Section 409A issue map: where nonqualified deferred compensation fails

Reviewed 2026-09-15 · AI-assisted draft and editing; sources and limitations remain visible for independent review.

Answer: Most section 409A problems are found faster by working through gates in order than by reading a plan front to back. Section 409A(d)(1) defines a nonqualified deferred compensation plan broadly as any plan providing for the deferral of compensation, excluding qualified employer plans and certain bona fide leave, disability and death benefit arrangements, and Reg. 1.409A-1(b)(4) carves out short-term deferrals paid within the applicable two and a half month period. If an arrangement survives those, four operative requirements follow: initial deferral elections generally had to be made by the close of the preceding taxable year, payment may be made only on the events listed in Reg. 1.409A-3(a), payment to a specified employee on separation from service must be delayed six months, and acceleration is prohibited except as the regulations allow. Failure is expensive and it lands on the wrong person: section 409A(a)(1) includes the deferred compensation in the service provider's gross income to the extent it is not subject to a substantial risk of forfeiture and not previously included, and adds interest at the underpayment rate plus one percentage point together with an amount equal to 20 percent of the includible compensation. Two IRS notices provide correction routes, and they are split along the documentary versus operational line.

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Scope

Jurisdiction: United States — federal

Tax periods: Amounts deferred after 2004, 26 CFR revised as of April 1, 2025, Notices 2008-113, 2010-6 and 2010-80

Assumptions

• The arrangement provides compensation to a service provider that may be paid in a year later than the year in which the legally binding right to it arose.
• The service recipient is a taxable entity, so the separate rules for certain tax-exempt and governmental arrangements are not the operative ones.
• The research question is whether a section 409A requirement is met, not how to value or account for the deferred amount.

Exclusions

• State and local tax treatment, including any state provision that mirrors section 409A.
• Section 457(f) and the rules for tax-exempt and governmental employers.
• Section 457A and nonqualified deferred compensation from certain foreign entities.
• Employment tax timing under section 3121(v)(2) and information reporting mechanics.
• A conclusion about whether any specific plan, amendment or payment complies.

1. Gate one: is there a deferral of compensation at all

Section 409A(d)(1) treats as a nonqualified deferred compensation plan any plan that provides for the deferral of compensation, other than a qualified employer plan and other than a bona fide vacation leave, sick leave, compensatory time, disability pay or death benefit plan. The breadth is the point: severance arrangements, bonus plans, and individual agreements can fall inside without anyone describing them as deferred compensation.

Reg. 1.409A-1(b)(4)(i) then removes a large category. A deferral of compensation does not occur with respect to a payment that is not a deferred payment if the service provider actually or constructively receives it on or before the last day of the applicable two and a half month period. Under Reg. 1.409A-1(b)(4)(i)(A), that period ends on the later of the fifteenth day of the third month following the end of the service provider's first taxable year in which the right to the payment is no longer subject to a substantial risk of forfeiture, or the fifteenth day of the third month following the end of the service recipient's first such taxable year. The rule is applied separately to each payment.

That makes the definition of the risk load-bearing. Reg. 1.409A-1(d)(1) states that compensation is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial. The same paragraph says that a salary deferral generally may not be made subject to a substantial risk of forfeiture. A vesting condition added to an amount the person already earned rarely does the work people expect it to do.

2. Gate two: was the deferral election made in time

Section 409A(a)(4)(B) sets the baseline that an initial election to defer compensation must be made not later than the close of the preceding taxable year. Two familiar variations sit on top of it. Reg. 1.409A-2(a)(7)(i) allows a service provider who first becomes eligible to participate in a plan to make an initial deferral election within 30 days after becoming eligible, but only with respect to compensation paid for services to be performed after the election. Reg. 1.409A-2(a)(8) provides a separate rule for performance-based compensation as defined in Reg. 1.409A-1(e), and Reg. 1.409A-2(a)(5) addresses certain forfeitable rights where the election is made at least 12 months in advance of the earliest date the forfeiture condition could lapse.

Changes to an existing election are governed separately. Reg. 1.409A-2(b)(1) permits a subsequent deferral election only on conditions that include that the election not take effect until at least 12 months after the date on which it is made, together with the further deferral requirement that section 409A(a)(4)(C) imposes for payments other than those on death, disability or unforeseeable emergency.

In practice this gate is where documents and behavior diverge. The file should record, for each deferral, the date the legally binding right arose, the date of the election, the form the election took, and which of the election rules is being relied on.

