409A Compliance Severance Agreement

When it comes to corporate compliance, one area that is often overlooked is the severance agreement. Specifically, companies need to be aware of the requirements for 409A compliance in their severance agreements.

What is 409A?

Section 409A of the Internal Revenue Code (IRC) was added in 2004 to regulate nonqualified deferred compensation (NQDC) plans offered by employers to their employees. The purpose of 409A is to ensure that employees participating in NQDC plans are not able to manipulate the timing or form of their compensation in order to receive tax benefits.

What is a severance agreement?

A severance agreement is a contract between an employer and an employee that provides for the payment of certain benefits, such as salary continuation or health insurance, in the event that the employee`s employment is terminated.

Why is 409A compliance important in severance agreements?

If a severance agreement provides for the payment of NQDC, it must comply with the rules of 409A. Failure to comply with these rules can result in severe tax consequences for both the employer and the employee.

What are the requirements for 409A compliance in severance agreements?

Severance agreements that provide for NQDC must meet several requirements in order to be 409A compliant. These include:

1. The benefits provided under the agreement must be paid at a specified time or according to a fixed schedule.

2. The amount of the benefits must be fixed at the time the agreement is entered into, and cannot be subject to discretion or further negotiation.

3. The benefits cannot be paid earlier than the date on which the employee`s employment is terminated, except under certain limited circumstances.

4. The payment of benefits cannot be accelerated or delayed based on the employee`s actions or performance.

5. The agreement cannot be amended or modified in a way that would violate 409A.

What are the consequences of non-compliance?

If a severance agreement fails to comply with the rules of 409A, the employee will be subject to immediate taxation on the unvested benefits, as well as a 20% penalty tax and interest. In addition, the employer may be subject to penalties and additional taxes.


When drafting severance agreements, it is important for employers to be aware of the requirements for 409A compliance in order to avoid potential tax consequences. By following these rules, employers can ensure that their employees receive the benefits they are entitled to, while also avoiding unnecessary tax liabilities.