solely for 

services performed during the final 

payroll period described in section 

3401(b) containing the last day of the 

service provider’s taxable year or, with 

respect to a non-employee service 

provider, a period not longer than the 

payroll period described in section 

3401(b), where such amount is payable 

pursuant to the timing arrangement 

under which the service recipient 

normally compensates service providers 

for services performed during a payroll 

period described in section 3401(b), or 

with respect to a non-employee service 

provider, a period not longer than the 

payroll period described in section 

3401(b), is treated as compensation for 

services performed in the subsequent 

taxable year in which the payment is 

made. The preceding sentence does not 

apply to any compensation paid during 

such period for services performed 

during any period other than such final 

payroll period, such as a payment of an 

annual bonus. Any amendment of a 

plan after December 31, 2007, to add a 

provision providing for a differing 

treatment of such compensation may 

not be effective for 12 months from the 

date the amendment is executed and 

enacted. 

(ii) Transition rule. For purposes of 

this paragraph (a)(13), a plan that was 

adopted and effective before December 

31, 2007, whether written or unwritten, 

will be treated as designating such 

compensation for services performed in 

the taxable year in which the payroll 

period ends, unless otherwise set forth 

in writing before December 31, 2007. 

(14) Elections to annualize recurring 

part-year compensation. In the case of a 

service provider receiving recurring 

part-year compensation, an election to 

defer all or a portion of the recurring 


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part-year compensation to be earned 

during a particular service period is 

considered to meet the requirements of 

this paragraph (a) if the election is made 

before the services for which the 

recurring part-year compensation is 

paid begin, and the election does not 

defer payment of any of the recurring 

part-year compensation to a date beyond 

the last day of the 13th month following 

the first date of the service period. For 

purposes of this paragraph (a)(14), the 

term recurring part-year compensation 

means compensation paid for services 

rendered in a position that the service 

recipient and service provider 

reasonably anticipate will continue on 

similar terms and conditions in 

subsequent years, and will require 

services to be provided during 

successive service periods each of 

which comprises less than 12 months 

(for example, a teacher providing 

services during a school year comprised 

of 10 consecutive months), and each of 

which periods begins in one taxable 

year of the service provider and ends in 

the next such taxable year. The rules of 

this paragraph (a)(14) apply to a 

particular amount of compensation only 

once, so that an amount deferred under 

this rule may not again be treated as 

recurring part-year compensation for 

purposes of this paragraph and subject 

to a second deferral election under this 

paragraph (a)(14). 

(15) USERRA rights. The requirements 

of this paragraph (a) are deemed 

satisfied to the extent an initial deferral 

election is provided to satisfy the 

requirements of the Uniformed Service 

Employment and Reemployment Rights 

Act of 1994, as amended, 38 U.S.C. 

4301–4334. 

(b) Subsequent changes in time and 

form of payment—(1) In general. A plan 

that permits under a subsequent 

election a delay in a payment or a 

change in the form of payment (a 

subsequent deferral election), including 

a subsequent deferral election made by 

a service provider or a service recipient, 

satisfies the requirements of section 

409A(a)(4)(C) only if the conditions of 

this paragraph (b) are met. For purposes 

of this paragraph (b), except as 

otherwise expressly provided in this 

section, a subsequent deferral election is 

not considered made until such election 

becomes irrevocable under the terms of 

the plan. Accordingly, a plan may 

provide that a subsequent deferral 

election may be changed at any time 

before the last permissible date for 

making such a subsequent deferral 

election. Where a plan permits a 

subsequent deferral election, the 

requirements of this paragraph are 

satisfied only if the following conditions 

are met: 

(i) The plan requires that such 

election not take effect until at least 12 

months after the date on which the 

election is made. 

(ii) In the case of an election related 

to a payment not described in § 1.409A–

3(a)(2) (payment on account of 

disability), § 1.409A–3(a)(3) (payment 

on account of death), or § 1.409A–3(a)(6) 

(payment on account of the occurrence 

of an unforeseeable emergency), the 

plan requires that the payment with 

respect to which such election is made 

be deferred for a period of not less than 

five years from the date such payment 

would otherwise have been paid (or in 

the case of a life annuity or installment 

payments treated as a single payment, 

five years from the date the first amount 

was scheduled to be paid). 

(iii) The plan requires that any 

election related to a payment described 

in § 1.409A–3(a)(4) (payment at a 

specified time or pursuant to a fixed 

schedule) be made not less than 12 

months before the date the payment is 

scheduled to be paid (or in the case of 

a life annuity or installment payments 

treated as a single payment, 12 months 

before the date the first amount was 

scheduled to be paid). 

(2) Definition of payments for 

purposes of subsequent changes in the 

time or form of payment—(i) In general. 

Except as provided in paragraphs 

(b)(2)(ii) and (iii) of this section, the 

term payment refers to each separately 

identified amount to which a service 

provider is entitled to payment under a 

plan on a determinable date, and 

includes amounts applied for the benefit 

of the service provider. An amount is 

separately identified only if the amount 

may be objectively determined under a 

nondiscretionary formula. For example, 

an amount identified as 10 percent of 

the account balance as of a specified 

payment date would be a separately 

identified amount. A payment includes 

the provision of any taxable benefit, 

including payment in cash or in kind. 

In addition, a payment includes, but is 

not limited to, the transfer, cancellation, 

or reduction of an amount of deferred 

compensation in exchange for benefits 

under a welfare benefit plan, a fringe 

benefit excludible under section 119 or 

section 132, or any other benefit that is 

excludible from gross income. For 

additional rules relating to the 

application of this paragraph (b) to 

amounts payable at a fixed time or 

pursuant to a fixed schedule, see 

§ 1.409A–3(i)(1). 

(ii) Life annuities—(A) In general. The 

entitlement to a life annuity is treated as 

the entitlement to a single payment. 

Accordingly, an election to delay 

payment of a life annuity, or to change 

the form of payment of a life annuity, 

must be made at least 12 months before 

the scheduled commencement of the life 

annuity, and must defer the payment for 

a period of not less than five years from 

the originally scheduled 

commencement of the life annuity. For 

purposes of § 1.409A–1, this section, 

and §§ 1.409A–3 through 1.409A–6, the 

term life annuity means a series of 

substantially equal periodic payments, 

payable not less frequently than 

annually, for the life (or life expectancy) 

of the service provider, or a series of 

substantially equal periodic payments, 

payable not less frequently than 

annually, for the life (or life expectancy) 

of the service provider, followed upon 

the death or end of the life expectancy 

of the service provider by a series of 

substantially equal periodic payments, 

payable not less frequently then 

annually, for the life (or life expectancy) 

of the service provider’s designated 

beneficiary (if any). A change in 

designated beneficiary before any 

annuity payment has been made under 

the plan is not a change in the time or 

form of payment. A change in the form 

of a payment before any annuity 

payment has been made under the plan, 

from one type of life annuity to another 

type of life annuity with the same 

scheduled date for the first annuity 

payment, is not considered a change in 

the time and form of a payment, 

provided that the annuities are 

actuarially equivalent applying 

reasonable actuarial methods and 

assumptions. For purposes of this 

paragraph (b)(2)(ii), a requirement that a 

service provider obtain the consent of a 

spouse or other potential recipient of a 

survivor annuity to change a beneficiary 

or form of payment is disregarded, so 

that any annuity form that the service 

recipient could elect to receive with 

such consent is considered currently 

available. 

(B) Certain features disregarded. 

Notwithstanding the foregoing 

provisions of this paragraph (b)(2)(ii), 

the following features are disregarded 

for purposes of determining whether a 

payment form is a life annuity within 

the meaning of this paragraph (b)(2)(ii), 

but are not disregarded for purposes of 

determining whether a life annuity is 

the actuarial equivalent of another life 

annuity except as otherwise provided in 

this paragraph (b)(2)(ii): 

(1) Term certain features under which 

annuity payments continue for the 

longer of the life of the annuitant or a 

fixed period of time. 

(2) Pop-up features under which 

payments increase upon the death of the 


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beneficiary or another event that 

eliminates the right to a survivor 

annuity. 

(3) Cash refund features under which 

payment is provided upon the death of 

the last annuitant in an amount that is 

not greater than the excess of the 

present value of the annuity at the 

annuity starting date over the total of 

payments before the death of the last 

annuitant. 

(4) Features under which an annuity 

form of payment provides higher 

periodic payments before the expected 

commencement of benefits under the 

Social Security Act (42 U.S.C. ch. 7) or 

the Railroad Retirement Act (45 U.S.C. 

231 et seq.) and lower periodic 

payments after such expected 

commencement date, so that the 

combined periodic payments under the 

arrangement and the Social Security Act 

or the Railroad Retirement Act, as 

applicable, are approximately level 

before and after such expected 

commencement date (Social Security or 

Railroad Retirement leveling features). 

(5) Features providing for an increase 

in the annuity payment in a manner 

described in § 1.401(a)(9)–6, Q&A–

14(a)(1) or (2) (eligible cost-of-living 

adjustments). 

(C) Subsidized joint and survivor 

annuities. For purposes of this 

paragraph (b)(2)(ii), a joint and survivor 

annuity will not fail to be treated as 

actuarially equivalent to a single life 

annuity due solely to the value of a 

subsidized survivor annuity benefit, 

provided that the annual lifetime 

annuity benefit available to the service 

provider under the joint and survivor 

annuity is not greater than the annual 

lifetime annuity benefit available to the 

service provider under the single life 

annuity alternative, and provided that 

the annual survivor annuity benefit is 

not greater than the annual lifetime 

annuity benefit available to the service 

provider under the joint and survivor 

annuity. 

(D) Actuarial assumptions and 

methods. For purposes of this paragraph 

(b)(2)(ii), at any given time the same 

actuarial assumptions and methods 

must be used in valuing each annuity 

payment option, in determining 

whether the payments are actuarially 

equivalent and such assumptions must 

be reasonable. This requirement applies 

over the entire term of the service 

provider’s participation in the plan, 

such that the annuity payment must be 

actuarially equivalent at all times for the 

annuity payment options to be treated 

as one time and form of payment. There 

is no requirement that the same 

actuarial methods and assumptions be 

used over the term of a service 

provider’s participation in a plan. 

Accordingly, a plan may change the 

actuarial assumptions and methods 

used to determine the life annuity 

payments provided that all of the 

actuarial assumptions and methods are 

reasonable. 

(iii) Installment payments. The 

entitlement to a series of installment 

payments that is not a life annuity is 

treated as the entitlement to a single 

payment, unless the plan provides at all 

times with respect to the amount 

deferred that the right to the series of 

installment payments is to be treated as 

a right to a series of separate payments. 

For purposes of § 1.409A–1, this section, 

and §§ 1.409A–3 through 1.409A–6, a 

series of installment payments refers to 

an entitlement to the payment of a series 

of substantially equal periodic amounts 

to be paid over a predetermined period 

of years, except to the extent any 

increase (or decrease) in the amount 

reflects reasonable earnings (or losses) 

through the date the amount is paid. For 

this purpose, a series of installment 

payments over a predetermined period 

and a series of installment payments 

over a shorter or longer period, or a 

series of installment payments over the 

same predetermined period but with a 

different commencement date, are 

different times and forms of payment. 

Accordingly, a change in the 

predetermined period or the 

commencement date is a change in the 

time and form of payment. 

Notwithstanding the foregoing, a 

schedule of payments does not fail to be 

an installment payment solely because 

such plan provides for an immediate 

payment of all remaining installments if 

the present value of the deferred amount 

to be paid in the remaining installment 

payments falls below a predetermined 

amount, and the immediate payment of 

such amount does not constitute an 

accelerated payment for purposes of 

§ 1.409A–3(j), provided that such 

feature including the predetermined 

amount is established by no later than 

the time and form of payment is 

otherwise required to be established, 

and provided further that any change in 

such feature including the 

predetermined amount is a change in 

the time and form of payment. 

(iv) Transition rule. For purposes of 

this section, a plan that was adopted 

and effective before December 31, 2007, 

whether written or unwritten, that fails 

to make a designation as to whether the 

entitlement to a series of payments is to 

be treated as an entitlement to a series 

of separate payments under paragraph 

(b)(2)(iii) of this section, may make such 

designation on or before December 31, 

2007, provided such designation is set 

forth in writing on or before December 

31, 2007. 

(3) Beneficiaries. The rules of this 

paragraph (b) governing changes in the 

time and form of payment apply to 

elections by beneficiaries with respect 

to the time and form of payment, as well 

as elections by service providers or 

service recipients with respect to the 

time and form of payment to 

beneficiaries. An election to change the 

identity of a beneficiary does not 

constitute a change in the time and form 

of payment merely because the election 

changes the identity of the recipient of 

the payment, if the time and form of the 

payment is not otherwise changed. In 

addition, an election to change the 

identity of a beneficiary before the 

initial payment of a life annuity does 

not constitute a change in the time and 

form of payment if the change in the 

time of payments stems solely from the 

different life expectancy of the new 

beneficiary, such as in the case of a joint 

and survivor annuity. 

(4) Domestic relations orders. The 

rules of this paragraph (b) governing 

changes in the time and form of 

payment do not apply to elections by 

individuals other than a service 

provider, with respect to payments to a 

person other than the service provider, 

to the extent such elections are reflected 

in, or made in accordance with, the 

terms of a domestic relations order (as 

defined in section 414(p)(1)(B)). 

(5) Coordination with prohibition 

against acceleration of payments. For 

purposes of applying the prohibition 

against the acceleration of payments in 

§ 1.409A–3(j), the definition of payment 

is the same as the definition in 

paragraph (b)(2) of this section. 

Accordingly, a change in the form of a 

payment that results in a more rapid 

schedule for payments generally will 

not constitute an acceleration of a 

payment, if the change in the form of 

payment is made in compliance with 

the subsequent deferral rules. For 

example, a change in form from a 10- 

year installment payment treated as a 

single payment to a lump-sum payment 

would not constitute an acceleration if 

the change in the form of the payment 

is made in compliance with the 

requirements of paragraph (b)(1) of this 

section, generally meaning that the 

election to change to a lump-sum 

payment must be made at least 12 

months before the installment payments 

were scheduled to commence and the 

lump-sum payment could not be made 

until at least five years after the date the 

installment payments were scheduled to 

commence. See § 1.409A–3(j)(4)(i) with 

respect to situations in which the failure 

to accelerate a payment or the 


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modification of a plan term relating to 

certain accelerated payments will not be 

subject to the rules of this paragraph (b). 

(6) Application to multiple payment 

events. In the case of a plan that permits 

a payment upon each of a number of 

potential permissible payment events, 

such as the earlier of a fixed date or 

separation from service, the 

requirements of paragraph (b)(1) of this 

section are applied separately to each 

payment (as defined in paragraph (b)(2) 

of this section) due upon each payment 

event. Notwithstanding the foregoing, 

the addition or deletion of a permissible 

payment event to a plan under which 

amounts were previously deferred is 

subject to the rules of this paragraph (b) 

where the addition or deletion of the 

permissible payment event may result 

in a change in the time or form of 

payment of the amount deferred. For 

application of the rules governing 

accelerations of payments to the 

addition of a permissible payment event 

to amounts deferred, see § 1.409A–3(j). 

(7) Delay of payments under certain 

circumstances. A payment may be 

delayed to a date after the designated 

payment date under any of the 

circumstances described in this 

paragraph (b)(7), and the provision will 

not fail to meet the requirements of 

establishing a permissible payment 

event and the delay in the payment will 

not constitute a subsequent deferral 

election, so long as the service recipient 

treats all payments to similarly situated 

service providers on a reasonably 

consistent basis. 

(i) Payments subject to section 

162(m). A payment may be delayed to 

the extent that the service recipient 

reasonably anticipates that if the 

payment were made as scheduled, the 

service recipient’s deduction with 

respect to such payment would not be 

permitted due to the application of 

section 162(m), provided that the 

payment is made either during the 

service provider’s first taxable year in 

which the service recipient reasonably 

anticipates, or should reasonably 

anticipate, that if the payment is made 

during such year, the deduction of such 

payment will not be barred by 

application of section 162(m) or during 

the period beginning with the date of 

the service provider’s separation from 

service and ending on the later of the 

last day of the taxable year of the service 

recipient in which the service provider 

separates from service or the 15th day 

of the third month following the service 

provider’s separation from service, and 

provided further that where any 

scheduled payment to a specific service 

provider in a service recipient’s taxable 

year is delayed in accordance with this 

paragraph, the delay in payment will be 

treated as a subsequent deferral election 

unless all scheduled payments to that 

service provider that could be delayed 

in accordance with this paragraph are 

also delayed. Where the payment is 

delayed to a date on or after the service 

provider’s separation from service, the 

payment will be considered a payment 

upon a separation from service for 

purposes of the rules under § 1.409A–

3(i)(2) (payments to specified employees 

upon a separation from service) and, in 

the case of a specified employee, the 

date that is six months after a service 

provider’s separation from service is 

substituted for any reference to a service 

provider’s separation from service in the 

first sentence of this paragraph. No 

election may be provided to the service 

provider with respect to the timing of 

the payment under this paragraph 

(b)(7)(i). 