3. Gate three: is the payment event on the list

Reg. 1.409A-3(a) states that the requirements of section 409A(a)(2)(A) are met only if the plan provides that deferred compensation may be paid only upon an event or at a time set out in that paragraph: separation from service as defined in Reg. 1.409A-1(h); the service provider becoming disabled; death; a time or fixed schedule specified under the plan; a change in the ownership or effective control of the corporation or in the ownership of a substantial portion of its assets; or the occurrence of an unforeseeable emergency.

Two drafting habits fail here quietly. A plan that says payment will be made as soon as practicable, without an objectively determinable date, and a plan that defines separation from service, change in control or disability in its own words rather than the regulation's, can both be non-compliant on the face of the document even while the arrangement is paying on schedule.

Reg. 1.409A-3(b) allows a designated payment period after a permissible event only on stated conditions, including that the designated period begin and end within one taxable year of the service provider, or that it be no longer than 90 days with the service provider having no right to designate the taxable year of payment.

4. Gate four: the six-month delay

Reg. 1.409A-3(i)(2)(i) provides that for a service provider who is a specified employee as of the date of a separation from service, the rule permitting payment on separation from service is satisfied only if payments may not be made before the date that is six months after the separation, or, if earlier than the end of that six-month period, the date of the specified employee's death.

Who is a specified employee is defined in Reg. 1.409A-1(i)(1): a service provider who, as of the date of separation from service, is a key employee, applying section 416(i)(1)(A)(i), (ii) or (iii) and disregarding section 416(i)(5), of a service recipient any stock of which is publicly traded on an established securities market or otherwise. Reg. 1.409A-1(i)(3) sets a default specified employee identification date of December 31 unless the service recipient designates another date under the conditions in that section.

The practical consequence is that a private company can acquire this requirement on the day its stock becomes publicly traded, for arrangements drafted years earlier. Identify whether the requirement applies before reading the payment timing, not after.

5. Gate five: was payment accelerated

Reg. 1.409A-3(j)(1) states that, except as provided in Reg. 1.409A-3(j)(4), a nonqualified deferred compensation plan may not permit the acceleration of the time or schedule of any payment or amount scheduled to be paid under the plan, and that no such accelerated payment may be made whether or not the plan provides for it. Section 409A(a)(3) is the statutory source of the prohibition.

The same paragraph clarifies what is not an acceleration: payment made in accordance with plan provisions or an election in effect at the time of the initial deferral, or added under the subsequent deferral rules, pursuant to which payment is required on an accelerated schedule. The exceptions in Reg. 1.409A-3(j)(4) are specific and conditioned, and each should be read against the exact facts rather than summarized.

6. Sort the failure: documentary or operational

The split matters because the two correction routes are different documents. Notice 2010-6, published in Internal Revenue Bulletin 2010-3 dated January 19, 2010, provides methods for correcting failures of a plan's terms to meet the section 409A document requirements, and addresses categories such as ambiguous payment terms, impermissible definitions of separation from service, change in control or disability, impermissible payment events and schedules, and a missing six-month delay provision for specified employees.

Notice 2008-113, published in Internal Revenue Bulletin 2008-51 dated December 22, 2008, addresses failures to comply with section 409A(a) in operation, including amounts not deferred, payments made at the wrong time, excess deferred amounts, certain stock right exercise price failures, and payments that breached the six-month delay. Its relief is organized by when the correction occurs, with correction in the same taxable year treated differently from correction in the following taxable year, and with separate treatment for service providers who are insiders.

Both notices condition relief. Notice 2010-6 states requirements including that the failure be inadvertent and unintentional, that substantially similar failures be corrected, that eligibility is generally unavailable where the service provider or service recipient is under examination with respect to nonqualified deferred compensation, and that specified information reporting be done. Reading the eligibility section before designing a correction is the whole job; a correction that does not satisfy the conditions is simply an unreported failure. Both notices were later modified. Notice 2010-80, in Internal Revenue Bulletin 2010-51, changes provisions of each, including which plans are eligible for relief under Notice 2010-6, an additional correction method for payments at separation from service conditioned on a release of claims, and the service provider information reporting requirements. Taxpayers may rely on it for the Notice 2008-113 modifications for taxable years beginning on or after January 1, 2010, and for the Notice 2010-6 modifications for taxable years beginning on or after January 1, 2009, so neither notice should be read on its own.

