Section 409A follows US citizens and green card holders wherever they work, so an ordinary UK deferred bonus or cash LTIP can fail it. What the rules require, what a failure costs, what to check.
Section 409A of the US Internal Revenue Code regulates the design of nonqualified deferred compensation: when a deferral may be elected, which events may trigger payment, and the rule that payment generally cannot be accelerated. It attaches to the person, not the payroll — a US citizen or green card holder is inside section 409A wherever they work and whoever employs them. So an unremarkable UK bonus-deferral or cash long-term incentive plan can be a non-compliant nonqualified plan for its American participants, and a failure pulls the deferred amount into income early with an additional 20% income tax and premium interest on top.
Enacted in the American Jobs Creation Act of 2004, section 409A applies in addition to the older doctrines of constructive receipt, economic benefit and cash equivalency. It does not stop an executive deferring pay; it sets the terms on which the deferral is respected.
The IRS summarises the regime as four principal requirements. First, an initial deferral election specifying the time and form of payment must generally be made before the calendar year in which the executive performs the services the compensation is earned for. Second, a later change to the payment date or form — a subsequent deferral election — is only effective if it meets specific timing conditions. Third, payment may be made only on a permitted event. Fourth, payment cannot be accelerated or delayed except as the regulations allow.
The definition of a plan is deliberately broad: any plan, agreement, method, programme or other arrangement providing for the deferral of compensation. A deferral generally occurs where the executive obtains a legally binding right to compensation in one taxable year that is, or may be, payable in a later one — no formal document and no trust required. Section 409A also reaches any service provider, including non-employee directors and independent contractors, though contractors may be exempt in some cases.
Nonqualified deferred compensation may be paid only on one or more of:
Notice what is absent. "When the remuneration committee decides", "on request" and "on relocation" are not on that list. A UK agreement that gives the committee discretion over timing, or lets the executive ask for early release, is already outside the permitted events — however reasonable it looks under UK practice.
Not every delayed payment is deferred compensation. Under the short-term deferral rule, an amount the executive has a legally binding right to, that is substantially vested and payable no later than 15 March of the following year, is outside section 409A. For a calendar-year taxpayer this is what keeps a normal annual bonus out of the regime, and it is the first thing to test.
Section 409A applies to the US taxpayer, not to the employer's jurisdiction. A UK plc or subsidiary running a deferred bonus scheme has no reason to consider the US code; nothing in drafting to the Companies Act, the UK Corporate Governance Code and HMRC practice produces a 409A-compliant document. The failure patterns are structural rather than exotic:
There is also a funding trap. Under section 409A(b)(1), where assets are set aside directly or indirectly in a trust to pay deferred compensation and that trust is located outside the United States, the arrangement is treated as a transfer of property under section 83 even if the assets remain available to the employer's general creditors. The rule does not apply to assets in a foreign jurisdiction where substantially all the services the deferred compensation relates to are performed in that jurisdiction. For an American working wholly in London that carve-out may be the answer — but it has to be established on the facts.
Equity awards are a different animal, analysed mostly under other provisions. If your package is options or share units rather than deferred cash, start with our guides to stock options, RSUs and equity compensation and EMI share options for US citizens in the UK. Instalment severance is its own topic — see UK termination payments for US persons.
If a plan fails the section 409A requirements at any time in a taxable year, or is not operated in accordance with them, all amounts deferred under the plan for that year and all preceding years, by any participant to whom the failure relates, become includible in gross income — to the extent not subject to a substantial risk of forfeiture and not previously included.
On top of ordinary income tax at the executive's marginal rate, two charges apply:
Amounts included under section 409A are wages for employment tax purposes. Employers report failure income in Form W-2 box 12 code Z (code Y covers ordinary 409A deferrals); for a nonemployee, failure income of at least $2,000 goes in box 15 of Form 1099-MISC. The individual reports it on Schedule 2 (Form 1040), Part II, line 17h, with line 17i reserved for section 457A compensation.
An American executive in London has $200,000 of vested deferred cash under a UK scheme, deferred across three prior years. A review on exit finds the plan allowed committee discretion over the release date — an impermissible payment event.
The cash has not moved. The tax has.
Section 457A, enacted in 2008 and effective from 1 January 2009, targets deferred compensation from nonqualified entities: broadly, any foreign corporation unless substantially all its income is either effectively connected with a US trade or business or subject to a comprehensive foreign income tax; and any partnership unless substantially all its income is allocated to persons other than foreign persons outside a comprehensive foreign income tax and US tax-exempt organisations.
Where section 457A applies, compensation deferred under such an entity's nonqualified plan is includible in gross income when there is no substantial risk of forfeiture. There is no designing your way to a later payment date. A short-term deferral exception applies where the compensation is paid not later than 12 months after the end of the service recipient's taxable year in which the right first ceased to be subject to a substantial risk of forfeiture. If the amount is not determinable then, it is included when it becomes determinable, and the tax for that year rises by 20% of the compensation plus the premium interest tax.
