Many school districts and teachers have been concerned about the application of new regulations under Internal Revenue Code section 409A. Section 409A was enacted in October 2004 and was generally effective on Jan. 1, 2005. Section 409A applies to compensation that workers earn in one year but that is not paid until a future year. Section 409A generally requires inclusion in income in the current year of amounts paid under a nonqualified deferred compensation plan.
Many public school teachers, either by making an election or by the employer’s requirement, receive pay over a 12-month period for a period of service less than 12 months (for example, August through May). Because they may be receiving some compensation in a later year than it was earned, they may be treated as participating in a nonqualified deferred compensation plan questions, and be subject to additional tax under section 409A and section 457(f).
The IRS has released Notice 2008-62, proposing a rule under new regulations for section 457(f) for part-year compensation that will eliminate the possibility of additional tax under 457(f) and 409 for most teachers and schools.
The proposed rule, which taxpayers may rely on immediately, provides that no deferral income will occur if both of the following apply:
-
The arrangement does not defer payment of any of the recurring part-year compensation beyond the last day of the 13th month following the beginning of the service period. For example, if the service period begins in August 2008, all compensation must be received by September 30, 2009.
-
The total amount deferred is less than a dollar amount provided under IRC 402(g)(1)(B) for that year. For 2008, this amount is $15,500.
Example: A teacher has an annual contract for service beginning August 1, 2008, and ending May 31, 2009 (five months service in each calendar year). The $60,000 salary is paid in twelve monthly increments of $5,000, with the first payment August 31, 2008, and the final payment July 31, 2009. Because half the service is performed in 2008 and half in 2009, $30,000 in wages is attributable to service in each year. Because of the equal salary payments over 12 months, $25,000 is received in 2008 and $35,000 in 2009. The amount deferred from 2008 to 2009 is $5,000. Because this is less than $15,500, and all payments will be received by the end of the 13th month (September 30), there is no additional tax.
|
2008
|
2009
|
Months of service |
5
|
5
|
Salary attributable to service |
$30,000
|
$30,000
|
Pay increments received |
5
|
7
|
Total pay received |
$25,000
|
$35,000
|
Amount earned in 2008 paid in 2009: $5,000
Applying the same facts as above, but changing the salary amount, indicates that only teachers with a salary of more than $186,000 would have deferred compensation subject to additional tax under the provisions of sections 409A and 457(f).
If the service period is different, use the appropriate allocation of wages. For example, a September 1 to June 30 service period would have four months service applicable to 2008 and six months in 2009. Use the appropriate allocation of salary based on the months served in each year and compare this to the amount actually received in each year. The difference between amount earned and amount paid in the first year will indicate the amount deferred. If this is less than $15,500, there is no deferred income subject to the additional tax requirements.
For more information on section 409A and its application to teachers, see
FAQs: Sec 409A and Deferred Compensation.
View Notice 2008-62.
|