7. Who pays, and what the workpaper has to say

Section 409A(a)(1)(A) includes the deferred compensation in gross income at the service provider level, to the extent not subject to a substantial risk of forfeiture and not previously included, and section 409A(a)(1)(B) adds interest at the underpayment rate plus one percentage point, computed from the year the amount was first deferred or, if later, first not subject to a substantial risk of forfeiture, plus an amount equal to 20 percent of the compensation required to be included. The employee or other service provider carries that result, which is why a drafting error in a plan document is a live issue for the individual and not only for the sponsor.

A usable workpaper names the arrangement and the date the legally binding right arose, walks the five gates in order with a yes, no or unresolved for each, identifies the regulation relied on at each gate, and states plainly whether any failure found is in the document or in the operation. Where the arrangement passes because of the short-term deferral rule, the workpaper should show the two and a half month computation rather than asserting the conclusion.

The sibling page The section 83(b) election: what it changes and how the 30-day rule works deals with property transferred now; this page deals with compensation promised for later, and the two use the phrase substantial risk of forfeiture under different definitions. If a plan document is the artifact in question, ask Taxterity a research question that quotes the plan's payment and election provisions and names the gate you are testing, or have it draft a Federal Tax Memo on the gate that failed, then verify each authority against the regulation before anyone amends anything.

Related research

• Reasonable compensation for owner-employees: the C corporation and S corporation forks
• Section 83(b) election: the 30-day deadline, Form 15620, statement contents and forfeiture
• Fringe benefit exclusions: matching each benefit to its own Code section
• Worker classification for federal tax: control test, section 530 relief, scope

Official sources

1. 26 U.S.C. 409A — Inclusion in gross income of deferred compensation under nonqualified deferred compensation plans — Section 409A(a)(1)(A) inclusion; (a)(1)(B) interest and 20 percent additional tax; (a)(2) permissible distributions and (a)(2)(B)(i) six-month delay; (a)(3) acceleration; (a)(4) elections; (d)(1) definition
2. 26 CFR 1.409A-1 — Definitions and covered plans (annual CFR pages, 4-1-25 edition) — Reg. 1.409A-1(b)(4)(i) and (b)(4)(i)(A) short-term deferrals and the applicable two and a half month period; (d)(1) substantial risk of forfeiture; (i)(1) and (i)(3) specified employee and identification date
3. 26 CFR 1.409A-2 — Deferral elections (annual CFR pages, 4-1-25 edition) — Reg. 1.409A-2(a)(5) certain forfeitable rights; (a)(7)(i) first year of eligibility 30-day election; (a)(8) performance-based compensation; (b)(1) and (b)(1)(i) subsequent deferral elections and the 12-month condition
4. 26 CFR 1.409A-3 — Permissible payments (annual CFR pages, 4-1-25 edition) — Reg. 1.409A-3(a)(1) through (a)(6) permissible payment events; (b) designated payment periods; (i)(2)(i) required six-month delay for specified employees; (j)(1) prohibition on acceleration
5. Internal Revenue Bulletin 2010-3 (January 19, 2010) — Notice 2010-6, relief and guidance on correction of document failures under section 409A(a); Section III eligibility and general relief conditions; categories of correctable document failures
6. Internal Revenue Bulletin 2008-51 (December 22, 2008) — Notice 2008-113, relief and guidance on correction of operational failures under section 409A(a); same taxable year and following taxable year correction sections; treatment of service providers who are insiders
7. Internal Revenue Bulletin 2010-51 (December 20, 2010) — Notice 2010-80, modification of Notice 2008-113 and Notice 2010-6: Section I purpose list; Section IV effective date and reliance years

Limitations

• This is an issue map at the level of the gate and the governing regulation. The definitional regulations under Reg. 1.409A-1, and the exceptions in Reg. 1.409A-3(j)(4), are far more detailed than any summary of them.
• Whether a particular arrangement is a plan providing for the deferral of compensation, and whether a substantial risk of forfeiture exists, are fact-dependent conclusions this page frames rather than reaches.
• The correction notices were read for their structure and conditions, not applied. Notice 2010-6 and Notice 2008-113 were both modified by Notice 2010-80; eligibility, the precise correction method and the reporting required must be read in all three before any correction is attempted, and guidance issued after 2026-09-15 has not been checked.
• Section 409A interacts with employment tax timing, information reporting and, for some employers, entirely separate regimes such as section 457(f). Those interactions are outside this page.