December 9, 2008
An Observation on Section 409A: Self-Correction of Amounts Prematurely Paid to “Specified Employees”
– Tahir J. Naim, Fenwick West
In going through Notice 2008-113 over the weekend, I found myself working out the effect of correction in the same year of a payment of deferred compensation made to a “specified employee” prior to the end of the 6-month delay as follows:
Under Section IV.B.2(b) (p.16) the employee is to repay the “amount that was erroneously paid….”
Under Section III.E (pg. 6) the “amount erroneously paid” is defined as the “gross amount paid…before…any withholding….”
Thus, it appears that if an employee in California receives approximately $65,000, net of federal and state income and employment tax withholding (at the minimum required rate and assuming any applicable wage base for employment taxes has already been exceeeded) of a $100,000 gross payment, the employee must pay back $100,000. While the employee will eventually receive $100,000 back from the employer, there is the obvious loss of use of the additional money during the time until repayment can occur, not to mention any transaction costs associated with raising the additional sum.
It also appears that while the employer can make an adjustment for employment taxes withheld under Sec. 6413 (pg. 17) the same is not to be true of withheld income taxes. Thus, part of the tradeoff for avoidance of the 409A taxes may be early payment of the income tax to be withheld.