(ii) Payments that would violate 

Federal securities laws or other 

applicable law. A payment may be 

delayed where the service recipient 

reasonably anticipates that the making 

of the payment will violate Federal 

securities laws or other applicable law; 

provided that the payment is made at 

the earliest date at which the service 

recipient reasonably anticipates that the 

making of the payment will not cause 

such violation. The making of a 

payment that would cause inclusion in 

gross income or the application of any 

penalty provision or other provision of 

the Internal Revenue Code is not treated 

as a violation of applicable law. 

(iii) Other events and conditions. A 

service recipient may delay a payment 

upon such other events and conditions 

as the Commissioner may prescribe in 

generally applicable guidance published 

in the Internal Revenue Bulletin (see 

§ 601.601(d)(2) of this chapter). For 

additional rules applicable to certain 

delayed payments pursuant to a change 

in control event, see § 1.409A–

3(i)(5)(iv). For additional rules 

applicable to amounts payable because 

of an unforeseeable emergency, see 

§ 1.409A–3(i)(3). 

(8) USERRA rights. The requirements 

of this paragraph (b) are deemed met to 

the extent an election to change the time 

or form of a payment of deferred 

compensation is provided to satisfy the 

requirements of the Uniformed Services 

Employment and Reemployment Rights 

Act of 1994, as amended, 38 U.S.C. 

4301–4344. 

(9) Examples. The following examples 

illustrate the application of the 

provisions of this section. For purposes 

of these examples, each employee is an 

individual with a calendar year taxable 

year, and is employed by the specified 

employer: 

Example 1. Initial election to defer salary. 

Employer ZZ sponsors a plan under which 

Employee A may elect to defer a percentage 

of Employee A’s salary. Employee A has 

participated in the plan in prior years. To 

satisfy the requirements of this section with 

respect to salary earned in calendar year 

2008, if Employee A elects to defer any 

amount of such salary, the deferral election 

(including an election as to the time and form 

of payment) must be made no later than 

December 31, 2007. 

Example 2. Designation of time and form 

of payment where an initial deferral election 

is not provided. Employer YY has a taxable 

year ending September 30. On July 1, 2008, 

Employer YY enters into a legally binding 

obligation to pay Employee B a $10,000 

bonus. The amount is not subject to a 

substantial risk of forfeiture and does not 

qualify as performance-based compensation 

as described in § 1.409A–1(e). Employer YY 

does not provide Employee B an election as 

to the time and form of payment. Unless the 

amount is to be paid in accordance with the 

short-term deferral rule of § 1.409A–1(b)(4), 

Employer YY must specify the time and form 

of payment on or before July 1, 2008, to 

satisfy the requirements of this section. 

Example 3. Initial election to defer bonus 

payable based on services during calendar 

year. Employer XX has a taxable year ending 

September 30. Employee C participates in a 

bonus plan under which Employee C is 

entitled to a bonus for services performed 

during the calendar year that, absent an 

election by Employee C, will be paid on 

March 15 of the following year. The amount 

is not subject to a substantial risk of forfeiture 

and does not qualify as performance-based 

compensation as described in § 1.409A–1(e). 

If Employee C elects to defer the payment of 

the bonus with respect to services rendered 

during calendar year 2008, Employee C must 

elect the time and form of payment not later 

than December 31, 2007, to satisfy the 

requirements of this section. 

Example 4. Initial election to defer bonus 

payable based on services during fiscal year 

other than calendar year. Employer WW has 

a taxable year ending September 30. 

Employee D participates in a bonus plan 

under which Employee D is entitled to a 

bonus for services performed during 

Employer WW’s fiscal year that, absent an 

election by Employee D, will be paid on 

December 15 of the calendar year in which 

the fiscal year ends. The amount is not 

subject to a substantial risk of forfeiture and 

does not qualify as performance-based 

compensation as described in § 1.409A–1(e). 

The amount qualifies as fiscal year 

compensation. If Employee D elects to defer 

the payment of the amount related to the 

fiscal year ending September 30, 2009, to 

satisfy the requirements of this section 

Employee D must elect the time and form of 

payment not later than September 30, 2008. 

Example 5. Initial election to defer bonus 

payable only if service provider completes at 

least 12 months of services after the election. 

Employer VV has a calendar year taxable 

year. On March 1, 2008, Employer VV grants 

Employee E a $10,000 bonus, payable on 


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March 1, 2010 (with reasonable interest), 

provided that Employee E continues 

performing services as an employee of 

Employer VV through March 1, 2010. The 

amount does not qualify as performancebased compensation as described in 

§ 1.409A–1(e), and Employee E already 

participates in another account balance 

nonqualified deferred compensation plan. 

Employee E may make an initial deferral 

election on or before March 31, 2008 (within 

30 days after obtaining a legally binding 

right), because at least 12 months of 

additional services are required after the date 

of election for the risk of forfeiture to lapse. 

Example 6. Initial election to defer bonus 

that would otherwise constitute a short-term 

deferral. The same facts as Example 5, except 

that Employee E does not make an initial 

deferral election on or before March 31, 2008. 

Because the right to the compensation would 

not be treated as a deferral of compensation 

pursuant to § 1.409A–1(b)(4) absent a deferral 

election (because the arrangement would be 

treated as a short-term deferral), Employee E 

may make an initial deferral election 

provided that the election may not become 

effective for 12 months and must defer the 

payment at least 5 years from March 1, 2010 

(the first date the payment could become 

substantially vested). Accordingly, Employee 

E may make an election before March 1, 

2009, provided that the election defers the 

payment to a date on or after March 1, 2015 

(other than a payment due to death, 

disability, unforeseeable emergency, or a 

change in control event). 

Example 7. Initial election to defer sales 

commissions. Employer UU has a calendar 

year taxable year. As part of Employee F’s 

services for Employer UU, Employee F sells 

refrigerators to customers unrelated to 

Employee F or Employer UU. Under the 

employment arrangement, Employee F is 

entitled to 10% of the sales price of any 

refrigerator Employee F sells, payable only 

upon the receipt of payment from the 

customer who purchased the refrigerator. For 

purposes of the initial deferral rule, 

Employee F is treated as performing the 

services related to each refrigerator sale in 

the calendar year in which each customer 

pays for the refrigerator. 

Example 8. Initial election to defer renewal 

sales commissions. The same facts as 

Example 7, except that Employee F also sells 

warranties related to the refrigerators sold. 

Under the warranty arrangement, refrigerator 

warranty customers are entitled in a future 

year to extend the warranty for an additional 

cost to be paid at the time of the extension. 

Under Employee F’s arrangement with 

Employer UU, Employee F is entitled to 10% 

of the amount paid for an extension of any 

warranty, payable upon the receipt of 

payment from the customer extending the 

warranty. For purposes of the initial deferral 

election rule, Employee F is treated as 

performing the services related to the amount 

paid for the extension of the warranty in the 

taxable year in which the customer pays for 

the warranty extension. 

Example 9. Initial election to defer 

investment commissions. Employer TT is in 

the trade or business of managing financial 

assets for customer accounts. Customers who 

deposit funds in an account with Employer 

TT are entitled to remove the account 

balance of such account upon 60 days notice 

to Employer TT. Employee G sells financial 

products and provides continuing customer 

service to certain unrelated customers 

involving the deposit and maintenance of 

funds in customer accounts managed by 

Employer TT. Under the employment 

arrangement, Employee G is entitled to a set 

percentage of the aggregate value of the assets 

held in the accounts of customers to whom 

Employee G sold financial products and 

provides customer service. Under the 

arrangement, the aggregate value of the assets 

held in the accounts is determined as of June 

30 of each year, and unless Employee G 

elects to defer the payment, the amount is 

payable to Employee G in a lump sum on 

December 31 of the year in which the 

valuation is made. Employee G has no 

control over the valuation of the assets held 

in the accounts, or the calculation of the 

amount due Employee G. For purposes of the 

initial deferral rule, Employee G is treated as 

providing the services to which a payment 

relates during the July 1 through June 30 

period ending on the June 30 date as of 

which the assets held in the account are 

valued. 

Example 10. Initial election to defer partyear compensation. Employee H provides 

services as a teacher to Employer SS, a school 

system. The period of services routinely 

begins on the second Monday of August of 

one year and ends on the first Friday of June 

of the subsequent year. Employer SS 

provides an election to Employee H to 

receive the compensation for the period of 

services ratably over the period beginning on 

the second Monday of August of one year 

and ending on the last day of August of the 

subsequent year. Because the compensation 

constitutes recurring part-year compensation, 

as defined in paragraph (a)(14) of this 

section, and because the schedule will 

provide that all of the recurring part-year 

compensation is paid no later than 

September 30 of the subsequent year, 

Employee H will be deemed to have made a 

timely deferral election with respect to such 

recurring part-year compensation if 

Employee H elects before the first day of the 

service period to have the recurring part-year 

compensation paid under such schedule. 

Example 11. Initial election to defer 

negotiated separation pay. Employer RR 

decides to terminate Employee J’s 

employment involuntarily. As part of the 

process of terminating Employee J, Employer 

RR enters into bona fide, arm’s length 

negotiations with respect to the terms of 

Employee J’s termination of employment. As 

part of the process, Employer RR offers 

Employee J an amount that is in addition to 

any amounts to which Employee J is 

otherwise entitled, payable either as a lump 

sum payment at the end of 3 years or in 3 

annual payments starting at the date of 

termination of employment. The election of 

the time and form of payment by Employee 

J may be made at any time before Employee 

J accepts the offer and obtains a legally 

binding right to the additional amount. The 

election may not apply to any amount to 

which Employee J already had a legally 

binding right. 

Example 12. Election of time and form of 

payments under a window program. 

Employer QQ establishes a window program, 

as defined in § 1.409A–1(b)(9)(vi). 

Individuals who elect to terminate 

employment under the window program are 

entitled to receive an amount equal to 2 

weeks pay multiplied by every year of service 

with Employer QQ. The individuals 

participating in the window program may 

elect to receive the payment as either a lump 

sum payment payable on the first day of the 

month after making the election to 

participate in the window program, or as a 

payment of 3 equal annual installments on 

each January 1 of the first 3 years following 

the election to participate in the window 

program. Employee K is eligible to 

participate in the window program. 

Employee K will be treated as making a 

timely deferral election if the election as to 

the time and form of payment is made on or 

before the date Employee K’s election to 

participate in the window program becomes 

irrevocable. 

Example 13. Initial election to defer salary 

earned during final payroll period beginning 

in one calendar year and ending in the 

subsequent calendar year. Employer PP pays 

the salary of its employees, including 

Employee L, on a bi-weekly basis. One biweekly payroll period runs from December 

24, 2008, through January 6, 2009, with a 

scheduled payment date of January 13, 2009. 

Employer PP sponsors, and Employee L 

participates in, a nonqualified deferred 

compensation plan under which Employee L 

may defer a specified percentage of his 

annual salary. The plan does not specify that 

any salary compensation paid for the payroll 

period in which falls January 1 is to be 

treated as compensation for services 

performed during the year preceding the year 

in which falls that January 1. For purposes 

of applying the initial deferral election rules, 

Employee L is deemed to have performed the 

services for the payroll period December 24, 

2008, through January 6, 2009, during the 

calendar year 2009. 

Example 14. Application of deferral 

election rules and anti-acceleration rules to 

a nonqualified deferred compensation plan 

linked to a qualified plan. Employee M 

participates in a qualified retirement plan 

that is a defined benefit plan that offers a 

subsidized early retirement benefit to 

employees who have attained age 55 and 

completed 30 years of service. Employee M, 

who has attained age 55 and completed 30 

years of service, also participates in a 

nonqualified deferred compensation plan, 

under which the benefit payable is calculated 

under a formula, with that benefit then 

reduced by any benefit that Employee M has 

accrued under the qualified retirement plan. 

In 2008, Employee M fails to elect the 

subsidized early retirement benefit under the 

qualified retirement plan, with the effect that 

the amounts payable under the nonqualified 

deferred compensation plan are increased by 

an amount equal to the reduction in the 

benefit payable under the qualified plan. In 

2009, Employer NN amends the qualified 

retirement plan to increase benefits under the 

plan, resulting in a decrease in the amounts 

payable under the nonqualified deferred 


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compensation plan equal to the increase in 

the benefit payable under the qualified plan. 

Neither of these actions constitutes a deferral 

election or an acceleration of a payment 

under the nonqualified deferred 

compensation plan. 

Example 15. Subsequent deferral election. 

Employee N participates in a nonqualified 

deferred compensation plan. Employee N 

elects to be paid in a lump sum payment at 

the earlier of age 65 or separation from 

service. Employee N anticipates that he will 

work after age 65, and wishes to defer 

payment to a later date. Provided that 

Employee N continues in employment and 

makes the election by his 64th birthday, 

Employee N may elect to receive a lump sum 

payment at the earlier of age 70 or separation 

from service. 

Example 16. Subsequent deferral election 

rule—change in form of payment from lump 

sum payment to life annuity. Employee P 

participates in a nonqualified deferred 

compensation plan. Employee P elects to be 

paid in a lump sum payment at age 65. 

Employee P wishes to change the payment 

form to a life annuity. Provided that 

Employee P makes the election on or before 

his 64th birthday, Employee P may elect to 

receive a life annuity commencing at age 70. 

Example 17. Subsequent deferral election 

rule—change in form of payment from life 

annuity to lump sum payment. Employee Q 

participates in a nonqualified deferred 

compensation plan. Employee Q elects to be 

paid in a life annuity at age 65. Employee Q 

wishes to change the payment form to a lump 

sum payment. Provided that Employee Q 

makes the election on or before his 64th 

birthday, Employee Q may elect to receive a 

lump sum payment at age 70. 

Example 18. Subsequent deferral election 

rule—installment payments designated as 

separate payments. Employee R, whose 

taxable year is the calendar year, participates 

in a nonqualified deferred compensation 

plan that provides for payment in a series of 

5 equal annual amounts, each designated as 

a separate payment. The first payment is 

scheduled to be made on January 1, 2010. 

Provided that Employee R makes the election 

on or before January 1, 2009, Employee R 

may elect for the first payment scheduled to 

be made on January 1, 2010, to be made on 

January 1, 2015. If Employee R makes that 

election, but does not elect to defer the 

remaining payments, the remaining 

payments continue to be due upon January 

1 of the 4 consecutive calendar years 

commencing on January 1, 2011. 

Example 19. Subsequent deferral election 

rule—change in form of payment from 

installment payments not designated as 

separate payments to lump sum payment. 

Employee S participates in a nonqualified 

deferred compensation plan that provides for 

payment in a series of 5 equal annual 

amounts that are not designated as a series 

of 5 separate payments. The first amount is 

scheduled to be paid on January 1, 2010. 

Employee S wishes to receive the entire 

amount equal to the sum of all 5 of the 

amounts to be paid as a lump sum payment. 

Provided that Employee S makes the election 

on or before January 1, 2009, Employee S 

may elect to receive a lump sum payment on 

or after January 1, 2015. 

Example 20. Subsequent deferral election 

rule—change in form of payment from 

installment payments designated as separate 

payments to lump sum payment. Employee 

T participates in a nonqualified deferred 

compensation plan that provides for payment 

in a series of 5 equal annual amounts each 

of which is designated as a separate payment. 

The first amount is scheduled to be paid on 

January 1, 2010. Employee T wishes to 

receive the entire amount equal to the sum 

of all 5 of the amounts in a single lump sum 

payment. Provided that Employee T makes 

the election on or before January 1, 2009, 

Employee T may elect to receive a lump sum 

payment on or after January 1, 2019. 

Example 21. Subsequent deferral election 

rule—change in form of payment from one 

life annuity form to another life annuity 

form. Employee U participates in a 

nonqualified deferred compensation plan 

that permits Employee U to elect before 

Employee U’s separation from service 

whether to be paid in the form of a single life 

annuity beginning on the first day of the 

month following Employee U’s separation 

from service, or an annuity beginning on the 

first day of the month following Employee 

U’s separation from service under which 

annuity payments continue for Employee U’s 

lifetime but not less than 10 years. The two 

types of annuities are actuarially equivalent 

at all times applying reasonable actuarial 

methods and assumptions. For purposes of 

this section, the two types of annuities are 

treated as a single form of payment. 

Accordingly, the election provided under the 

plan is not treated as providing a subsequent 

deferral election or accelerated payment, and 

an election by Employee U under the plan 

between the two annuity options made before 

the first scheduled payment date for an 

annuity payment is not treated as a 

subsequent deferral election or an 

acceleration of a payment. 

Example 22. Subsequent deferral election 

rule—change in time of payment from 

payment at specified age to payment at later 

of specified age or separation from service. 

Employee V participates in a nonqualified 

deferred compensation plan that provides for 

a lump sum payment at age 65. Employee V 

wishes to modify the plan so that the 

deferred amount will be payable upon the 

later of Employee V’s attainment of a 

specified age or separation from service. 

Provided that Employee V makes such 

election on or before his 64th birthday, 

Employee V may modify the plan so 

Employee V will receive a lump sum 

payment upon the later of age 70 or 

separation from service. 

