California Governor Jerry Brown has signed into law a measure that will reduce the California income tax penalty for violations of Section 409A of the Internal Revenue Code of 1986, as amended, (“Section 409A”) from 20% to 5%.

California law previously provided for a state income tax penalty equal to the federal income tax penalty for violations of Section 409A (see California Revenue and Taxation Code Section 17501). This resulted in a 20% state income tax penalty in addition to the 20% federal income tax penalty on amounts previously deferred and includible in income as a result of a Section 409A violation.

The new law, AB 1173, Chapter 536, adds CA Revenue and Taxation Code Section 17508.2, which substitutes the phrase “five percent” in lieu of the phrase “20 percent” as the additional income tax penalty for violations of Section 409A.

The reduced income tax penalty is applicable for taxable years beginning on or after January 1, 2013.

The federal tax provisions and the California state interest penalty provisions are unaffected by the new law and remain applicable to Section 409A violations.

As a reminder, certain violations of Section 409A can be corrected under federal and state correction programs that may reduce or eliminate these penalties but the programs remain available for a limited number of taxable years after the violation. As we approach the end of the year, now would be a good time for employers to review their deferred compensation plans and processes and take any appropriate corrective action.

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.