As employers increasingly focus on in-person office mandates, reimbursements for relocation expenses have once again become a key component of attracting top talent. If not carefully structured, however, such expense reimbursements may inadvertently trigger significant adverse tax consequences under Section 409A of the Internal Revenue Code. This post discusses some of the requirements under Section 409A and offers tips for avoiding some of the common pitfalls in drafting relocation benefits. 

Section 409A 

Section 409A applies to compensation which is promised in one taxable year, but which is or may be payable in a following one. A failure to comply with Section 409A’s rules regarding timing and structure can result in an additional 20% excise tax on the employee, immediate income inclusion, and potential penalties for both the employee and employer. 

Applying Section 409A to Relocation Benefits

To the extent that a reimbursement is subject to Section 409A, employers must carefully craft their arrangements to satisfy its requirements, which include: 

1. The expenses eligible for reimbursement must be nondiscretionary and objectively defined and determinable;
2. The period during which the expenses eligible for reimbursement are incurred must be specifically prescribed; 
3. The amount of expenses eligible for reimbursement during the service provider’s taxable year may not affect the expenses eligible for reimbursement in any other taxable year;
4. The reimbursement must be made on or before the end of the service provider’s taxable year following the taxable year in which the expense was incurred; and
5. The right to reimbursement must not be subject to liquidation or exchange for another benefit. 

For example, an employer offers an employee a relocation package which includes a reimbursement of up to $75,000 for “relocation expenses” at any time during employment. Because all or a portion of the $75,000 could be paid in a different tax year than the year the employee was promised the benefit, Section 409A would apply. Further, this arrangement would not comply with Section 409A because: (1) “relocation expenses” is not objectively defined and determinable; and (2) the amount of expenses eligible for reimbursement in one year will affect the reimbursable expenses in other years due to the application of the “cap” of $75,000. If instead the employer provides that the reimbursement would be for “housing expenses” with appropriate limitations on types of housing, location, etc. up to $25,000 during each of the first three years of employment (e.g., eligible for up to a total of $75,000), then the reimbursement benefit would satisfy the pitfalls discussed above. 

Further Thoughts

Employers offering employees reimbursement for relocation benefits should consider the following:  

• Details are Key. Employers should provide sufficient details regarding what expenses are eligible for reimbursement. For example, for temporary housing, consider what types of housing, location, utilities, etc, they will reimburse. Not only does Section 409A require a nondiscretionary and objectively defined set of parameters, but this also avoids unnecessary misunderstandings with new employees. 
• Reimbursement Period. Rather than a lifetime “cap” on reimbursable expenses which creates Section 409A compliance issues, an annual or monthly “cap” on expenses can be structured to comply with Section 409A. 
• Cash is King. Rather than a reimbursement of expenses, an alternative is a one-time cash signing bonus which can be used to cover relocation costs. This approach is easier to administer (e.g., no more receipts) and allows the employee flexibility to allocate the funds without worrying about Section 409A. 

Relocation reimbursements can be a powerful tool to attract and retain sought-after candidates for your business, but such arrangements must be drafted with precision or the intended benefit could result in substantial adverse tax consequences.