Example 23. Subsequent deferral election 

rule—change in time of payment from 

payment at separation from service to 

payment at later of separation from service 

or specified age. Employee W participates in 

a nonqualified deferred compensation plan 

that provides for a lump sum payment at 

separation from service. Employee W wishes 

to make the payment payable upon the later 

of separation from service or a predetermined 

age. Provided that Employee W makes such 

election on or before the date 1 year before 

a separation from service, Employee W may 

elect to receive a lump sum payment upon 

the later of the date 5 years following a 

separation from service or at a specified age. 

Example 24. Subsequent deferral election 

rule—change in time of payment from 

payment at separation from service to 

payment at a change in control event. 

Employee X participates in a nonqualified 

deferred compensation plan that provides for 

a lump sum payment at separation from 

service. Employee X wishes to change the 

payment provision such that the payment is 

payable upon a change in control event. A 

change in the distribution provision to 

provide for a payment only upon a change in 

control event will violate the rules governing 

payment provisions, because the change 

could result in an acceleration if the change 

in control event occurs before Employee X 

separates from service, or a subsequent 

deferral if the change in control does not 

occur until after Employee X separates from 

service. However, provided that Employee X 

makes such election on or before the date 1 

year before a separation from service, 

Employee X may elect to receive a payment 

upon the later of a change in control event 

or 5 years following a separation from 

service. 

(c) Special rules for certain resident 

aliens. For the first taxable year of an 

individual in which such individual is 

a resident alien, a nonqualified deferred 

compensation plan is deemed to meet 

the requirements of paragraph (a) of this 

section if, with respect to compensation 

payable for services performed during 

that first taxable year or with respect to 

compensation the right to which is 

subject to a substantial risk of forfeiture 

as of the first day of that first taxable 

year, an initial deferral election is made 

by the end of such first taxable year, 

provided that the initial deferral 

election may not apply to amounts that 

have already been paid or made 

available to the service provider before 

the election is made. For any year after 

the first taxable year in which an 

individual is classified as a resident 

alien, this paragraph (c) does not apply, 

provided that a taxable year may again 

be treated as the first taxable year in 

which an individual is classified as a 

resident alien if such individual is 

classified as a resident alien in that 

taxable year and has not been classified 

as a resident alien for the three 

consecutive taxable years immediately 

preceding that taxable year. 

§ 1.409A–3 Permissible payments. 

(a) In general. The requirements of 

section 409A(a)(2)(A) are met only if the 

plan provides that an amount of 

deferred compensation under the plan 

may be paid only upon an event or at 

a time set forth in this paragraph (a): 

(1) The service provider’s separation 

from service (as defined in § 1.409A–

1(h) and in accordance with paragraph 

(i)(2) of this section). 


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(2) The service provider becoming 

disabled (in accordance with paragraph 

(i)(4) of this section). 

(3) The service provider’s death. 

(4) A time or a fixed schedule 

specified under the plan (in accordance 

with paragraph (i)(1) of this section). 

(5) A change in the ownership or 

effective control of the corporation, or in 

the ownership of a substantial portion of 

the assets of the corporation (in 

accordance with paragraph (i)(5) of this 

section). 

(6) The occurrence of an 

unforeseeable emergency (in accordance 

with paragraph (i)(3) of this section). 

(b) Designation of payment upon a 

permissible payment event. Except as 

otherwise specified in this section, a 

plan provides for the payment upon an 

event described in paragraph (a)(1), (2), 

(3), (5), or (6) of this section if the plan 

provides the date of the event is the 

payment date, or specifies another 

payment date that is objectively 

determinable and nondiscretionary at 

the time the event occurs. A plan may 

also provide that a payment upon an 

event described in paragraph (a)(1), (2), 

(3), (5), or (6) of this section is to be 

made in accordance with a schedule 

that is objectively determinable and 

nondiscretionary based on the date the 

event occurs and that would qualify as 

a fixed schedule under paragraph (i)(1) 

of this section if the payment event were 

instead a fixed date, provided that the 

schedule must be fixed at the time the 

permissible payment event is 

designated. In addition, a plan may 

provide that a payment, including a 

payment that is part of a schedule, is to 

be made during a designated taxable 

year of the service provider that is 

objectively determinable and 

nondiscretionary at the time the 

payment event occurs such as, for 

example, a schedule of three 

substantially equal payments payable 

during the first three taxable years 

following the taxable year in which a 

separation from service occurs. A plan 

may also provide that a payment, 

including a payment that is part of a 

schedule, is to be made during a 

designated period objectively 

determinable and nondiscretionary at 

the time the payment event occurs, but 

only if the designated period both 

begins and ends within one taxable year 

of the service provider or the designated 

period is not more than 90 days and the 

service provider does not have a right to 

designate the taxable year of the 

payment (other than an election that 

complies with the subsequent deferral 

election rules of § 1.409A–2(b)). Where 

a plan provides for a period of more 

than one day following a payment event 

during which a payment may be made, 

such as within 90 days following the 

date of the event, the payment date for 

purposes of the subsequent deferral 

rules under § 1.409A–2(b) is treated as 

the first possible date upon which a 

payment could be made under the terms 

of the plan. A plan may provide for 

payment upon the earliest or latest of 

more than one event or time, provided 

that each event or time is described in 

paragraphs (a)(1) through (6) of this 

section. For examples illustrating the 

provisions of this paragraph, see 

paragraph (i)(1)(vi) of this section. 

(c) Designation of alternative specified 

dates or payment schedules based upon 

date of permissible event. Except as 

otherwise provided in this paragraph 

(c), a plan may designate only one time 

and form of payment upon the 

occurrence of each event described in 

paragraph (a)(1), (2), (3), (5), or (6) of 

this section. For example, a plan does 

not satisfy the requirements of this 

paragraph (c) if it provides for one 

payment date or schedule of payments 

if a specified event occurs on a Monday, 

but another payment date or schedule of 

payments if the event occurs on any 

other day of the week. However, a plan 

that provides for a payment upon an 

event described in paragraph (a)(2), (3), 

(5), or (6) of this section may allow for 

an alternative payment schedule if the 

event occurs on or before one (but not 

more than one) specified date, provided 

that the addition or deletion of such a 

different time and form of payment 

applicable to an existing deferral is 

subject to § 1.409A–2(b) (subsequent 

deferral elections) and paragraph (j) of 

this section (accelerated payments). For 

example, a plan may provide that a 

service provider will receive a lump 

sum payment of the service provider’s 

entire benefit under the plan on the first 

day of the month following a change in 

control event that occurs before the 

service provider attains age 55, but will 

receive 5 substantially equal annual 

payments commencing on the first day 

of the month following a change in 

control event that occurs on or after the 

service provider attains age 55. In the 

case of a plan that provides that a 

payment upon an event described in 

paragraph (a)(1) of this section (a 

payment upon a separation from 

service), a different time and form of 

payment may be designated with 

respect to a separation from service 

under each of the following conditions, 

provided that the addition or deletion of 

such a different time and form of 

payment applicable to an existing 

deferral is subject to § 1.409A–2(b) and 

paragraph (j) of this section: 

(1) A separation from service during 

a limited period of time not to exceed 

two years following a change in control 

event (as defined in paragraph (i)(5) of 

this section). 

(2) A separation from service before or 

after a specified date (for example, the 

attainment of a specified age), or a 

separation from service before or after a 

combination of a specified date, such as 

attaining a specified age, and a specified 

period of service determined under a 

predetermined, nondiscretionary, 

objective formula or pursuant to the 

method for crediting service under a 

qualified plan sponsored by the service 

recipient. 

(3) A separation from service not 

described in paragraphs (c)(1) or (c)(2) 

of this section. 

(d) When a payment is treated as 

made upon the designated payment 

date. Except as otherwise specified in 

this section, a payment is treated as 

made upon the date specified under the 

plan (including a date specified under 

paragraph (a)(4) of this section) if the 

payment is made at such date or a later 

date within the same taxable year of the 

service provider or, if later, by the 15th 

day of the third calendar month 

following the date specified under the 

plan and the service provider is not 

permitted, directly or indirectly, to 

designate the taxable year of the 

payment. In addition, a payment is 

treated as made upon the date specified 

under the plan (including a date 

specified under paragraph (a)(4) of this 

section) and is not treated as an 

accelerated payment if the payment is 

made no earlier than 30 days before the 

designated payment date and the service 

provider is not permitted, directly or 

indirectly to designate the taxable year 

of the payment. For purposes of this 

paragraph, if the date specified is only 

a designated taxable year of the service 

provider, or a period of time during 

such a taxable year, the date specified 

under the plan is treated as the first day 

of such taxable year or the first day of 

the period of time during such taxable 

year, as applicable. The payment with 

respect to a stock right generally occurs 

upon the exercise of the stock right, so 

that where a stock right designates a 

fixed exercise date, the stock right will 

be deemed to have been paid at such 

date if the exercise and payment occur 

on such date or a later date within the 

same taxable year of the service 

provider or, if later, by the 15th day of 

the third calendar month following the 

exercise date specified under the plan. 

If calculation of the amount of the 

payment is not administratively 

practicable due to events beyond the 

control of the service provider (or 


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Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 19311 

service provider’s beneficiary), the 

payment will be treated as made upon 

the date specified under the plan if the 

payment is made during the first taxable 

year of the service provider in which the 

calculation of the amount of the 

payment is administratively practicable. 

For purposes of this paragraph, the 

inability of a service recipient to 

calculate the amount or timing of a 

payment due to a failure of a service 

provider (or service provider’s 

beneficiary) to provide reasonably 

available information necessary to make 

such calculation does not constitute an 

event beyond the control of the service 

provider. Similarly, if the making of the 

payment at the date specified under the 

plan would jeopardize the ability of the 

service recipient to continue as a going 

concern, the payment will be treated as 

made upon the date specified under the 

plan if the payment is made during the 

first taxable year of the service provider 

in which the making of the payment 

would not have such effect. 

(e) Designation of time and form of 

payment with respect to earnings. A 

nonqualified deferred compensation 

plan that provides for actual or notional 

earnings to be credited on amounts of 

deferred compensation may specify, in 

accordance with the requirements of 

§ 1.409A–2(a) (initial deferral elections), 

that such earnings are treated separately 

from the right to the other amounts 

deferred under the plan for purposes of 

designating the time and form of 

payments under such plan, provided 

that to satisfy the requirements of this 

paragraph (e), actual or notional 

earnings must be credited at least 

annually. For these purposes, a right to 

dividend equivalents may be treated 

analogously to a right to actual or 

notional earnings on an amount of 

deferred compensation. For purposes of 

this paragraph (e), the term dividend 

equivalents means the right to an 

amount equal to all or a specified 

portion of dividends declared and paid, 

if any, on a specified number of shares 

of stock. 

(f) Substitutions. Except as otherwise 

provided under these regulations, the 

payment of an amount as a substitute for 

a payment of deferred compensation 

will be treated as a payment of the 

deferred compensation. A forfeiture or 

voluntary relinquishment of an amount 

of deferred compensation will not be 

treated as a payment of the 

compensation, but there is no forfeiture 

or voluntary relinquishment for this 

purpose if an amount is paid, or a 

legally binding right to a payment is 

created, that acts as a substitute for the 

forfeited or voluntarily relinquished 

amount. Whether a payment or a right 

to a payment acts as a substitute for a 

payment of deferred compensation is 

determined based on all the facts and 

circumstances. However, where the 

payment of an amount results in an 

actual or potential reduction of, or 

current or future offset to, an amount of 

deferred compensation, or if the service 

provider receives a loan the repayment 

of which is secured by or may be 

accomplished through an offset of or a 

reduction in an amount deferred under 

a nonqualified deferred compensation 

plan, the payment or loan is a substitute 

for the deferred compensation. In 

addition, where a service provider’s 

right to deferred compensation is made 

subject to anticipation, alienation, sale, 

transfer, assignment, pledge, 

encumbrance, attachment, or 

garnishment by creditors of the service 

provider or the service provider’s 

beneficiary, the deferred compensation 

is treated as having been paid. For the 

treatment of certain offsets, see 

paragraph (j)(4)(xiii) of this section. 

Even where there is no explicit 

reduction or offset, the payment of an 

amount or creation of a new right to a 

payment proximate to the purported 

forfeiture or voluntary relinquishment 

of a right to deferred compensation is 

presumed to be a substitute for the 

deferred compensation. The 

presumption is rebuttable by a showing 

that the compensation paid would have 

been received regardless of the forfeiture 

or voluntary relinquishment of the right 

to deferred compensation. Factors 

indicating that a payment would have 

been received regardless of such 

forfeiture or voluntarily relinquishment 

include that the amount paid is 

materially less than the forfeited or 

relinquished amount, or consists of a 

type of payment customarily made in 

the ordinary course of business of the 

service recipient to service providers 

who do not forfeit or relinquish deferred 

compensation (for example, a payment 

of accrued but unused leave or a 

payment for a release of actual or 

potential claims). See § 1.409A–

1(b)(9)(i) with respect to certain 

separation pay plans. 

(g) Disputed payments and refusals to 

pay. If a service recipient fails to make 

a payment in whole or in part as of the 

date specified under a plan, either 

intentionally or unintentionally, other 

than with the express or implied 

consent of the service provider, the 

payment will be treated as made upon 

the date specified under the plan if the 

service provider accepts the portion (if 

any) of the payment that the service 

recipient is willing to make (unless such 

acceptance will result in a 

relinquishment of the claim to all or 

part of the remaining amount), makes 

prompt and reasonable, good faith 

efforts to collect the remaining portion 

of the payment, and any further 

payment (including payment of a lesser 

amount that satisfies the obligation to 

make the payment) is made no later 

than the end of the first taxable year of 

the service provider in which the 

service recipient and the service 

provider enter into a legally binding 

settlement of such dispute, the service 

recipient concedes that the amount is 

payable, or the service recipient is 

required to make such payment 

pursuant to a final and nonappealable 

judgment or other binding decision. For 

purposes of this paragraph (g), efforts to 

collect the payment will be presumed 

not to be prompt, reasonable, good faith 

efforts, unless the service provider 

provides notice to the service recipient 

within 90 days of the latest date upon 

which the payment could have been 

timely made in accordance with the 

terms of the plan and these regulations, 

and unless, if not paid, the service 

provider takes further enforcement 

measures within 180 days after such 

latest date. For purposes of this 

paragraph (g), a service recipient is not 

treated as having failed to make a 

payment where pursuant to the terms of 

the plan the service provider is required 

to request payment, or otherwise 

provide information or take any other 

action, and the service provider has 

failed to take such action. In addition, 

for purposes of this paragraph (g), the 

service provider is deemed to have 

requested that a payment not be made, 

rather than the service recipient having 

failed to make such payment, where the 

service recipient’s decision to refuse to 

make the payment is made by the 

service provider or a member of the 

service provider’s family (as defined in 

section 267(c)(4) applied as if the family 

of an individual includes the spouse of 

any member of the family), or any 

person or group of persons over whom 

the service provider or service 

provider’s family member has effective 

control, or any person any portion of 

whose compensation is controlled the 

service provider or service provider’s 

family member. 

(h) Special rule for certain resident 

aliens. An agreement, method, program, 

or other arrangement that is, or 

constitutes part of, a nonqualified 

deferred compensation plan is deemed 

to meet the requirements of this section 

with respect to any amount payable in 

the first taxable year of the service 

provider in which a service provider is 

a resident alien, and with respect to any 


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19312 Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 

amount payable in a subsequent taxable 

year if no later than the last day of the 

first taxable year of the service provider 

in which the service provider is a 

resident alien, the plan is amended as 

necessary so that the times and forms of 

payment of amounts payable in a 

subsequent year comply with the 

provisions of this section. For any year 

after the first taxable year of an 

individual in which the individual is a 

resident alien, this paragraph (h) does 

not apply, provided that a taxable year 

may again be treated as the first taxable 

year in which an individual is a resident 

alien if such individual has not been a 

resident alien for at least three 

consecutive taxable years immediately 

preceding the taxable year in which the 

service provider is again a resident 

alien. 

