Annualized Partial-Year Compensation

[Guest mbw]

The IRS published guidance earlier this month addressing the election requirements for employees that annualize partial-year compensation...significantly teachers.

The guidance suggests that any time an employee can annualize partial-year compensation, an election is required. Doesn't this ignore the short-term deferral rule? Compensation is not deferred compensation subject to 409A if it is paid by the 15th day of the third month following the later of the last day of the employee's taxable year or the employer's taxable year.

I understand a lot of schools have fiscal years that may coincide with the school year or close thereto. If a school district has a fiscal year of August 1 to July 31, wouldn't all the teacher's compensation paid from September of Year 1 through May of Year 2 be a STD if it were paid by October 15, Year 2--the date that is 2.5 months from the last day of the school's fiscal year? In this case, no election would be necessary. Am I overlooking something obvious? It just seems odd the IRS would publish this guidance and not reference the possibility of the STD rule (which is perhaps why I am questioning what I could be missing).

[Steelerfan]

The IRS published guidance earlier this month addressing the election requirements for employees that annualize partial-year compensation...significantly teachers.

The guidance suggests that any time an employee can annualize partial-year compensation, an election is required. Doesn't this ignore the short-term deferral rule? Compensation is not deferred compensation subject to 409A if it is paid by the 15th day of the third month following the later of the last day of the employee's taxable year or the employer's taxable year.

I understand a lot of schools have fiscal years that may coincide with the school year or close thereto. If a school district has a fiscal year of August 1 to July 31, wouldn't all the teacher's compensation paid from September of Year 1 through May of Year 2 be a STD if it were paid by October 15, Year 2--the date that is 2.5 months from the last day of the school's fiscal year? In this case, no election would be necessary. Am I overlooking something obvious? It just seems odd the IRS would publish this guidance and not reference the possibility of the STD rule (which is perhaps why I am questioning what I could be missing).

I thought the period you measure from for the STD rule in your example is from 12/31 of year 1. Assuming you are correct, isn't the problem that teachers have limited choices in the form in which they can receive their pay--meaning that they either get paid ratably over the school year or the full fiscal year; the school district would presumably not allow any other arrangement. Therefore, since some of the "stretched" payments will necessarily go beyond the STD period, the STD rule cannot be used. I doubt the IRS entertained the idea that a teacher could negotiate for an "accelerated" payment since the idea is for the teacher to have the money spread out so they don't have to "go without" a paycheck.

[Guest mbw]

Don't you measure from the later of the last day of the teacher's taxable year (Dec. 31) OR the last day of the school's taxable year? If true, then nothing exceeds the STD period, correct?

[Steelerfan]

Don't you measure from the later of the last day of the teacher's taxable year (Dec. 31) OR the last day of the school's taxable year? If true, then nothing exceeds the STD period, correct?

Looks like you have a good point; they failed to acknowledge that year 2 pay might not be deferred compensation-assuming the fiscal year is as in your example. IMHO this is just another example of an overbroad statute that kills the horse just to get to the fly. The idea of teachers spreading out their pay being deferred comp is a little ridiculous. I'll have to tell my mom that for 30 years she was in a deferred comp plan. Also, this provides another great reason to have just given us until the end of following year, then we could leave the poor teachers alone!

[Guest mbw]

Exactly. I can deal with the deferred comp issues but what is going to happen when the reporting and withholding guidance comes out? If you assume that the teacher's annualized comp is deferred comp what a headache for school districts to separately report these trivial amounts of comp each year.

[Steelerfan]

This makes me wonder if it would have been better, if practicable, for Congress to have "baked into" 409A the concept that a plan should have as its primary purpose, or at least a clear intent, to create deferred compensation--meaning an intended deferral of taxation. If there could be a rule to that effect, then the IRS could have authority to declare that some plans, even though they might fit the technical definition of deferred comp, simply aren't intended to defer compensation and thus should be exempted, such as teacher pay.

I can think of other types of "sales incentive" compensation plans that seem to fit that category, such as gift card or points programs that allow a person to hold on to points and redeem them later. Even these innocuous, fairly insignificant (monetarily) plans, can fall under 409A. Such persons are not trying to defer taxation, but rather just waiting to redeem their points.

There should be a away of exempting more plans from 409A based on intent and/or who the participants are. Of course this could also open up 409A to more complicated ERISA-like notions.

[Guest egd_@hotmail.com]

I agree with the above. The only argument the IRS could have is a school district has a fiscal year but the short-term rule refers to the service recipient's "taxable year". Could the IRS argue the school district does not have a taxable year because it doesn't pay taxes?

[Guest aunti]

I agree with the above. The only argument the IRS could have is a school district has a fiscal year but the short-term rule refers to the service recipient's "taxable year". Could the IRS argue the school district does not have a taxable year because it doesn't pay taxes?

I think the problem is that 457(f) refers only to the employee's taxable year, which almost always is the calendar year. Even though a short-term deferral could be based on either the employee's taxable year or the employer's fiscal year, 457(f) and 409A need to operate based on the same 12-month period.

[GBurns]

Somehow, I cannot see what the problem is.

In the School Districts that I know, the employee's salary "year" or contract year is the same as the SD's fiscal year. So whether 10 month or 12 month the entire salary gets paid during the fiscal year in all cases.

Then there are the options of "the later of..." and "or" in the Regs.

[Guest aunti]

Somehow, I cannot see what the problem is.

In the School Districts that I know, the employee's salary "year" or contract year is the same as the SD's fiscal year. So whether 10 month or 12 month the entire salary gets paid during the fiscal year in all cases.

Then there are the options of "the later of..." and "or" in the Regs.

According to Stephen Tackney, in addition to the issue of 457(f) applying on the basis of the participant's taxable year, which is almost always the calendar year, regardless of the contract year, the IRS is not satisfied that local governments have a fiscal year since they do not file tax returns. This seems bizarre since they all operate and budget based on a fiscal year (which rarely is the calendar year), but that's what he said.