Salary Deferrals in the Time of COVID-19

As the saying goes, “drastic times call for drastic measures” and, from an economic standpoint, these are drastic times. To fight the battle to stay in business many employers are considering a wide range of alternatives, including employee furloughs, layoffs and terminations. While some employers may also consider sweeping salary reductions, other employers may consider reducing current salaries with the promise to pay those salaries in the future. Employers taking this latter approach must understand that deferring salaries from 2020 to 2021 (or to some other future year) can create compliance issues under Section 409A of the Internal Revenue Code (“409A”).

409A is a comprehensive statute governing “deferred compensation,” which the IRS broadly defines as the current right to receive compensation in a future year. And yes, moving compensation from 2020 to 2021 (whether initiated by the employer or the employee) implicates 409A, unless the deferred salary is paid no later than March 15, 2021.

An employer considering this alternative may simply want to defer the salary until the COVID-19 pandemic is resolved or business gets back to normal. However, if the salary deferral is subject to 409A, the deferral can only be paid on one of the following events: separation from service; death; disability; fixed date; hardship; or change in control. Violating 409A results in the employee including in current income the amount of the salary deferral plus an additional 20% tax.

An employer considering salary deferrals due to the COVID-19 pandemic should carefully consider how 409A could impact that decision.