(i) Definitions and special rules—(1) 

Specified time or fixed schedule—(i) In 

general. Amounts are payable at a 

specified time or pursuant to a fixed 

schedule if objectively determinable 

amounts are payable at a date or dates 

that are nondiscretionary and 

objectively determinable at the time the 

amount is deferred. An amount is 

objectively determinable for this 

purpose if the amount is specifically 

identified or if the amount may be 

determined at the time payment is due 

pursuant to an objective, 

nondiscretionary formula specified at 

the time the amount is deferred (for 

example, 50 percent of a specified 

account balance). Except as otherwise 

provided in paragraph (i)(1) of this 

section, an amount is not objectively 

determinable if the amount of the 

payment is based all or in part upon the 

occurrence of an event, including the 

consummation of a transaction by, or a 

payment of an amount to, a service 

recipient. If an amount is payable in a 

service provider’s taxable year (or 

pursuant to a fixed schedule of taxable 

years of the service provider) that is 

designated at the time the amount is 

deferred and that is objectively 

determinable, the amount is treated as 

payable at a specified time (or pursuant 

to a fixed schedule), provided that for 

purposes of the application of the 

subsequent deferral rules contained in 

§ 1.409A–2(b), the specified time or 

fixed schedule of payments is deemed 

to refer to the first day of the relevant 

taxable year or years. A specified time 

or fixed schedule also includes the 

designation at the time the amount is 

deferred of a defined period or periods 

within the service provider’s taxable 

year or taxable years that are objectively 

determinable, provided that no such 

defined period may begin within one 

taxable year and end within another 

taxable year, and provided further that 

for purposes of the application of the 

subsequent deferral rules contained in 

§ 1.409A–2(b), the specified time or 

fixed schedule of payments is deemed 

to refer to the first day of the relevant 

period in which the payment will be 

made. A plan may provide that a 

payment upon the lapse of a substantial 

risk of forfeiture is to be made in 

accordance with a fixed schedule that is 

objectively determinable based on the 

date the substantial risk of forfeiture 

lapses (disregarding any discretionary 

acceleration of the lapse of the 

substantial risk of forfeiture), provided 

that the schedule must be fixed on the 

date the time and form of payment are 

designated, and any change in the fixed 

schedule will constitute a change in the 

time and form of payment. For example, 

a plan that provides for a bonus 

payment subject to the condition that 

the service provider complete three 

years of service, and subject to the 

further condition that such requirement 

of continued services will lapse upon 

the occurrence of an initial public 

offering, which condition if applied 

alone would constitute a substantial risk 

of forfeiture, may provide that a service 

provider is entitled to substantially 

equal payments on each of the first three 

anniversaries of the date the substantial 

risk of forfeiture lapses (the earlier of 

three years of service or the date of an 

initial public offering). 

(ii) Payment schedules with formula 

and fixed limitations—(A) Individual 

limitations. A schedule of payments 

does not fail to be a fixed schedule of 

payments where the amount of a 

payment or payments that may be paid 

at a specified time or during a specified 

period is limited by an objective 

nondiscretionary formula or a specified 

amount that is not under the effective 

control of the service provider and is 

not subject to the exercise of discretion 

by the service recipient, where such 

limitation is established on or before the 

date the time and form of payment is 

otherwise required to be set under these 

regulations, and the plan specifies the 

time and form of any payment that will 

be made or completed after its original 

payment date due to the application of 

the limitation. A change in the 

limitation or a change in the time and 

form of any payment that exceeds the 

limitation is subject to the requirements 

of § 1.409A–2(b) (subsequent deferral 

elections) and paragraph (j) of this 

section (accelerated payments). For 

purposes of this paragraph, a plan 

provision that reduces a schedule of 

periodic payments on a dollar-for-dollar 

basis by the amount of Social Security 

payments received or receivable may be 

treated as a nondiscretionary, objective 

formula limitation, if such reduction 

does not otherwise affect the time of 

payment of the deferred compensation 

(other than a forfeiture due to the 

reduction), including changes based on 

the service provider’s eligibility or 

elections related to Social Security 

benefits. Similarly, a plan provision that 

reduces a schedule of periodic 

payments on a dollar-for-dollar basis by 

the amount of bona fide disability pay 

(within the meaning of § 1.409A–1(a)(5)) 

received or receivable may be treated as 

a nondiscretionary, objective formula 

limitation, if the disability payments are 

made pursuant to a plan sponsored by 

the service recipient that covers a 

substantial number of service providers 

and was established before the service 

provider became disabled, and if such 

reduction does not otherwise affect the 

time of payment of the deferred 

compensation (other than a forfeiture 

due to the reduction). Whether an 

amendment to, or other change in the 

benefit payable under, such bona fide 

disability plan results in an acceleration 

of a payment for purposes of paragraph 

(j) of this section or a subsequent 

election to delay the time or change the 

form of payment for purposes of 

§ 1.409A–2(b) is determined based on 

all of the relevant facts and 

circumstances. 

(B) Limitations on aggregate payments 

to all participants in substantially 

identical plans. A schedule of payments 

does not fail to be a fixed schedule of 

payments where the amount of the 

aggregate payments that will be made 

during a specified period of time to all 

participants in substantially identical 

plans is limited by an objective 

nondiscretionary formula or specified 

amount that is not under the effective 

control of the service provider and is 

not subject to the exercise of discretion 

by the service recipient, where the limit 

is established on or before the date the 

time and form of payment of the amount 

deferred is otherwise required to be set 

under these regulations, the method of 

allocating payments among the 

participants where there is an overall 

limitation on the aggregate amount that 

may be paid to a group of service 

providers during a specified period is an 

objective nondiscretionary allocation 

method that is not under the effective 

control of the service provider and is 

not subject to the exercise of discretion 

by the service recipient, the method is 

established on or before the date the 

time and form of payment of the amount 

deferred is otherwise required to be set, 


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Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 19313 

and the plan specifies the time and form 

of any payment of any amount that will 

be paid after its original payment date 

due to the application of the limitation. 

A change in the limitation or a change 

in the time and form of payment of any 

payment that is not otherwise made at 

the scheduled payment date due to 

application of the formula limitation is 

subject the requirements of § 1.409A–

2(b) (subsequent deferral elections) and 

paragraph (j) of this section (accelerated 

payments). 

(iii) Payment schedules determined by 

timing of payments received by the 

service recipient. A payment schedule 

determined by reference to the timing of 

payments received by the service 

recipient (not including payments from 

one entity to another entity where both 

entities are treated as part of a single 

service recipient), meets the 

requirements of a specified date or fixed 

schedule of payments if the following 

conditions are met: 

(A) The payments due to the service 

recipient arise from bona fide and 

routine transactions in the ordinary 

course of business of the service 

recipient. 

(B) The service provider does not 

have effective control of the service 

recipient, the person from whom such 

amounts are due, or the collection of 

any of the amounts due to the service 

recipient. 

(C) The payment schedule provides 

an objective, nondiscretionary method 

of identification of the payments to the 

service recipient from which the 

amount of the payment from the service 

recipient to the service provider is 

determined. 

(D) The payment schedule provides 

an objective, nondiscretionary schedule 

under which the payments will be made 

to the service provider. 

(E) The payments to the service 

recipient from which the amount of the 

payments from service recipient to the 

service provider are determined result 

from sales of a type that the service 

recipient is in the trade or business of 

making and makes frequently, and 

either all such sales by the service 

recipient are taken into account for 

purposes of determining the payment to 

the service provider, or there is a 

legitimate, non-tax business reason for 

identifying the specific sales taken into 

account. 

(iv) Reimbursement or in-kind benefit 

plans—(A) General rule. A plan that 

provides for reimbursements of 

expenses incurred by a service provider, 

or in-kind benefits, meets the 

requirements of a specified date or fixed 

schedule of payments with respect to 

such reimbursements or benefits if the 

following conditions are met: 

(1) The plan provides an objectively 

determinable nondiscretionary 

definition of the expenses eligible for 

reimbursement or of the in-kind benefits 

to be provided. 

(2) The plan provides for the 

reimbursement of expenses incurred or 

for the provision of the in-kind benefits 

during an objectively and specifically 

prescribed period (including the 

lifetime of the service provider). 

(3) The plan provides that the amount 

of expenses eligible for reimbursement, 

or in-kind benefits provided, during a 

service provider’s taxable year may not 

affect the expenses eligible for 

reimbursement, or in-kind benefits to be 

provided, in any other taxable year. 

(4) The reimbursement of an eligible 

expense is made on or before the last 

day of the service provider’s taxable 

year following the taxable year in which 

the expense was incurred. 

(5) The right to reimbursement or inkind benefits is not subject to 

liquidation or exchange for another 

benefit. 

(B) Medical reimbursement 

arrangements. Notwithstanding the 

foregoing, an arrangement providing for 

the reimbursement of expenses referred 

to in section 105(b) will not be deemed 

to fail to meet the requirements of 

paragraph (i)(1)(iv)(A)(3) of this section 

solely because the arrangement provides 

for a limit on the amount of expenses 

that may be reimbursed under such 

arrangement over some or all of the 

period in which the reimbursement 

arrangement remains in effect. 

(v) Tax gross-up payments. A plan 

providing a right to a tax gross-up 

payment will be treated as providing for 

payment at a specified time or on a 

fixed schedule of payments if the plan 

provides that payment will be made, 

and the payment is made, by the end of 

the service provider’s taxable year next 

following the service provider’s taxable 

year in which the service provider 

remits the related taxes. For purposes of 

this paragraph (i)(1)(v), the term tax 

gross-up payment refers to a payment to 

reimburse the service provider in an 

amount equal to all or a designated 

portion of the Federal, state, local, or 

foreign taxes imposed upon the service 

provider as a result of compensation 

paid or made available to the service 

provider by the service recipient, 

including the amount of additional 

taxes imposed upon the service provider 

due to the service recipient’s payment of 

the initial taxes on such compensation. 

In addition, a right to the 

reimbursement of expenses incurred 

due to a tax audit or litigation 

addressing the existence or amount of a 

tax liability, whether Federal, state, 

local, or foreign, satisfies the 

requirement of a fixed time and form of 

payment if the right to the 

reimbursement provides that payment 

will be made, and the payment is made, 

by the end of the service provider’s 

taxable year following the service 

provider’s taxable year in which the 

taxes that are the subject of the audit or 

litigation are remitted to the taxing 

authority, or where as a result of such 

audit or litigation no taxes are remitted, 

the end of the service provider’s taxable 

year following the service provider’s 

taxable year in which the audit is 

completed or there is a final and 

nonappealable settlement or other 

resolution of the litigation. Nothing in 

this paragraph (i)(1)(v) otherwise alters 

the application of section 409A to the 

underlying compensation arrangement 

or other arrangement that results in the 

taxes subject to the right to the tax grossup payment. 

(vi) Examples. The following 

examples (in which each employee is an 

individual whose taxable year is the 

calendar year) illustrate the principles 

of paragraphs (a), (b), (c), (d), and (i)(1) 

of this section: 

Example 1. Employee A provides services 

as an employee of Employer Z, but is not a 

specified employee. Employee A participates 

in a nonqualified deferred compensation 

plan providing for a lump sum payment 

payable on or before December 31 of the 

calendar year in which Employee A separates 

from service. The plan provides for a 

payment upon a separation from service in 

compliance with this section. 

Example 2. Employee B provides services 

as an employee of Employer Y, but is not a 

specified employee. Employee B participates 

in a nonqualified deferred compensation 

plan providing for a lump sum payment 

payable on or before the 90th day 

immediately following the date upon which 

Employee B separates from service. Employer 

Y retains the sole discretion to determine 

when during the 90-day period the payment 

will be made. Although the plan does not 

specify a period during one calendar year in 

which the payment will be made, the plan 

provides for a payment upon a separation 

from service in compliance with this section 

because the period over which the payment 

may be made is not longer than 90 days. 

Example 3. Employee C provides services 

as an employee of Employer X, but is not a 

specified employee. Employee C participates 

in a nonqualified deferred compensation 

plan providing for a lump sum payment 

payable on or before the 180th day following 

the date upon which Employee C separates 

from service. Employer X retains the sole 

discretion to determine when during the 180- 

day period the payment will be made. 

Because the plan does not specify a period 

during one calendar year in which the 

payment will be made, and because the 


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period over which the payment may be made 

is longer than 90 days, the plan does not 

provide for a payment upon a separation 

from service that complies with this section. 

Example 4. Employee D provides services 

as an employee of Employer W, but is not a 

specified employee. Employee D participates 

in a nonqualified deferred compensation 

plan providing for 10 installment payments 

payable on the first 10 anniversaries of the 

date Employee D separates from service, 

provided that no installment payment in any 

year may be more than 1% of Employer W’s 

net income for the previous calendar year, 

and provided further that the excess over 

such limit that would otherwise be payable 

but is not paid due to application of the limit 

will become payable as of the first 

installment payment date at which time such 

amount, in combination with any installment 

payment otherwise due Employee D, does 

not exceed 1% of Employer W’s net income 

for the previous calendar year. Provided that 

Employee D does not retain effective control 

of the calculation of Employer W’s net 

income or the amount that Employee D will 

not be paid due to application of the limit, 

the plan provides for a schedule of payments 

upon a separation from service that complies 

with this section. 

Example 5. Employee E and Employee F 

provide services as employees of Employer 

V, but neither is a specified employee. 

Employee E and Employee F both participate 

in substantially identical nonqualified 

deferred compensation plans providing for 

10 installment payments payable on the first 

10 anniversaries of the date the respective 

employee separates from service, provided 

that the total amount of installment payments 

in any year may not be more than 1% of 

Employer V’s net income for the previous 

year, that where any payments are not made 

due to application of the limit the 

determination of the amount not paid to a 

particular employee will be made by 

applying the overall limit proportionately 

based upon the installment payment due the 

employee that year, and that the excess over 

such limit that would otherwise be payable 

but is not paid due to application of the limit 

will become payable as of the first 

installment payment date at which time such 

amount, in combination with any installment 

payments otherwise due the participants, 

does not exceed 1% of Employer V’s net 

income for the previous calendar year. 

Provided that neither Employee E nor 

Employee F retains effective control of the 

calculation of Employer V’s net income or 

the amount that the respective employee will 

not be paid due to application of the limit, 

the plan provides for a schedule of payments 

upon a separation from service that complies 

with this section. 

Example 6. Employee G provides services 

as an employee of Employer U, but is not a 

specified employee. As a bona fide part of 

this employment relationship, Employee G 

provides professional services to clients of 

Employer U as part of the bona fide, ordinary 

course of Employer U’s trade or business. 

Under an arrangement between Employee G 

and Employer U, Employer U agrees to pay 

Employee G upon Employee G’s separation 

from service an amount equal to 5% of any 

amount collected from Company T, a client 

of Employer U for which Employee G 

performed services during his employment 

with Employer U, during the 36 months 

following Employee G’s separation from 

service. Under the arrangement, the amounts 

due to Employee G based upon payments 

received by Employer U during any calendar 

year are payable to Employee G on April 1 

of the subsequent calendar year. Provided 

that Employee G does not have effective 

control of Employer U, Company T, or the 

collection of any amounts due Employer Y 

from Company T, the arrangement provides 

for a schedule of payments upon a separation 

from service that complies with this section. 

Example 7. Employee H provides services 

as an employee of Employer S, but is not a 

specified employee. Under a plan sponsored 

by Employer S, Employee H has a legally 

binding right upon a separation from service 

to the reimbursement of country club dues 

paid in the calendar year of the separation 

from service and each of the next 3 calendar 

years following the separation from service in 

an amount not to exceed $30,000 in any 

calendar year, provided that the amount of 

dues paid in any calendar year that are 

eligible for reimbursement equals only the 

amount actually expended during such 

calendar year, and the maximum amount 

available for reimbursement in any calendar 

year will not be increased or decreased to 

reflect the amount expended or reimbursed 

in a prior or subsequent calendar year. The 

plan further provides that any reimbursement 

must be paid to Employee H by December 31 

of the calendar year following the year in 

which Employee H pays the country club 

dues. The reimbursement plan provides for a 

schedule of payments upon a separation from 

service that complies with this section. 

Example 8. Employee J provides services 

as an employee of Employer Q, but is not a 

specified employee. Under a plan sponsored 

by Employer Q, Employee J has a legally 

binding right upon a separation from service 

to the reimbursement of country club dues 

paid during the calendar year in which the 

separation from service occurs and the next 

3 calendar years in a total amount not to 

exceed $90,000. The plan further provides 

that any reimbursement must be paid to 

Employee J by December 31 of the calendar 

year following the year in which Employee 

J pays the country club dues. Because the 

reimbursement of a payment of country club 

dues in one calendar year may affect the 

amount of country club dues available for 

reimbursement in another calendar year, the 

plan does not provide for a schedule of 

payments upon a separation from service that 

complies with this section. 

(2) Separation from service—required 

delay in payment to a specified 

employee pursuant to a separation from 

service—(i) In general. In the case of any 

service provider who is a specified 

employee (as defined in § 1.409A–1(i)) 

as of the date of a separation from 

service, the requirements of paragraph 

(a)(1) of this section permitting a 

payment upon a separation from service 

are satisfied only if payments may not 

be made before the date that is six 

months after the date of separation from 

service (or, if earlier than the end of the 

six-month period, the date of death of 

the specified employee). For this 

purpose, a service provider who is not 

a specified employee as of the date of 

a separation from service will not be 

treated as subject to this requirement 

even if the service provider would have 

become a specified employee if the 

service provider had continued to 

provide services through the next 

specified employee effective date. 

Similarly, a service provider who is 

treated as a specified employee as of the 

date of a separation from service will be 

subject to this requirement even if the 

service provider would not have been 

treated as a specified employee after the 

next specified employee effective date 

had the specified employee continued 

providing services through the next 

specified employee effective date. 

Notwithstanding the foregoing, this 

paragraph (i)(2)(i) does not apply to a 

payment made under the circumstances 

described in paragraph (j)(4)(ii) 

(domestic relations order), (j)(4)(iii) 

(conflicts of interest), or (j)(4)(vi) 

(payment of employment taxes) of this 

section. 

