A recent Memorandum issued by the Office of Chief Counsel within the Internal Revenue Service demonstrates yet again the perils of failing to comply with Section 409A of the Internal Revenue Code. The Memorandum takes the position that Section 409A penalties may apply even when a non-complying provision in a deferred compensation arrangement is corrected before the amounts subject to deferral become substantially vested.

Background -

A company entered into a retention agreement with one of its executives. The agreement provided for the executive to vest in his right to a retention bonus if he remained continuously employed until the third anniversary of the execution date of the agreement. The bonus was to be paid in two equal installments on the first and second anniversaries of the vesting date.