Employment agreements must be amended to include “release timing” language by the end of 2012

Employment agreements typically require a terminated employee to sign and return a release of legal claims after termination before the employee is eligible to receive a severance payment. Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”) prevents parties to such agreements from delaying execution of an Agreement in order to defer severance to later tax years. Violations of Section 409A subject the employee to immediate taxation on the deferred amount, plus interest and a 20% penalty.

In 2010 the IRS established a limited window during which taxpayers may correct deficient release timing language, if the employment or severance agreements were entered into prior to January 1, 2011. IRS Notice 2010-80 (modifying IRS Notices 2010-6, 2008-113). Bringing deficient Agreements into compliance before the end of 2012 generally requires amending the Agreement to remove the employee’s power to delay or accelerate the timing of the payment.

  • If the employment/severance contract promises payment following the return of a signed Agreement, the employment/severance contract should be amended to specify payment will occur (i) only upon a fixed date either 60 or 90 days following the occurrence of a “permissible payment event” (as specified in Section 409A, such as separation from service), or (ii) for payment during a specified period not longer than 90 days following the occurrence of the permissible payment event (and in the second taxable year, if the specified period begins in one taxable year and ends in the next).
  • If the employment/severance contract promises payment following the return of a signed Agreement and within a designated period, and the employee’s action could affect the tax year of such payment, then the employment/severance contract must be amended to provide for payment (i) only on the last day of such designated period, or (ii) in the second taxable year.

Notice 2010-80 also aids some employers who have already made payments under deficient employment/severance contracts (under methods outlined in Notices 2010-80 and Notice 2008-113). Starting January 1, 2013, however, repairing even non-paid deficient employment/severance contracts would likely involve the IRS’s approval and may expose the parties to additional fees.

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Roger Royse
rroyse@rroyselaw.com

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City. Read My Full Bio

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