(ii) Application of payment rules to 

delayed payments. The required delay 

in payment is met if payments to which 

a specified employee would otherwise 

be entitled during the first six months 

following the date of separation from 

service are accumulated and paid on the 

first day of the seventh month following 

the date of separation from service, or if 

each payment to which a specified 

employee is otherwise entitled upon a 

separation from service is delayed by six 

months. A service recipient may retain 

discretion to choose which method will 

be implemented, provided that no direct 

or indirect election as to the method 

may be provided to the service provider. 

For an affected specified employee, a 

date upon which the plan or the service 

recipient designates that the payment 

will be made after the six-month delay 

is treated as a fixed payment date for 

purposes of paragraph (d) of this section 

once the separation from service has 

occurred. 

(3) Unforeseeable emergency—(i) 

Definition. For purposes of §§ 1.409A–1 

and 1.409A–2, this section, and 

§§ 1.409A–4 through 1.409A–6, an 

unforeseeable emergency is a severe 

financial hardship to the service 

provider resulting from an illness or 

accident of the service provider, the 

service provider’s spouse, the service 

provider’s beneficiary, or the service 

provider’s dependent (as defined in 

section 152, without regard to section 

152(b)(1), (b)(2), and (d)(1)(B)); loss of 


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the service provider’s property due to 

casualty (including the need to rebuild 

a home following damage to a home not 

otherwise covered by insurance, for 

example, not as a result of a natural 

disaster); or other similar extraordinary 

and unforeseeable circumstances arising 

as a result of events beyond the control 

of the service provider. For example, the 

imminent foreclosure of or eviction 

from the service provider’s primary 

residence may constitute an 

unforeseeable emergency. In addition, 

the need to pay for medical expenses, 

including non-refundable deductibles, 

as well as for the costs of prescription 

drug medication, may constitute an 

unforeseeable emergency. Finally, the 

need to pay for the funeral expenses of 

a spouse, a beneficiary, or a dependent 

(as defined in section 152, without 

regard to section 152(b)(1), (b)(2), and 

(d)(1)(B)) may also constitute an 

unforeseeable emergency. Except as 

otherwise provided in this paragraph 

(i)(3)(i), the purchase of a home and the 

payment of college tuition are not 

unforeseeable emergencies. Whether a 

service provider is faced with an 

unforeseeable emergency permitting a 

distribution under this paragraph 

(i)(3)(i) is to be determined based on the 

relevant facts and circumstances of each 

case, but, in any case, a distribution on 

account of unforeseeable emergency 

may not be made to the extent that such 

emergency is or may be relieved through 

reimbursement or compensation from 

insurance or otherwise, by liquidation 

of the service provider’s assets, to the 

extent the liquidation of such assets 

would not cause severe financial 

hardship, or by cessation of deferrals 

under the plan. A plan may provide for 

a payment upon a specific type or types 

of unforeseeable emergency, without 

providing for payment upon all 

unforeseeable emergencies, provided 

that any event upon which a payment 

may be made qualifies as an 

unforeseeable emergency. 

(ii) Amount of payment permitted 

upon an unforeseeable emergency. 

Distributions because of an 

unforeseeable emergency must be 

limited to the amount reasonably 

necessary to satisfy the emergency need 

(which may include amounts necessary 

to pay any Federal, state, local, or 

foreign income taxes or penalties 

reasonably anticipated to result from the 

distribution). Determinations of 

amounts reasonably necessary to satisfy 

the emergency need must take into 

account any additional compensation 

that is available if the plan provides for 

cancellation of a deferral election upon 

a payment due to an unforeseeable 

emergency. See paragraph (j)(4)(viii) of 

this section. However, the 

determination of amounts reasonably 

necessary to satisfy the emergency need 

is not required to take into account any 

additional compensation that due to the 

unforeseeable emergency is available 

under another nonqualified deferred 

compensation plan but has not actually 

been paid, or that is available due to the 

unforeseeable emergency under another 

plan that would provide for deferred 

compensation except due to the 

application of the effective date 

provisions under § 1.409A–6. The 

payment may be made from any plan in 

which the service provider participates 

that provides for payment upon an 

unforeseeable emergency, provided that 

the plan under which the payment was 

made must be designated at the time of 

payment. 

(iii) Payments due to an unforeseeable 

emergency. A service provider may 

retain discretion with respect to 

whether to apply for a payment upon an 

unforeseeable emergency, and a service 

recipient may retain discretion with 

respect to whether to make a payment 

available under the plan due to an 

unforeseeable emergency. A service 

provider who has experienced an 

unforeseeable emergency will not be 

treated as making a subsequent deferral 

election under § 1.409A–2(b) 

(subsequent deferral election rules) if 

the service provider does not apply for 

or elect to receive a payment available 

under the plan. A service recipient will 

not be treated as making a subsequent 

deferral election under § 1.409A–2(b) 

(subsequent deferral election rules) if 

the service recipient exercises its 

discretion not to make a payment 

otherwise available due to an 

unforeseeable emergency. 

(4) Disability—(i) In general. For 

purposes of §§ 1.409A–1 and 1.409A–2, 

this section, and §§ 1.409A–4 through 

1.409A–6, except as otherwise 

specifically provided, a service provider 

is considered disabled if the service 

provider meets one of the following 

requirements: 

(A) The service provider is unable to 

engage in any substantial gainful 

activity by reason of any medically 

determinable physical or mental 

impairment that can be expected to 

result in death or can be expected to last 

for a continuous period of not less than 

12 months. 

(B) The service provider is, by reason 

of any medically determinable physical 

or mental impairment that can be 

expected to result in death or can be 

expected to last for a continuous period 

of not less than 12 months, receiving 

income replacement benefits for a 

period of not less than three months 

under an accident and health plan 

covering employees of the service 

provider’s employer. 

(ii) Limited plan definition of 

disability. A plan may provide for a 

payment upon any disability, and need 

not provide for a payment upon all 

disabilities, provided that any disability 

upon which a payment may be made 

under the plan complies with the 

provisions of this paragraph (i)(4). 

(iii) Determination of disability. A 

plan may provide that a service provider 

will be deemed disabled if determined 

to be totally disabled by the Social 

Security Administration or Railroad 

Retirement Board. A plan may also 

provide that a service provider will be 

deemed disabled if determined to be 

disabled in accordance with a disability 

insurance program, provided that the 

definition of disability applied under 

such disability insurance program 

complies with the requirements of this 

paragraph (i)(4). 

(5) Change in the ownership or 

effective control of a corporation, or a 

change in the ownership of a substantial 

portion of the assets of a corporation—

(i) In general. Pursuant to section 

409A(a)(2)(A)(v), a plan may permit a 

payment upon the occurrence of a 

change in the ownership of the 

corporation (as defined in paragraph 

(i)(5)(v) of this section), a change in 

effective control of the corporation (as 

defined in paragraph (i)(5)(vi) of this 

section), or a change in the ownership 

of a substantial portion of the assets of 

the corporation (as defined in paragraph 

(i)(5)(vii) of this section) (collectively 

referred to as a change in control event). 

To qualify as a change in control event, 

the occurrence of the event must be 

objectively determinable and any 

requirement that any other person or 

group, such as a plan administrator or 

compensation committee, certify the 

occurrence of a change in control event 

must be strictly ministerial and not 

involve any discretionary authority. The 

plan may provide for a payment on a 

particular type or types of change in 

control events, and need not provide for 

a payment on all such events, provided 

that each event upon which a payment 

is provided qualifies as a change in 

control event. For rules regarding the 

ability of the service recipient to 

terminate the plan and pay amounts of 

deferred compensation upon a change 

in control event, see paragraph 

(j)(4)(ix)(B) of this section. 

(ii) Identification of relevant 

corporation—(A) In general. To 

constitute a change in control event 

with respect to the service provider, the 

change in control event must relate to—


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(1) The corporation for whom the 

service provider is performing services 

at the time of the change in control 

event; 

(2) The corporation that is liable for 

the payment of the deferred 

compensation (or all corporations liable 

for the payment if more than one 

corporation is liable) but only if either 

the deferred compensation is 

attributable to the performance of 

service by the service provider for such 

corporation (or corporations) or there is 

a bona fide business purpose for such 

corporation or corporations to be liable 

for such payment and, in either case, no 

significant purpose of making such 

corporation or corporations liable for 

such payment is the avoidance of 

Federal income tax; or 

(3) A corporation that is a majority 

shareholder of a corporation identified 

in paragraph (i)(5)(ii)(A)(1) or (2) of this 

section, or any corporation in a chain of 

corporations in which each corporation 

is a majority shareholder of another 

corporation in the chain, ending in a 

corporation identified in paragraph 

(i)(5)(ii)(A)(1) or (2) of this section. 

(B) Majority shareholder. For 

purposes of this paragraph (i)(5)(ii), a 

majority shareholder is a shareholder 

owning more than 50 percent of the 

total fair market value and total voting 

power of such corporation. 

(C) Example. The following example 

illustrates the rules of this paragraph 

(i)(5)(ii): 

Example. Corporation A is a majority 

shareholder of Corporation B, which is a 

majority shareholder of Corporation C. A 

change in ownership of Corporation B 

constitutes a change in control event to 

service providers performing services for 

Corporation B or Corporation C, and to 

service providers for which Corporation B or 

Corporation C is solely liable for payments 

under the plan (for example, former 

employees), but is not a change in control 

event as to Corporation A or any other 

corporation of which Corporation A is a 

majority shareholder unless the sale 

constitutes a change in the ownership of a 

substantial portion of Corporation A’s assets 

(see paragraph (i)(5)(vii) of this section). 

(iii) Attribution of stock ownership. 

For purposes of paragraph (i)(5) of this 

section, section 318(a) applies to 

determine stock ownership. Stock 

underlying a vested option is 

considered owned by the individual 

who holds the vested option (and the 

stock underlying an unvested option is 

not considered owned by the individual 

who holds the unvested option). For 

purposes of the preceding sentence, 

however, if a vested option is 

exercisable for stock that is not 

substantially vested (as defined by 

§ 1.83–3(b) and (j)), the stock underlying 

the option is not treated as owned by 

the individual who holds the option. 

(iv) Special rules for certain delayed 

payments pursuant to a change in 

control event—(A) Certain transactionbased compensation. Payments of 

compensation related to a change in 

control event described in paragraph 

(i)(5)(v) of this section (change in the 

ownership of a corporation) or 

paragraph (i)(5)(vii) of this section 

(change in the ownership of a 

substantial portion of a corporation’s 

assets), that occur because a service 

recipient purchases its stock held by the 

service provider or because the service 

recipient or a third party purchases a 

stock right held by a service provider, or 

that are calculated by reference to the 

value of stock of the service recipient 

(collectively, transaction-based 

compensation), may be treated as paid 

at a designated date or pursuant to a 

payment schedule that complies with 

the requirements of section 409A if the 

transaction-based compensation is paid 

on the same schedule and under the 

same terms and conditions as apply to 

payments to shareholders generally with 

respect to stock of the service recipient 

pursuant to a change in control event 

described in paragraph (i)(5)(v) of this 

section (change in the ownership of a 

corporation) or as apply to payments to 

the service recipient pursuant to a 

change in control event described in 

paragraph (i)(5)(vii) of this section 

(change in the ownership of a 

substantial portion of a corporation’s 

assets), and to the extent that the 

transaction-based compensation is paid 

not later than five years after the change 

in control event, the payment of such 

compensation will not violate the initial 

or subsequent deferral election rules set 

out in § 1.409A–2(a) and (b) solely as a 

result of such transaction-based 

compensation being paid pursuant to 

such schedule and terms and 

conditions. If before and in connection 

with a change in control event described 

in paragraph (i)(5)(v) or (i)(5)(vii) of this 

section, transaction-based compensation 

that would otherwise be payable as a 

result of such event is made subject to 

a condition on payment that constitutes 

a substantial risk of forfeiture (as 

defined in § 1.409A–1(d), without 

regard to the provisions of that section 

under which additions or extensions of 

forfeiture conditions are disregarded) 

and the transaction-based compensation 

is payable under the same terms and 

conditions as apply to payments made 

to shareholders generally with respect to 

stock of the service recipient pursuant 

to a change in control event described 

in paragraph (i)(5)(v) of this section or 

to payments to the service recipient 

pursuant to a change in control event 

described in paragraph (i)(5)(vii) of this 

section, for purposes of determining 

whether such transaction-based 

compensation is a short-term deferral 

the requirements of § 1.409A–1(b)(4) are 

applied as if the legally binding right to 

such transaction-based compensation 

arose on the date that it became subject 

to such substantial risk of forfeiture. 

(B) Certain nonvested compensation. 

Notwithstanding the provisions of 

§ 1.409A–1(d) (definition of a 

substantial risk of forfeiture) that 

disregard the extension or modification 

of a condition for purposes of 

determining whether a condition on 

payment constitutes a substantial risk of 

forfeiture, a condition that is a 

substantial risk of forfeiture that 

otherwise would lapse as a result of a 

change in control event described in 

paragraph (i)(5)(v) or (i)(5)(vii) of this 

section may be extended or modified 

before and in connection with such 

event to provide for a condition on 

payment that will not lapse as a result 

of such change in control event, and 

such extended or modified condition 

will be treated as continuing to subject 

the amount to a substantial risk of 

forfeiture, provided that the transaction 

constituting the change in control event 

is a bona fide arm’s length transaction 

between the service recipient or its 

shareholders and one or more parties 

who are unrelated to the service 

recipient and service provider (applying 

the rules of § 1.409A–1(f)(2)(ii)) and the 

modified or extended condition to 

which the payment is subject would 

otherwise be treated as a substantial risk 

of forfeiture under § 1.409A–1(d) 

(without regard to the provisions 

disregarding additions or extensions of 

forfeiture conditions). In such a case, 

the continued application of a fixed 

schedule of payments based upon the 

lapse of the substantial risk of forfeiture, 

so that payments commence upon the 

lapse of the modified or extended 

condition on payment, will not be 

treated as a change in the fixed schedule 

of payments for purposes of § 1.409A–

2(b) (subsequent deferral elections) or 

paragraph (j) of this section (prohibition 

on the acceleration of payments). 

(v) Change in the ownership of a 

corporation—(A) In general. Except as 

provided in paragraph (i)(5)(vi)(C) of 

this section, a change in the ownership 

of a corporation occurs on the date that 

any one person, or more than one 

person acting as a group (as defined in 

paragraph (i)(5)(v)(B) of this section), 

acquires ownership of stock of the 

corporation that, together with stock 

held by such person or group, 


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constitutes more than 50 percent of the 

total fair market value or total voting 

power of the stock of such corporation. 

A nonqualified deferred compensation 

plan may provide that amounts payable 

upon a change in the ownership of a 

corporation will be paid only if the 

conditions in the preceding sentence are 

satisfied but substituting a percentage 

specified in the plan that is higher than 

50 percent for the words ‘‘50 percent’’

in the preceding sentence, but only if 

the provision is set forth in the plan no 

later than the date by which the time 

and form of payment must be 

established under § 1.409A–2. However, 

if any one person, or more than one 

person acting as a group, is considered 

to own more than 50 percent of the total 

fair market value or total voting power 

of the stock of a corporation (or such 

higher percentage specified in 

accordance with the preceding 

sentence), the acquisition of additional 

stock by the same person or persons is 

not considered to cause a change in the 

ownership of the corporation (or to 

cause a change in the effective control 

of the corporation (within the meaning 

of paragraph (i)(5)(vi) of this section)). 

An increase in the percentage of stock 

owned by any one person, or persons 

acting as a group, as a result of a 

transaction in which the corporation 

acquires its stock in exchange for 

property will be treated as an 

acquisition of stock for purposes of this 

section. This section applies only when 

there is a transfer of stock of a 

corporation (or issuance of stock of a 

corporation) and stock in such 

corporation remains outstanding after 

the transaction (see paragraph (i)(5)(vii) 

of this section for rules regarding the 

transfer of assets of a corporation). See 

§ 1.280G–1, Q&A–27(d), Example 1, 

Example 2, Example 5, and Example 6. 

(B) Persons acting as a group. For 

purposes of paragraph (i)(5)(v)(A) of this 

section, persons will not be considered 

to be acting as a group solely because 

they purchase or own stock of the same 

corporation at the same time, or as a 

result of the same public offering. 

However, persons will be considered to 

be acting as a group if they are owners 

of a corporation that enters into a 

merger, consolidation, purchase or 

acquisition of stock, or similar business 

transaction with the corporation. If a 

person, including an entity, owns stock 

in both corporations that enter into a 

merger, consolidation, purchase or 

acquisition of stock, or similar 

transaction, such shareholder is 

considered to be acting as a group with 

other shareholders only with respect to 

the ownership in that corporation before 

the transaction giving rise to the change 

and not with respect to the ownership 

interest in the other corporation. See 

§ 1.280G–1, Q&A–27(d), Example 3 and 

Example 4. 

(vi) Change in the effective control of 

a corporation—(A) In general. 

