The law of unintended consequences: international implications of section 409A.

Interestingly, the 1995 third protocol to the U.S.-Canada treaty expanded the definition of retirement plan to include "other retirement arrangement," which might capture retirement-type deferred compensation, such as SERPs. The pertinent treaty provisions, however, relate only to payments under the plan, not contributions or accruals.

(42) See, e.g., PLRs 8537010 and 9243026 (section 422 incentive stock options and section 423 employee stock purchase plans, respectively).

(43) An additional twist is provided by new section 72(w), added by the AJCA. Section 72(w) revamps the rules for taxing distributions to USCRs under section 72, e.g., in the event of distributions from nonqualified plans (including foreign qualified-type plans). Amounts distributed will now be taxable by the United States (through the mechanism of excluding them from the employee's basis, i.e., "investment in the contract") if they are attributable to contributions (or earnings thereon) with respect to compensation for foreign services performed while the individual was an NRA that were not subject to tax by the United States or a foreign country (but would have been taxable if paid to the NRA in cash when the services were performed). Section 409A(c) should prevent later taxation of any amounts taxed under section 409A.

(44) TMEI Roundtable, at 1784; BNA Daily Tax Report No. 23, G-7 (February 4, 2005); 33 Tax Management Compensation Planning Journal 17 (January 7, 2005).

(45) As previously discussed, deferred compensation derived from foreign services is unlikely to be taxed by the United States absent a peculiar "effectively connected" situation or subsequent conversion to USCR status.

(46) Section 871(b) has a small 90-day/$3,000 exception for services for certain foreign entities or offices (section 864(b)(1)).

(47) Of note, however, the IRS treats that portion of a distribution allocable to earnings within a U.S. qualified plan as U.S. source income not effectively connected with a U.S. trade or business and therefore subject to 30-percent FDAP withholding (absent treaty protection). See, e.g., Rev. Rul. 79-388, 1979-2 C.B. 270; Rev. Proc. 2004-37, 2004-26 I.R.B. 26. By comparison, earnings on a nonqualified plan--whether U.S. or foreign--generally are sourced in the same manner as the underlying compensation (i.e., based on the place where services were performed.)

(48) See Treasury Department Technical Explanation to 1996 United States Model Income Tax Convention, Art. 15, [paragraph] 1, stating the converse rule in non-exempt situations: "[A] person who receives the right to a future payment in consideration for services rendered in a Contracting State would be taxable in that State even if the payment is received at a time when the recipient is a resident of the other Contracting State." A more subtle issue is presented if the individual is no longer a resident of the foreign treaty country (or any treaty country with a comparable provision) in the year the deferred compensation is received, since the exemption is only available to treaty residents.

(49) See, e.g., Treasury Department Technical Explanation of the 1996 United States Model Income Tax Convention, Art. 14, [paragraph] 1.

(50) See generally note 41 supra.

(51) New I.R.C. [subsection] 6051(a)(13) and 3401(a) (flush sentence at end) (employees) and [section] 6041(g) (non-employees). A more liberal grandfather rule applies for reporting purposes (pre-2005 actual deferrals, whether or not vested, and regardless of post-October 3, 2004, material modifications) than for section 409A in general, per Q&A-28 of Notice 2005-1. Reporting for nonaccount balance plans may be deferred until the amount thereof becomes reasonably ascertainable (Q&A-26), and aggregate deferrals for an individual employee of $600 or less need not be reported (Q&A-27). For general provisions subjecting foreign employers to withholding rules, see, e.g., Treas. Reg. [subsection] 31.3401(a)-1(b)(7) and 31.3401(a)(6), and Rev. Rul. 92-106, 1992-2 C.B. 258.

(52) See TMEI Roundtable, at 1783.

(53) Similar concepts can be found in section 871(f) (annuities under U.S. qualified plans) and, somewhat perversely, in new section 72(w).

(54) Pertinent definitions could be borrowed from the section 404A definitions.

PATRICIA GIMBEL LEWIS is a member of the Washington, D.C., law firm of Caplin & Drysdale, Chartered. She received J.D. and M.B.A. degrees from Harvard University in 1971, with honors, and her undergraduate degree from Wellesley College. Mrs. Lewis was a member of the 1994-1996 IRS Commissioner's Advisory Group, and co-chaired the Taxation Section of the District of Columbia Bar from 1992 to 1995. Mrs. Lewis's prior articles for The Tax Executive include: "What's New? What's Missing? The IRS Updates APA Procedures" (2004); and "Second First??? Transfer Pricing Issues in Secondment of Personnel" (2002).

MICHAEL G. PFEIFER is also a member of Caplin & Drysdale, having joined the firm in 2004. He received a J.D. from Cornell University in 1975, an LL.M. in taxation from New York University in 1981, and his undergraduate degree from Yale University. His practice focuses on the international tax issues of wealthy individuals. Before joining Caplin & Drysdale, Mr. Pfeifer was an international tax partner in the National Tax Department of Ernst & Young LLP. From 1993-1995, Mr. Pfeifer was the Special Assistant to the Associate Chief Counsel (International) at the Internal Revenue Service. He has spoken and written extensively on tax matters; this is his first article for The Tax Executive.

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