Have or Want a Bonus Plan?

Ensure It Complies with IRS Tax Code or Face Hefty Fines

The Internal Revenue Service (“IRS”) recently ruled that an employee’s bonus plan violated Section 409A of the tax code (“409A”), even though the errors in the bonus plan were corrected before the employee earned the bonus. What does this mean for you and your company?
There are two important lessons to be learned from this ruling.

1) First, a bonus plan that violates 409A results in income inclusion plus a 20 percent excise tax penalty as soon as the right to payments under the bonus plan become vested.

2) Second, you may be able to correct 409A errors before they affect you.

409A generally governs the tax treatment of money that people earn in one year, but that is paid in a future year. For example, a bonus plan may provide that an employee will be paid $10,000 at retirement if the employee remains employed by the company for the next five years. After five years of employment, the employee will have earned the bonus. However, the bonus will not be paid until the employee retires.