Notwithstanding that a corporation has 

not undergone a change in ownership 

under paragraph (i)(5)(v) of this section, 

a change in the effective control of the 

corporation occurs only on either of the 

following dates: 

(1) The date any one person, or more 

than one person acting as a group (as 

determined under paragraph (i)(5)(v)(B) 

of this section), acquires (or has 

acquired during the 12-month period 

ending on the date of the most recent 

acquisition by such person or persons) 

ownership of stock of the corporation 

possessing 30 percent or more of the 

total voting power of the stock of such 

corporation. A nonqualified deferred 

compensation plan may provide that 

amounts payable upon an effective 

change in control of a corporation will 

be paid only if the conditions in the 

preceding sentence are satisfied but 

substituting a percentage specified in 

the plan that is higher than 30 percent 

for the word ‘‘30 percent’’ in the 

preceding sentence, but only if the 

percentage is set forth in the plan no 

later than the date by which the time 

and form of payment must be 

established under § 1.409A–2). 

(2) The date a majority of members of 

the corporation’s board of directors is 

replaced during any 12-month period by 

directors whose appointment or election 

is not endorsed by a majority of the 

members of the corporation’s board of 

directors before the date of the 

appointment or election, provided that 

for purposes of this paragraph 

(i)(5)(vi)(A) the term corporation refers 

solely to the relevant corporation 

identified in paragraph (i)(5)(ii) of this 

section for which no other corporation 

is a majority shareholder for purposes of 

that paragraph. For example, if 

Corporation A is a publicly held 

corporation with no majority 

shareholder, and Corporation A is the 

majority shareholder of Corporation B, 

which is the majority shareholder of 

Corporation C, the term corporation for 

purposes of this paragraph 

(i)(5)(vi)(A)(2) would refer solely to 

Corporation A. A nonqualified deferred 

compensation plan may provide that 

amounts payable upon a change in the 

effective control of a corporation will be 

paid only if the conditions in the first 

sentence of this paragraph are satisfied 

substituting a portion of the members of 

the corporation’s board of directors that 

is higher than the words ‘‘a majority of 

the members of the corporation’s board 

of directors’’ in the first sentence of this 

paragraph, but only if the higher portion 

is set forth in the plan no later than the 

date by which the time and form of 

payment must be established under 

§ 1.409A–2(a)). 

(B) Multiple change in control events. 

A change in effective control may occur 

in a transaction in which one of the two 

corporations involved in the transaction 

has a change in control event under 

paragraph (i)(5)(v) or (i)(5)(vii) of this 

section. Thus, for example, assume 

Corporation P transfers more than 40 

percent of the total gross fair market 

value of its assets to Corporation O in 

exchange for 35 percent of O’s stock. P 

has undergone a change in ownership of 

a substantial portion of its assets under 

paragraph (i)(5)(vii) of this section and 

O has a change in effective control 

under this paragraph (i)(5)(vi). 

(C) Acquisition of additional control. 

If any one person, or more than one 

person acting as a group, is considered 

to effectively control a corporation 

(within the meaning of this paragraph 

(i)(5)(vi)), the acquisition of additional 

control of the corporation by the same 

person or persons is not considered to 

cause a change in the effective control 

of the corporation (or to cause a change 

in the ownership of the corporation 

within the meaning of paragraph 

(i)(5)(v) of this section). 

(D) Persons acting as a group. Persons 

will not be considered to be acting as a 

group solely because they purchase or 

own stock of the same corporation at the 

same time, or as a result of the same 

public offering. However, persons will 

be considered to be acting as a group if 

they are owners of a corporation that 

enters into a merger, consolidation, 

purchase or acquisition of stock, or 

similar business transaction with the 

corporation. If a person, including an 

entity, owns stock in both corporations 

that enter into a merger, consolidation, 

purchase or acquisition of stock, or 

similar transaction, such shareholder is 

considered to be acting as a group with 

other shareholders in a corporation only 

with respect to the ownership in that 

corporation before the transaction giving 

rise to the change and not with respect 

to the ownership interest in the other 

corporation. See § 1.280G–1, Q&A–

27(d), Example 4. 

(vii) Change in the ownership of a 

substantial portion of a corporation’s 

assets—(A) In general. A change in the 

ownership of a substantial portion of a 

corporation’s assets occurs on the date 

that any one person, or more than one 

person acting as a group (as determined 

in paragraph (i)(5)(v)(B) of this section), 

acquires (or has acquired during the 12- 


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month period ending on the date of the 

most recent acquisition by such person 

or persons) assets from the corporation 

that have a total gross fair market value 

equal to or more than 40 percent of the 

total gross fair market value of all of the 

assets of the corporation immediately 

before such acquisition or acquisitions 

(or such higher amount specified by the 

plan no later than the date by which the 

time and form of payment must be 

established under § 1.409A–2). For this 

purpose, gross fair market value means 

the value of the assets of the 

corporation, or the value of the assets 

being disposed of, determined without 

regard to any liabilities associated with 

such assets. 

(B) Transfers to a related person—(1) 

There is no change in control event 

under this paragraph (i)(5)(vii) when 

there is a transfer to an entity that is 

controlled by the shareholders of the 

transferring corporation immediately 

after the transfer, as provided in this 

paragraph (i)(5)(vii)(B). A transfer of 

assets by a corporation is not treated as 

a change in the ownership of such assets 

if the assets are transferred to—

(i) A shareholder of the corporation 

(immediately before the asset transfer) 

in exchange for or with respect to its 

stock; 

(ii) An entity, 50 percent or more of 

the total value or voting power of which 

is owned, directly or indirectly, by the 

corporation; 

(iii) A person, or more than one 

person acting as a group, that owns, 

directly or indirectly, 50 percent or 

more of the total value or voting power 

of all the outstanding stock of the 

corporation; or 

(iv) An entity, at least 50 percent of 

the total value or voting power of which 

is owned, directly or indirectly, by a 

person described in paragraph 

(i)(5)(vii)(B)(1)(iii) of this section. 

(2) For purposes of this paragraph 

(i)(5)(vii)(B) and except as otherwise 

provided in this paragraph (i), a 

person’s status is determined 

immediately after the transfer of the 

assets. For example, a transfer to a 

corporation in which the transferor 

corporation has no ownership interest 

before the transaction, but that is a 

majority-owned subsidiary of the 

transferor corporation after the 

transaction is not treated as a change in 

the ownership of the assets of the 

transferor corporation. 

(C) Persons acting as a group. Persons 

will not be considered to be acting as a 

group solely because they purchase 

assets of the same corporation at the 

same time. However, persons will be 

considered to be acting as a group if 

they are owners of a corporation that 

enters into a merger, consolidation, 

purchase or acquisition of assets, or 

similar business transaction with the 

corporation. If a person, including an 

entity shareholder, owns stock in both 

corporations that enter into a merger, 

consolidation, purchase or acquisition 

of assets, or similar transaction, such 

shareholder is considered to be acting as 

a group with other shareholders in a 

corporation only to the extent of the 

ownership in that corporation before the 

transaction giving rise to the change and 

not with respect to the ownership 

interest in the other corporation. See 

§ 1.280G–1, Q&A–27(d), Example 4. 

(6) Certain back-to-back 

arrangements—(i) In general. This 

paragraph (i)(6) applies where a service 

provider is providing services to a 

service recipient (the intermediate 

service recipient), who in turn is 

providing services to another service 

recipient (the ultimate service 

recipient), the services provided by the 

service provider to the intermediate 

service recipient are closely related to 

the services provided by the 

intermediate service recipient to the 

ultimate service recipient, there is a 

nonqualified deferred compensation 

plan providing for payments by the 

ultimate service recipient to the 

intermediate service recipient (the 

ultimate service recipient plan), there is 

a nonqualified deferred compensation 

plan or other agreement, method, 

program, or other arrangement 

providing for payments of compensation 

by the intermediate service recipient to 

the service provider (the intermediate 

service recipient plan), and the 

intermediate service recipient plan 

provides for a payment upon the 

occurrence of an event described in 

paragraph (a)(1), (2), (3), (5), or (6) of 

this section. In such a case, 

notwithstanding the generally 

applicable limits on payments in 

paragraph (a) of this section, the 

ultimate service recipient plan may 

provide for a payment to the 

intermediate service recipient upon the 

occurrence of a payment event under 

the intermediate service recipient plan 

described in paragraph (a)(1), (2), (3), 

(5), or (6) of this section if the time and 

form of payment is defined as the same 

time and form of payment provided 

under the intermediate service recipient 

plan, the amount of the payment under 

the ultimate service recipient plan does 

not exceed the amount of the payment 

under the intermediate service recipient 

plan, and the ultimate service recipient 

plan and the intermediate service 

recipient plan otherwise satisfy the 

requirements of section 409A 

(regardless of whether such plan is 

subject to section 409A). 

(ii) Example. The provisions of 

paragraph (i)(6)(i) of this section are 

illustrated by the following example: 

Example. Company B (intermediate service 

recipient) provides services to Company C 

(ultimate service recipient). Employee A 

(service provider) provides services to 

Company B that are closely related to the 

services Company B provides to Company C. 

Pursuant to a nonqualified deferred 

compensation plan meeting the requirements 

of section 409A, Employee A is entitled to a 

payment of deferred compensation upon a 

separation from service with Company B (the 

intermediate service recipient plan). Under 

an arrangement between Company B and 

Company C (the ultimate service recipient 

plan), Company C agrees to pay an amount 

of deferred compensation to Company B 

upon Employee A’s separation from service 

with Company B, in accordance with the 

time, form and amount of payment provided 

in the intermediate service recipient plan. 

Provided that the intermediate service 

recipient plan and the ultimate service 

recipient plan otherwise comply with the 

requirements of section 409A (regardless of 

whether such arrangements are subject to 

section 409A), Company C’s payment to 

Company B of the amount due under the 

ultimate service recipient plan upon the 

separation from service of Employee A from 

Company B may constitute a permissible 

payment event for purposes of paragraph (a) 

of this section. 

(j) Prohibition on acceleration of 

payments—(1) In general. Except as 

provided in paragraph (j)(4) of this 

section, a nonqualified deferred 

compensation plan may not permit the 

acceleration of the time or schedule of 

any payment or amount scheduled to be 

paid pursuant to the terms of the plan, 

and no such accelerated payment may 

be made whether or not provided for 

under the terms of such plan. For 

purposes of determining whether a 

payment of deferred compensation has 

been made, the rules of paragraph (f) of 

this section (substituted payments) 

apply. For purposes of this paragraph 

(j), an impermissible acceleration does 

not occur if payment is made in 

accordance with plan provisions or an 

election as to the time and form of 

payment in effect at the time of initial 

deferral (or added in accordance with 

the rules applicable to subsequent 

deferral elections under § 1.409A–2(b)) 

pursuant to which payment is required 

to be made on an accelerated schedule 

as a result of an intervening event that 

is an event described in paragraph 

(a)(1), (2), (3), (5), or (6) of this section. 

For example, a plan may provide that a 

participant will receive six installment 

payments commencing at separation 

from service, and also provide that if the 

participant dies after such payments 


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Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 19319 

commence but before all payments have 

been made, all remaining amounts will 

be paid in a lump sum payment. 

Additionally, it is not an acceleration of 

the time or schedule of payment of a 

deferral of compensation if a service 

recipient waives or accelerates the 

satisfaction of a condition constituting a 

substantial risk of forfeiture applicable 

to such deferral of compensation, 

provided that the requirements of 

section 409A (including the requirement 

that the payment be made upon a 

permissible payment event) are 

otherwise satisfied with respect to such 

deferral of compensation. For example, 

if a nonqualified deferred compensation 

plan provides for a lump sum payment 

of the vested benefit upon separation 

from service, and the benefit vests under 

the plan only after 10 years of service, 

it is not a violation of the requirements 

of section 409A if the service recipient 

reduces the vesting requirement to five 

years of service, even if a service 

provider becomes vested as a result and 

receives a payment in connection with 

a separation from service before the 

service provider would have completed 

10 years of service. However, if the plan 

in this example had provided for a 

payment at a fixed date, rather than at 

separation from service, the date of 

payment could not be accelerated due to 

the accelerated vesting. For the 

definition of a payment for purposes of 

this paragraph (j), see § 1.409A–2(b)(5) 

(coordination of the subsequent deferral 

election rules with the prohibition on 

acceleration of payments). For other 

permissible payments, see § 1.409A–

2(b)(2)(iii) (certain immediate payments 

of remaining installments) and 

paragraph (d) of this section (certain 

payments made no more than 30 days 

before the designated payment date). 

(2) Application to multiple payment 

events. Generally, the addition of a 

permissible payment event, the deletion 

of a permissible payment event, or the 

substitution of one permissible payment 

event for another permissible payment 

event, results in an acceleration of a 

payment if the addition, deletion, or 

substitution could result in the payment 

being made at an earlier date than such 

payment would have been made absent 

such addition, deletion, or substitution. 

Notwithstanding the previous sentence, 

the addition of death, disability (as 

defined in paragraph (i)(4) of this 

section), or an unforeseeable emergency 

(as defined in paragraph (i)(3) of this 

section), as a potentially earlier 

alternative payment event to an amount 

previously deferred will not be treated 

as resulting in an acceleration of a 

payment, even if such addition results 

in the payment being paid at an earlier 

time than such payment would have 

been made absent the addition of the 

payment event. However, the addition 

of such a payment event as a potentially 

later alternative payment event 

generally is subject to the rules 

governing changes in the time and form 

of payment (see § 1.409A–2(b)). 

(3) Beneficiaries. The rules of this 

paragraph (j) apply to elections by 

beneficiaries with respect to the time 

and form of payment, as well as 

elections by service providers or service 

recipients with respect to the time and 

form of payment to beneficiaries. An 

election to change the identity of a 

beneficiary does not constitute an 

acceleration of a payment merely 

because the election changes the 

identity of the recipient of the payment, 

if the time and form of the payment is 

not otherwise changed. In addition, an 

election before the commencement of a 

life annuity to change the identity of a 

beneficiary does not constitute an 

acceleration of a payment if the change 

in the time of payments stems solely 

from the different life expectancy of the 

new beneficiary, such as in the case of 

a joint and survivor annuity, and does 

not change the commencement date of 

the life annuity. 

(4) Exceptions—(i) In general. Except 

as otherwise expressly provided, a plan 

may provide for the acceleration of a 

payment in accordance with paragraphs 

(j)(4)(ii) through (xiv) of this section, or 

may provide a service recipient 

discretion to accelerate payments in 

accordance with the provisions of 

paragraphs (j)(4)(ii) through (xiv) of this 

section. A plan may not provide a 

service provider discretion with respect 

to whether a payment will be 

accelerated, and a service recipient may 

not provide a service provider a direct 

or indirect election as to whether the 

service recipient’s discretion to 

accelerate a payment will be exercised, 

even if such acceleration would be 

permitted under paragraphs (j)(4)(ii) 

through (xiv) of this section. Whether a 

service recipient has provided a service 

provider an election as to whether the 

service recipient’s discretion to 

accelerate a payment will be exercised 

is determined based on all the facts and 

circumstances, including whether 

similarly situated service providers have 

been treated differently. Except as 

otherwise provided in paragraphs 

(j)(4)(ii) through (xiv) of this section, the 

plan need not set forth the exception in 

writing, and provided all other 

requirements of this section are met, the 

making of such a payment or the 

addition of a plan term permitting the 

making of such a payment will not 

constitute the acceleration of a payment, 

and the failure to make such a payment 

or the deletion or modification of a plan 

term permitting the making of such a 

payment will not be subject to the rules 

regarding a change in the time and form 

of payment under § 1.409A–2(b). 

(ii) Domestic relations order. A plan 

may provide for acceleration of the time 

or schedule of a payment under the plan 

to an individual other than the service 

provider, or a payment under such plan 

may be made to an individual other 

than the service provider, to the extent 

necessary to fulfill a domestic relations 

order (as defined in section 

414(p)(1)(B)). 

(iii) Conflicts of interest—(A) 

Compliance with ethics agreements with 

the Federal government. A plan may 

provide for acceleration of the time or 

schedule of a payment under the plan, 

or a payment may be made under a 

plan, to the extent necessary for any 

Federal officer or employee in the 

executive branch to comply with an 

ethics agreement with the Federal 

government. 

(B) Compliance with ethics laws or 

conflicts of interest laws. A plan may 

provide for acceleration of the time or 

schedule of a payment under the plan, 

or a payment may be made under a 

plan, to the extent reasonably necessary 

to avoid the violation of an applicable 

Federal, state, local, or foreign ethics 

law or conflicts of interest law 

(including where such payment is 

reasonably necessary to permit the 

service provider to participate in 

activities in the normal course of his or 

her position in which the service 

provider would otherwise not be able to 

participate under an applicable rule). A 

payment is reasonably necessary to 

avoid the violation of a Federal, state, 

local, or foreign ethics law or conflicts 

of interest law if the payment is a 

necessary part of a course of action that 

results in compliance with a Federal, 

state, local, or foreign ethics law or 

conflicts of interest law that would be 

violated absent such course of action, 

regardless of whether other actions 

would also result in compliance with 

the Federal, state, local, or foreign ethics 

law or conflicts of interest law. For this 

purpose, a provision of foreign law is 

considered applicable only to foreign 

earned income (as defined under section 

911(b)(1) without regard to section 

911(b)(1)(B)(iv) and without regard to 

the requirement that the income be 

attributable to services performed 

during the period described in section 

911(d)(1)(A) or (B)) from sources within 

the foreign country that promulgated 

such law. 