This is why section 457A matters disproportionately to fund and offshore structures — management companies, advisory entities and incentive arrangements in jurisdictions without a comprehensive income tax. Critically, section 409A applies separately and in addition to section 457A: satisfying one does not dispose of the other. See also carried interest for US citizens in UK funds.
The UK taxes general earnings on a receipts basis. Under section 18 of the Income Tax (Earnings and Pensions) Act 2003, money earnings are treated as received on the earliest of actual payment and the executive becoming entitled to payment, with additional triggers for directors. In practice a deferred cash bonus is a UK taxable receipt in the year it is paid.
The US may tax earlier. On a section 409A failure, inclusion falls in the year of the failure; under section 457A, on vesting. Either way the US taxing point can arrive years before the UK one.
Foreign tax credits are matched by year and by category. If the US taxes $200,000 in year one and the UK taxes the same $200,000 in year four, there may be no UK tax in year one to credit against the US liability, and no US liability in year four against which to use the UK tax. Unused foreign taxes carry back one year and forward ten — but a carryforward only has value if there is future foreign-source income of the right category to absorb it. This is how credits strand; our guide to the foreign tax credit carryover for US expats sets out the mechanics.
Article 14 of the US–UK income tax treaty provides that remuneration derived by a resident of one state in respect of an employment is taxable only in that state unless the employment is exercised in the other state, in which case the other state may tax it.
For an American, that is not the end of it. Article 1(4) is the saving clause: notwithstanding any provision of the Convention except paragraph 5, a Contracting State may tax its residents and, by reason of citizenship, may tax its citizens as if the Convention had not come into effect. Paragraph 5 preserves certain benefits, including Article 24 (Relief From Double Taxation). So the treaty does not generally relieve a US citizen from US tax on employment income; relief runs through the credit mechanism, and whether it works turns on the facts and the timing. Our guide to how the US–UK treaty prevents double tax covers the wider framework.
| Arrangement | 409A likely to apply? | Timing risk | What to establish |
|---|---|---|---|
| Annual UK bonus paid by 15 March following the vesting year | No — short-term deferral | Low | Payment date fixed and inside the window; amount substantially vested |
| UK deferred cash bonus or cash LTIP paid over 2–3 years | Yes | High | Election timing; permitted payment events; no committee discretion; leaver clauses |
| Contractual severance paid in instalments across tax years | Often | Medium–high | Whether a short-term deferral or separation-pay exception applies |
| Unfunded employer top-up promise outside a registered pension scheme | Yes | High | Whether it is a plan for 409A; the funding arrangement; the offshore trust position |
| Deferred pay from an offshore fund or management entity | Yes — and consider 457A | High | Whether the payer is a nonqualified entity; the vesting date; determinability |
| Non-employee director fee deferral | Yes | Medium | Election timing; payment events; whether any contractor exemption applies |
Treat this as due diligence on the document, not a negotiation over the number.
1. Is this plan documented as section 409A-compliant? Ask in writing; "we have never had an issue" is not an answer.
2. Who advises the plan on US tax? If nobody does, you are the plan's US tax function.
3. What are the permitted payment events, exactly? Read them against the six; any discretion over timing is a finding.
4. Is the separation-from-service definition consistent with section 409A? UK leaver language usually is not.
5. When must I elect, and is it irrevocable? Test it against the pre-year rule, the 30-day first-eligibility rule and the six-month performance rule — and, if the group is listed, confirm the specified-employee six-month delay is in the document.
6. What happens if I move between countries? Relocation is not a permitted payment event. Confirm nothing accelerates or is released on a move.
7. Where are any set-aside assets held? A trust outside the US puts the section 409A(b)(1) position in issue.
> This is the point to get specialist help, and quickly. Section 409A correction is narrow, technical and deadline-driven. What relief is available depends on the type of failure and which year it relates to, and several routes close at the end of the taxable year in which the failure arises — so a delay of weeks can remove the only option you had. Do not amend the plan, accept a payment or sign a release before the position has been reviewed.
The IRS has published correction guidance: Notice 2008-113 for operational failures, Notice 2010-6 for plan document failures, and Notices 2008-115 and 2010-80 on related points. These are programmes with conditions attached, not a general amnesty, and what is achievable turns on the facts, the dates and the employer's cooperation.
Deferred compensation is the one part of a senior package where the document, not the number, decides the tax outcome — and a problem found at exit is usually one created at signature. Look before you elect, before you move and before you leave.
At Next Tax Source a licensed CPA or Enrolled Agent reviews and signs off the US position and an ACCA-qualified accountant handles the UK side, so both taxing points are modelled together rather than in sequence. To have your plan documents and election history read properly, book a consultation. This article is general information about how these rules work, not advice on any particular plan.