More than other taxpayers, Californians have felt the brunt of the Internal Revenue Code's section 409A. This provision regulates the treatment of nonqualified deferred compensation for federal income tax purposes and mandates a 20% surtax plus interest on prior underpayments. California state law has augmented the penalty because it allows for an additional state 409A penalty equal to the federal 20%. What's more, because deferred compensation is common in one of the state's biggest industries, the entertainment sector, taxpayers of all stripes (not just highly paid executives in the financial or high-tech sectors who obtain compensation in the form of stock options) have suffered the provision's blow. As one expert notes, the reach of section 409A is long. "It can crop up wherever payments are delayed or contingent. Be careful."
But, in a rare bit of good news, California's Governor Jerry Brown recently signed a bill that will reduce the state penalty to 5% and thus drop the total additional tax from 40% to 25% come Jan. 1, 2014.
Read more on the legislation.