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(iv) Section 457 plans. A plan subject 

to section 457(f) may provide for an 

acceleration of the time or schedule of 

a payment to a service provider, or a 

payment may be made under such a 

plan, to pay Federal, state, local, and 

foreign income taxes due upon a vesting 

event, provided that the amount of such 

payment is not more than an amount 

equal to the Federal, state, local, and 

foreign income tax withholding that 

would have been remitted by the 

employer if there had been a payment 

of wages equal to the income includible 

by the service provider under section 

457(f) at the time of the vesting. 

(v) Limited cashouts. A plan may 

require or provide a service recipient 

discretion to require (or be amended to 

require or to provide a service recipient 

discretion to require), a mandatory lump 

sum payment of amounts deferred 

under the plan that do not exceed a 

specified amount, provided that such 

plan term or amendment is executed 

and effective, and any required exercise 

of service recipient discretion is 

evidenced in writing, no later than the 

date of such payment, and provided 

that—

(A) The payment results in the 

termination and liquidation of the 

entirety of the service provider’s interest 

under the plan, including all 

agreements, methods, programs, or other 

arrangements with respect to which 

deferrals of compensation are treated as 

having been deferred under a single 

nonqualified deferred compensation 

plan under § 1.409A–1(c)(2); and 

(B) The payment is not greater than 

the applicable dollar amount under 

section 402(g)(1)(B). 

(vi) Payment of employment taxes. A 

plan may provide for the acceleration of 

the time or schedule of a payment, or a 

payment may be made under the plan, 

to pay the Federal Insurance 

Contributions Act (FICA) tax imposed 

under section 3101, section 3121(a), and 

section 3121(v)(2), or the Railroad 

Retirement Act tax imposed under 

section 3201, section 3211, section 

3231(e)(1), and section 3231(e)(8), 

where applicable, on compensation 

deferred under the plan (the FICA or 

RRTA amount). Additionally, a plan 

may provide for the acceleration of the 

time or schedule of a payment, or a 

payment may be made under the plan, 

to pay the income tax at source on 

wages imposed under section 3401 or 

the corresponding withholding 

provisions of applicable state, local, or 

foreign tax laws as a result of the 

payment of the FICA or RRTA amount, 

and to pay the additional income tax at 

source on wages attributable to the 

pyramiding section 3401 wages and 

taxes. However, the total payment under 

this acceleration provision must not 

exceed the aggregate of the FICA or 

RRTA Amount, and the income tax 

withholding related to such FICA or 

RRTA amount. 

(vii) Payment upon income inclusion 

under section 409A. A plan may provide 

for the acceleration of the time or 

schedule of a payment, or a payment 

under such plan may be made, at any 

time the plan fails to meet the 

requirements of section 409A and these 

regulations. Such payment may not 

exceed the amount required to be 

included in income as a result of the 

failure to comply with the requirements 

of section 409A and these regulations. 

(viii) Cancellation of deferrals 

following an unforeseeable emergency 

or hardship distribution. A plan may 

provide for a cancellation of a service 

provider’s deferral election, or such a 

cancellation may be made, due to an 

unforeseeable emergency or a hardship 

distribution pursuant to § 1.401(k)–

1(d)(3). The deferral election must be 

cancelled, not merely postponed or 

otherwise delayed. Accordingly, any 

later deferral election will be subject to 

the provisions governing initial deferral 

elections. See § 1.409A–2(a). 

(ix) Plan terminations and 

liquidations. A plan may provide for the 

acceleration of the time and form of a 

payment, or a payment under such plan 

may be made, where the acceleration of 

the payment is made pursuant to a 

termination and liquidation of the plan 

in accordance with one of the following: 

(A) The service recipient’s 

termination and liquidation of the plan 

within 12 months of a corporate 

dissolution taxed under section 331, or 

with the approval of a bankruptcy court 

pursuant to 11 U.S.C. § 503(b)(1)(A), 

provided that the amounts deferred 

under the plan are included in the 

participants’ gross incomes in the latest 

of the following years (or, if earlier, the 

taxable year in which the amount is 

actually or constructively received). 

(1) The calendar year in which the 

plan termination and liquidation occurs. 

(2) The first calendar year in which 

the amount is no longer subject to a 

substantial risk of forfeiture. 

(3) The first calendar year in which 

the payment is administratively 

practicable. 

(B) The service recipient’s termination 

and liquidation of the plan pursuant to 

irrevocable action taken by the service 

recipient within the 30 days preceding 

or the 12 months following a change in 

control event (as defined in paragraph 

(i)(5) of this section), provided that this 

paragraph will only apply to a payment 

under a plan if all agreements, methods, 

programs, and other arrangements 

sponsored by the service recipient 

immediately after the time of the change 

in control event with respect to which 

deferrals of compensation are treated as 

having been deferred under a single 

plan under § 1.409A–1(c)(2) are 

terminated and liquidated with respect 

to each participant that experienced the 

change in control event, so that under 

the terms of the termination and 

liquidation all such participants are 

required to receive all amounts of 

compensation deferred under the 

terminated agreements, methods, 

programs, and other arrangements 

within 12 months of the date the service 

recipient irrevocably takes all necessary 

action to terminate and liquidate the 

agreements, methods, programs, and 

other arrangements. Solely for purposes 

of this paragraph (j)(4)(ix)(B), where the 

change in control event results from an 

asset purchase transaction, the 

applicable service recipient with the 

discretion to liquidate and terminate the 

agreements, methods, programs, and 

other arrangements is the service 

recipient that is primarily liable 

immediately after the transaction for the 

payment of the deferred compensation. 

(C) The service recipient’s termination 

and liquidation of the plan, provided 

that—

(1) The termination and liquidation 

does not occur proximate to a downturn 

in the financial health of the service 

recipient; 

(2) The service recipient terminates 

and liquidates all agreements, methods, 

programs, and other arrangements 

sponsored by the service recipient that 

would be aggregated with any 

terminated and liquidated agreements, 

methods, programs, and other 

arrangements under § 1.409A–1(c) if the 

same service provider had deferrals of 

compensation under all of the 

agreements, methods, programs, and 

other arrangements that are terminated 

and liquidated; 

(3) No payments in liquidation of the 

plan are made within 12 months of the 

date the service recipient takes all 

necessary action to irrevocably 

terminate and liquidate the plan other 

than payments that would be payable 

under the terms of the plan if the action 

to terminate and liquidate the plan had 

not occurred; 

(4) All payments are made within 24 

months of the date the service recipient 

takes all necessary action to irrevocably 

terminate and liquidate the plan; and 

(5) The service recipient does not 

adopt a new plan that would be 

aggregated with any terminated and 

liquidated plan under § 1.409A–1(c) if 

the same service provider participated 


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Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 19321 

in both plans, at any time within three 

years following the date the service 

recipient takes all necessary action to 

irrevocably terminate and liquidate the 

plan. 

(D) Such other events and conditions 

as the Commissioner may prescribe in 

generally applicable guidance published 

in the Internal Revenue Bulletin (see 

§ 601.601(d)(2) of this chapter). 

(x) Certain distributions to avoid a 

nonallocation year under section 409(p). 

A plan may provide for an acceleration 

of the time and form of a payment, or 

a payment may be made under such 

plan, to prevent the occurrence of a 

nonallocation year (within the meaning 

of section 409(p)(3)) in the plan year of 

an employee stock ownership plan next 

following the plan year in which such 

payment is made, provided that the 

amount distributed may not exceed 125 

percent of the minimum amount of 

distribution necessary to avoid the 

occurrence of a nonallocation year. 

Solely for purposes of determining 

permissible distributions under this 

paragraph (j)(4)(x), synthetic equity 

(within the meaning of section 

409(p)(6)(C) and § 1.409(p)–1(f)) granted 

during the plan year of the employee 

stock ownership plan in which such 

payment is made is disregarded for 

purposes of determining whether the 

subsequent plan year would result in a 

nonallocation year. 

(xi) Payment of state, local, or foreign 

taxes. A plan may provide for an 

acceleration of the time and form of a 

payment, or a payment may be made 

under such plan, to reflect payment of 

state, local, or foreign tax obligations 

arising from participation in the plan 

that apply to an amount deferred under 

the plan before the amount is paid or 

made available to the participant (the 

state, local, or foreign tax amount). Such 

payment may not exceed the amount of 

such taxes due as a result of 

participation in the plan. Such payment 

may be made by distributions to the 

participant in the form of withholding 

pursuant to provisions of applicable 

state, local, or foreign law or by 

distribution directly to the participant. 

Additionally, an arrangement may 

provide for the acceleration of the time 

or schedule of payment, or a payment 

may be made under such arrangement, 

to pay the income tax at source on 

wages imposed under section 3401 as a 

result of such payment and to pay the 

additional income tax at source on 

wages imposed under section 3401 

attributable to such additional section 

3401 wages and taxes. However, the 

total payment under this acceleration 

provision must not exceed the aggregate 

of the state, local, and foreign tax 

amount, and the income tax 

withholding related to such state, local, 

and foreign tax amount. 

(xii) Cancellation of deferral elections 

due to disability. A plan may provide 

for a cancellation of a service provider’s 

deferral election, or a cancellation of 

such election may be made, where such 

cancellation occurs by the later of the 

end of the taxable year of the service 

provider or the 15th day of the third 

month following the date the service 

provider incurs a disability. For 

purposes of this paragraph, a disability 

refers to any medically determinable 

physical or mental impairment resulting 

in the service provider’s inability to 

perform the duties of his or her position 

or any substantially similar position, 

where such impairment can be expected 

to result in death or can be expected to 

last for a continuous period of not less 

than six months. 

(xiii) Certain offsets. A plan may 

provide for the acceleration of the time 

or schedule of a payment, or a payment 

may be made under such plan, as 

satisfaction of a debt of the service 

provider to the service recipient, where 

such debt is incurred in the ordinary 

course of the service relationship 

between the service recipient and the 

service provider, the entire amount of 

reduction in any of the service 

recipient’s taxable years does not exceed 

$5,000, and the reduction is made at the 

same time and in the same amount as 

the debt otherwise would have been due 

and collected from the service provider. 

(xiv) Bona fide disputes as to a right 

to a payment. A plan may provide for 

the acceleration of the time or schedule 

of one or more payments, or a payment 

may be made under such plan, where 

such payments occur as part of a 

settlement between the service provider 

and the service recipient of an arm’s 

length, bona fide dispute as to the 

service provider’s right to the deferred 

amount. Discretion to accelerate 

payments, other than due to an arm’s 

length settlement of a bona fide dispute 

as to the service provider’s right to the 

deferred amount, is not permitted under 

this paragraph (j)(4)(xiv). Whether a 

payment qualifies for the exception 

under this paragraph is based on all 

relevant facts and circumstances. A 

payment will be presumed not to meet 

this exception unless the payment is 

subject to a substantial reduction in the 

value of the payment made in relation 

to the amount that would have been 

payable had there been no dispute as to 

the service provider’s right to the 

payment. For this purpose, a reduction 

that is less than 25 percent of the 

present value of the deferred amount in 

dispute generally is not a substantial 

reduction. In addition, a payment will 

be presumed not to meet this exception 

if the payment is made proximate to a 

downturn in the financial health of the 

service recipient. 

(5) Nonqualified deferred 

compensation plans linked to qualified 

employer plans or certain other 

arrangements. If a nonqualified deferred 

compensation plan provides that the 

amount deferred under the plan is the 

amount determined under the formula 

determining benefits under a qualified 

employer plan (as defined in § 1.409A–

1(a)(2)), or a broad-based foreign 

retirement plan (as defined in § 1.409A–

1(a)(3)(v)) maintained by the service 

recipient but applied without regard to 

one or more limitations applicable to 

the qualified employer plan under the 

Internal Revenue Code or to the broadbased foreign retirement plan under 

other applicable law, or that the amount 

deferred under the nonqualified 

deferred compensation plan is 

determined as an amount offset by some 

or all of the benefits provided under the 

qualified employer plan or broad-based 

foreign retirement plan, a decrease in 

amounts deferred under the 

nonqualified deferred compensation 

plan that results directly from changes 

in benefit limitations applicable to the 

qualified employer plan or the broadbased foreign retirement plan under the 

Internal Revenue Code or other 

applicable law does not constitute an 

acceleration of a payment under the 

nonqualified deferred compensation 

plan, provided that such operation does 

not otherwise result in a change in the 

time or form of a payment under the 

nonqualified deferred compensation 

plan, and provided further that the 

change in the amounts deferred under 

the nonqualified deferred compensation 

plan does not exceed such change in the 

amounts deferred under the qualified 

employer plan or the broad-based 

foreign retirement plan, as applicable. In 

addition, with respect to such a 

nonqualified deferred compensation 

plan, the following actions or failures to 

act will not constitute an acceleration of 

a payment under the nonqualified 

deferred compensation plan even if in 

accordance with the terms of the 

nonqualified deferred compensation 

plan, the actions or inactions result in 

a decrease in the amounts deferred 

under the plan, provided that such 

actions or inactions do not otherwise 

affect the time or form of payment under 

the nonqualified deferred compensation 

plan, and provided further that with 

respect to actions or inactions described 

in paragraphs (j)(5)(i) and (ii) of this 

section, the change in the amount 


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deferred under the nonqualified 

deferred compensation plan does not 

exceed the change in the amounts 

deferred under the qualified employer 

plan or the broad-based foreign 

retirement plan, as applicable: 

(i) A service provider’s action or 

inaction under the qualified employer 

plan or broad-based foreign retirement 

plan with respect to whether to elect to 

receive a subsidized benefit or an 

ancillary benefit under the qualified 

employer plan or broad-based foreign 

retirement plan. 

(ii) The amendment of a qualified 

employer plan or broad-based foreign 

retirement plan to increase benefits 

provided under such plan, or to add or 

remove a subsidized benefit or an 

ancillary benefit. 

(iii) A service provider’s action or 

inaction under a qualified employer 

plan with respect to elective deferrals 

and other employee pre-tax 

contributions subject to the contribution 

restrictions under section 401(a)(30) or 

section 402(g), including an adjustment 

to a deferral election under such 

qualified employer plan, provided that 

for any given taxable year, the service 

provider’s action or inaction does not 

result in a decrease in the amounts 

deferred under all nonqualified deferred 

compensation plans in which the 

service provider participates (other than 

amounts described in paragraph 

(j)(5)(iv) of this section) in excess of the 

limit with respect to elective deferrals 

under section 402(g)(1)(A), (B), and (C) 

in effect for the taxable year in which 

such action or inaction occurs. 

(iv) A service provider’s action or 

inaction under a qualified employer 

plan with respect to elective deferrals 

and other employee pre-tax 

contributions subject to the 

contributions restrictions under section 

401(a)(30) or section 402(g), and aftertax contributions by the service provider 

to a qualified employer plan that 

provides for such contributions that 

affects the amounts that are credited 

under one or more nonqualified 

deferred compensation plans as 

matching amounts or other similar 

amounts contingent on such elective 

deferrals, pre-tax contributions, or aftertax contributions, provided that the total 

of such matching or contingent 

amounts, as applicable, never exceeds 

100 percent of the matching or 

contingent amounts that would be 

provided under the qualified employer 

plan absent any plan-based restrictions 

that reflect limits on qualified plan 

contributions under the Internal 

Revenue Code. 

(6) Changes in elections under a 

cafeteria plan. A change in an election 

under a cafeteria plan (as defined in 

section 125(d)) does not result in an 

accelerated payment of an amount 

deferred under a nonqualified deferred 

compensation plan to the extent that the 

change in the amount deferred under 

the nonqualified deferred compensation 

plan results solely from the application 

of the change in amount eligible to be 

treated as compensation under the terms 

of the nonqualified deferred 

compensation plan resulting from the 

election change under the cafeteria plan, 

to a benefit formula under the 

nonqualified deferred compensation 

plan based upon the service provider’s 

eligible compensation, and only to the 

extent that such change applies in the 

same manner as any other increase or 

decrease in compensation would apply 

to such benefit formula. 

§ 1.409A–4 Calculation of income 

inclusion [Reserved] 

§ 1.409A–5 Funding [Reserved] 

§ 1.409A–6 Application of section 409A 

and effective dates. 

