In a positive development for employees, California recently reduced its excise tax rate for failures to comply with the California analog to Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”). California Assembly Bill 1173, which was signed into law on October 4, 2013, provides that, for taxable years beginning January 1, 2013, the excise tax rate imposed by California for non-compliance with California’s equivalent of Section 409A has been reduced from 20% to 5%.

Section 409A governs nonqualified deferred compensation plans. In general, a nonqualified deferred compensation plan is an arrangement that provides for the payment of compensation in a year later than the year in which the compensation was earned. Specifically excluded from the definition of nonqualified deferred compensation plans, and therefore not subject to Section 409A, are tax-qualified retirement plans, such as 401(k) plans, and bona fide vacation leave, sick leave, compensatory time, disability pay, and death benefit plans. Plans, agreements, and arrangements that could provide for payments that are subject to Section 409A include employment agreements, severance agreements, change in control agreements, other compensation agreements providing for deferred payments, discounted stock options, and other phantom equity arrangements, such as restricted stock units. If a nonqualified deferred compensation plan does not comply with Section 409A, individuals eligible to receive payments under the plan may be subject to federal and state income tax before compensation under the plan is paid (with punitive interest imposed if the individual does not correctly recognize the compensation and pay the related income tax), and the individual will be subject to an additional 20% Section 409A federal excise tax.