(a) Statutory application and effective 

dates—(1) Application to amounts 

deferred—(i) In general. Except as 

otherwise provided in this section, 

section 409A applies with respect to 

amounts deferred in taxable years 

beginning after December 31, 2004, and 

with respect to amounts deferred in 

taxable years beginning before January 

1, 2005, if the plan under which the 

deferral is made is materially modified 

after October 3, 2004. For amounts 

deferred in taxable years beginning 

before January 1, 2005, under a plan that 

is materially modified after October 3, 

2004, whether the plan complies with 

the requirements of section 409A and 

these regulations is determined by 

reference to the terms of the plan in 

effect as of, and any actions taken under 

the plan on or after, the date of the 

material modification. Section 409A is 

applicable with respect to earnings on 

amounts deferred only to the extent that 

section 409A is applicable with respect 

to the amounts deferred. Accordingly, 

section 409A does not apply with 

respect to earnings on amounts deferred 

before January 1, 2005, unless section 

409A applies with respect to the 

amounts deferred. For this purpose, a 

right to earnings that is subject to a 

substantial risk of forfeiture (as defined 

in § 1.83–3(c)) or a requirement to 

perform further services, on an amount 

deferred that is not subject to a 

substantial risk of forfeiture (as defined 

in § 1.83–3(c)) or a requirement to 

perform further services, is not treated 

as earnings on the amount deferred, but 

a separate right to compensation. Except 

as otherwise provided in applicable 

guidance (see § 601.601(d)(2) of this 

chapter), the provisions of §§ 1.409A–1 

through 1.409A–5 and this section 

provide the exclusive means of 

identifying agreements, methods, 

programs, or other arrangements subject 

to section 409A, and the exclusive 

means of satisfying the requirements of 

section 409A with respect to such 

agreements, methods, programs, or other 

arrangements. 

(ii) Collectively bargained plans. 

Section 409A does not apply with 

respect to amounts deferred under a 

plan maintained pursuant to one or 

more bona fide collective bargaining 

agreements in effect on October 3, 2004, 

for the period ending on the earlier of 

the date on which the last of such 

collective bargaining agreements 

terminates (determined without regard 

to any extension thereof after October 3, 

2004) or December 31, 2009. 

(2) Identification of date of deferral 

for statutory effective date purposes. For 

purposes of determining whether 

section 409A is applicable with respect 

to an amount, the amount is considered 

deferred before January 1, 2005, if before 

January 1, 2005, the service provider 

had a legally binding right to be paid the 

amount, and the right to the amount was 

earned and vested. For purposes of this 

paragraph (a)(2), a right to an amount 

was earned and vested only if the 

amount was not subject to a substantial 

risk of forfeiture (as defined in § 1.83–

3(c)) or a requirement to perform further 

services. Amounts to which the service 

provider did not have a legally binding 

right before January 1, 2005 (for 

example, because the service recipient 

retained discretion to reduce the 

amount), will not be considered 

deferred before January 1, 2005. In 

addition, amounts to which the service 

provider had a legally binding right 

before January 1, 2005, but the right to 

which was subject to a substantial risk 

of forfeiture or a requirement to perform 

further services after December 31, 

2004, are not considered deferred before 

January 1, 2005, for purposes of the 

effective date. Notwithstanding the 

foregoing, an amount to which the 

service provider had a legally binding 

right before January 1, 2005, but for 

which the service provider was required 

to continue performing services to retain 

the right only through the completion of 

the payroll period (as defined in 

§ 1.409A–1(b)(3)) that includes 

December 31, 2004, is not treated as 

subject to a requirement to perform 

further services (or a substantial risk of 

forfeiture) for purposes of the effective 

date. For purposes of this paragraph 

(a)(2), a stock option, stock appreciation 


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right, or similar compensation that on or 

before December 31, 2004, was 

immediately exercisable for cash or 

substantially vested property (as defined 

in § 1.83–3(b)) is treated as earned and 

vested, regardless of whether the right 

would terminate if the service provider 

ceased providing services for the service 

recipient. 

(3) Calculation of amount of 

compensation deferred for statutory 

effective date purposes—(i) Nonaccount 

balance plans. The amount of 

compensation deferred before January 1, 

2005, under a nonqualified deferred 

compensation plan that is a nonaccount 

balance plan (as defined in § 1.409A–

1(c)(2)(i)(C)), equals the present value of 

the amount to which the service 

provider would have been entitled 

under the plan if the service provider 

voluntarily terminated services without 

cause on December 31, 2004, and 

received a payment of the benefits 

available from the plan on the earliest 

possible date allowed under the plan to 

receive a payment of benefits following 

the termination of services, and receive 

the benefits in the form with the 

maximum value. Notwithstanding the 

foregoing, for any subsequent taxable 

year of the service provider, the 

grandfathered amount may increase to 

equal the present value of the benefit 

the service provider actually becomes 

entitled to, in the form and at the time 

actually paid, determined under the 

terms of the plan (including applicable 

limits under the Internal Revenue 

Code), as in effect on October 3, 2004, 

without regard to any further services 

rendered by the service provider after 

December 31, 2004, or any other events 

affecting the amount of or the 

entitlement to benefits (other than a 

participant election with respect to the 

time or form of an available benefit). For 

purposes of calculating the present 

value of a benefit under this paragraph 

(c)(3)(i), reasonable actuarial 

assumptions and methods must be used. 

Whether assumptions and methods are 

reasonable for this purpose is 

determined as of each date the benefit 

is valued for purposes of determining 

the grandfathered benefit, provided that 

any reasonable actuarial assumptions 

and methods that were used by the 

service recipient with respect to such 

benefit as of December 31, 2004, will 

continue to be treated as reasonable 

assumptions and methods for purposes 

of calculating the grandfathered benefit. 

Actuarial assumptions and methods will 

be presumed reasonable if they are the 

same as those used to value benefits 

under a qualified plan sponsored by the 

service recipient the benefits under 

which are part of the benefit formula 

under, or otherwise impact the amount 

of benefits under, the nonaccount 

balance nonqualified deferred 

compensation plan. 

(ii) Account balance plans. The 

amount of compensation deferred before 

January 1, 2005, under a nonqualified 

deferred compensation plan that is an 

account balance plan (as defined in 

§ 1.409A–1(c)(2)(i)(A)), equals the 

portion of the service provider’s account 

balance as of December 31, 2004, the 

right to which is earned and vested (as 

defined in paragraph (a)(2) of this 

section) as of December 31, 2004, plus 

any future contributions to the account, 

the right to which was earned and 

vested (as defined in paragraph (a)(2) of 

this section) as of December 31, 2004, to 

the extent such contributions are 

actually made. 

(iii) Equity-based compensation 

plans. For purposes of determining the 

amounts deferred before January 1, 

2005, under an equity-based 

compensation plan, the rules of 

paragraph (a)(3)(ii) of this section 

governing account balance plans are 

applied except that the account balance 

is deemed to be the amount of the 

payment available to the service 

provider on December 31, 2004 (or that 

would be available to the service 

provider if the right were immediately 

exercisable) the right to which is earned 

and vested (as defined in paragraph 

(a)(2) of this section) as of December 31, 

2004. For this purpose, the payment 

available to the service provider 

excludes any exercise price or other 

amount that must be paid by the service 

provider. 

(iv) Earnings. Earnings on amounts 

deferred under a plan before January 1, 

2005, include only income (whether 

actual or notional) attributable to the 

amounts deferred under a plan as of 

December 31, 2004, or to such income. 

For example, notional interest earned 

under the plan on amounts deferred in 

an account balance plan as of December 

31, 2004, generally will be treated as 

earnings on amounts deferred under the 

plan before January 1, 2005. Similarly, 

an increase in the amount of payment 

available pursuant to a stock option, 

stock appreciation right, or other equitybased compensation above the amount 

of payment available as of December 31, 

2004, due to appreciation in the 

underlying stock after December 31, 

2004, or accrual of other earnings such 

as dividends, is treated as earnings on 

the amount deferred. In the case of a 

nonaccount balance plan, earnings 

include the increase, due solely to the 

passage of time, in the present value of 

the future payments to which the 

service provider has obtained a legally 

binding right, the present value of 

which constituted the amounts deferred 

under the plan before January 1, 2005. 

Thus, for each year, there will be an 

increase (determined using the same 

interest rate used to determine the 

amounts deferred under the plan before 

January 1, 2005) resulting from the 

shortening of the discount period before 

the future payments are made, plus, if 

applicable, an increase in the present 

value resulting from the service 

provider’s survivorship during the year. 

However, an increase in the potential 

benefits under a nonaccount balance 

plan due to, for example, an application 

of an increase in compensation after 

December 31, 2004, to a final average 

pay plan or subsequent eligibility for an 

early retirement subsidy, does not 

constitute earnings on the amounts 

deferred under the plan before January 

1, 2005. 

(v) Definition of plan. For purposes of 

paragraphs (a)(1), (2), and (3) of this 

section, the term ‘‘plan’’ has the 

meaning provided in § 1.409A–1(c), 

except that the plan aggregation rules do 

not apply for purposes of the actuarial 

assumptions and methods used in 

paragraph (a)(3)(i) of this section. 

Accordingly, different reasonable 

actuarial assumptions and methods may 

be used to calculate the amounts 

deferred by a service provider in two 

different agreements, methods, 

programs, or other arrangements each of 

which constitutes a nonaccount balance 

plan. 

(4) Material modifications—(i) In 

general. Except as otherwise provided, a 

modification of a plan is a material 

modification if a benefit or right existing 

as of October 3, 2004, is materially 

enhanced or a new material benefit or 

right is added, and such material 

enhancement or addition affects 

amounts earned and vested before 

January 1, 2005. Such material benefit 

enhancement or addition is a material 

modification whether it occurs pursuant 

to an amendment or to the service 

recipient’s exercise of discretion under 

the terms of the plan. For example, an 

amendment to a plan to add a provision 

that payments of deferred amounts 

earned and vested before January 1, 

2005, may be allowed upon request if 

service providers are required to forfeit 

20 percent of the amount of the payment 

(a haircut) would be a material 

modification to the plan. Similarly, a 

material modification would occur if a 

service recipient exercised discretion to 

accelerate vesting of a benefit under the 

plan to a date on or before December 31, 

2004. However, it is not a material 

modification for a service recipient to 


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exercise discretion over the time and 

manner of payment of a benefit to the 

extent such discretion is provided under 

the terms of the plan as of October 3, 

2004. It is not a material modification 

for a service provider to exercise a right 

permitted under the plan as in effect on 

October 3, 2004. The amendment of a 

plan to bring the plan into compliance 

with the provisions of section 409A will 

not be treated as a material 

modification. However, a plan 

amendment or the exercise of discretion 

under the terms of the plan that 

materially enhances an existing benefit 

or right or adds a new material benefit 

or right will be considered a material 

modification even if the enhanced or 

added benefit would be permitted under 

section 409A. For example, the addition 

of a right to a payment upon an 

unforeseeable emergency of an amount 

earned and vested before January 1, 

2005, would be considered a material 

modification. The reduction of an 

existing benefit is not a material 

modification. For example, the removal 

of a haircut provision generally would 

not constitute a material modification. 

The following modifications also are not 

material modifications for purposes of 

this paragraph (a)(4)(i): 

(A) The establishment of or 

contributions to a trust or other 

arrangement from which benefits under 

the plan are to be paid is not a material 

modification of the plan, provided that 

the contribution to the trust or other 

arrangement would not otherwise cause 

an amount to be includible in the 

service provider’s gross income. 

(B) The modification of a provision 

requiring the immediate cancellation of 

a current deferral election, to require the 

cancellation of deferrals for the same 

length of time beginning with the first 

date at which the application of such 

cancellation would not violate section 

409A (for example, the first date of the 

service provider’s first taxable year 

following the cancellation). 

(C) Compliance with a domestic 

relations order (as defined in § 1.409A–

3(j)(4)(ii)) with respect to payments to 

an individual other than the service 

provider, or an amendment to a plan to 

require compliance with a domestic 

relations order with respect to payments 

to an individual other than the service 

provider. 

(D) The modification of a plan 

providing a life annuity form of 

payment to permit an election between 

the existing life annuity form of 

payment and other forms of annuity 

payments that would be treated as a 

single form of payment with the existing 

life annuity form of payment under 

§ 1.409A–2(b)(2)(ii). 

(E) The modification of a 

grandfathered plan to add a limited 

cashout feature consistent with 

§ 1.409A–3(j)(4)(v) (exception to 

prohibition on accelerated payments). 

(ii) Adoptions of new plans. It is 

presumed that the adoption of a new 

plan or the grant of an additional benefit 

under an existing plan after October 3, 

2004, and before January 1, 2005, 

constitutes a material modification of a 

plan. However, the presumption may be 

rebutted by demonstrating that the 

adoption of the plan or grant of the 

additional benefit was consistent with 

the service recipient’s historical 

compensation practices. For example, 

the presumption that the grant of a 

discounted stock option on November 1, 

2004, is a material modification of a 

plan may be rebutted by demonstrating 

that the grant was consistent with the 

historic practice of granting 

substantially similar discounted stock 

options (both as to terms and amounts) 

each November for a significant number 

of years. Notwithstanding paragraph 

(a)(4)(i) of this section and this 

paragraph (a)(4)(ii), the grant of an 

additional benefit under an existing 

plan that consists of a deferral of 

additional compensation not otherwise 

provided under the plan as of October 

3, 2004, will be treated as a material 

modification of the plan only as to the 

additional deferral of compensation, if 

the plan explicitly identifies the 

additional deferral of compensation and 

provides that the additional deferral of 

compensation is subject to section 

409A. Accordingly, amendments to 

conform a plan to the requirements of 

section 409A with respect to deferrals 

under a plan occurring after December 

31, 2004, will not constitute a material 

modification of the plan with respect to 

amounts deferred that are earned and 

vested on or before December 31, 2004, 

provided that there is no concurrent 

material modification with respect to 

the amount of, or rights to, amounts 

deferred that were earned and vested on 

or before December 31, 2004. Similarly, 

a grant of an additional benefit under a 

new plan adopted after October 3, 2004, 

and before January 1, 2005, will not be 

treated as a material modification of an 

existing plan to the extent that the new 

plan explicitly identifies additional 

deferrals of compensation and provides 

that the additional deferrals of 

compensation are subject to section 

409A. 

(iii) Suspension or termination of a 

plan. A cessation of deferrals under, or 

termination of, a plan, pursuant to the 

provisions of such plan, is not a 

material modification. Amending a plan 

to provide participants an election 

whether to terminate participation in a 

plan generally constitutes a material 

modification of the plan. 

(iv) Changes to investment 

measures—account balance plans. With 

respect to an account balance plan (as 

defined in § 1.409A–1(c)(2)(i)(A)), it is 

not a material modification to change a 

notional investment measure, or to add 

to an existing investment measure, to an 

investment measure that qualifies as a 

predetermined actual investment within 

the meaning of § 31.3121(v)(2)–1(d)(2) of 

this chapter or, for any given taxable 

year, reflects a reasonable rate of interest 

(determined in accordance with 

§ 31.3121(v)(2)–1(d)(2)(i)(C) of this 

chapter). For this purpose, if with 

respect to an amount deferred for a 

period, a plan provides for a fixed rate 

of interest to be credited, and the rate is 

to be reset under the plan at a specified 

future date that is not later than the end 

of the fifth taxable year that begins after 

the beginning of the period, the rate is 

reasonable at the beginning of the 

period, and the rate is not changed 

before the reset date, then the rate will 

be treated as reasonable in all future 

periods before the reset date. 

(v) Stock rights. The modification, 

extension, or renewal of a stock right 

will not constitute a material 

modification of the stock right, if the 

modification, extension, or renewal 

would not be treated as the grant of a 

new stock right under § 1.409A–

1(b)(5)(v)(A), and would not result in 

the stock right being treated as having 

had a deferral feature from the date of 

grant pursuant to § 1.409A–1(b)(5)(v)(C). 

(vi) Rescission of modifications. Any 

modification to the terms of a plan that 

would inadvertently result in treatment 

as a material modification under this 

section is not considered a material 

modification of the plan to the extent 

the modification in the terms of the plan 

is rescinded by the earlier of a date 

before the right is exercised (if the 

change grants a discretionary right) or 

the last day of the taxable year of the 

service provider during which such 

change occurred. Thus, for example, if 

a service recipient modifies the terms of 

a plan on March 1 to allow an 

individual employee to elect a new 

change in the time or form of payment 

without realizing that such a change 

constituted a material modification that 

would subject the plan to the 

requirements of section 409A, and the 

modification is rescinded on November 

1, then if no change in the time or form 

of payment has been made pursuant to 

the modification before November 1, the 

plan is not considered materially 

modified under this section. 


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Federal Register / Vol. 72, No. 73 / Tuesday, April 17, 2007 / Rules and Regulations 19325 

(vii) Definition of plan. For purposes 

of this paragraph (a)(4), the term ‘‘plan’’

has the same meaning provided in 

§ 1.409A–1(c), except that the plan 

aggregation rules of § 1.409A–1(c)(2) do 

not apply. 

(b) Regulatory applicability date. 

§ 1.409A–1, § 1.409A–2, § 1.409A–3 and 

this section are applicable for taxable 

years beginning on or after January 1, 

2008. 

Kevin M. Brown, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: March 20, 2007. 

Eric Solomon, 

Assistant Secretary of the Treasury. 

[FR Doc. 07–1820 Filed 4–10–07; 8:45 am] 

BILLING CODE 4830–01–P 


sroberts on PROD1PC70 with RULES