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457(f) Taxes on Quarterly Contribution by Employer


Rick S

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My wife has a 457(F) plan with a hospital in which her employer contributes $3,000 per quarter or $12,000 per year.

However, each $3000 quarterly contribution is taxed (Federal, FICA, etc) -- it shows up as a separate paycheck with applicable tax deductions -- and the remaining amount (around $2000) is then deposited into a deferred account that grows tax free until it is distributed at a later date based on SRF conditions.  As we understand, the SRF conditions are staying employed with the hospital for 3 years or meeting a retirement age of 65. 

Her HR Benefits department has stated that their 457(F) plan is unique in that it taxes the $3,000 quarterly contribution upfront.

She will be leaving her job and will not meet the SRF conditions so she will loose all of the contributions that are in this deferred account.

Since the $3,000 quarterly contributions are in her paycheck, taxes deducted, and eventually her W2 as income, should these contributions be deducted by her employer from her income and her W2 adjusted since she will forfeit these contributions?

Any thoughts or guidance is much appreciated.

Thank you,

Rick S

 

 

 

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I would say I haven't seen early inclusion for income taxes and FICA taxes before either. 

So for income taxes, I can see the company issuing W-2c's for the prior tax years to reverse amounts includible in income which would permit you to refile your 1040's for those years to recover taxes paid. 

I can also see the company showing adjustments for this year only (notionally repaying this year amounts "received" in prior years) which would adjust current year taxable income only.  This would likely be less favorable to you since tax rates decreased this year (YMMV).

Now FICA may be a different story.  The company opted for early inclusion for FICA purposes.  If FICA was assessed in a timely manner, then you may not be eligible to receive a FICA refund even though the amounts were ultimately never received. There was a recent court case BALESTRA v. U.S. that ruled that there was no FICA refund available for amounts appropriately assessed but not received due to bankruptcy.  That's not to say that FICA was appropriately assessed to begin with.  This is the "worst case" scenario.

 

 - There are two types of people in the world: those who can extrapolate from incomplete data sets...

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I appreciate the feedback. The somewhat good news is these quarterly contributions will be only for this year (2018). So the hospital will not have to issue any corrected W2's for previous years.

Does anyone know if the employer (Hospital) is required (legally) to adjust the W2 since they have included this as taxed income that will be forfeited because of not meeting the SRF conditions?

Or do I need to adjust the w2 income somehow when I file taxes with one of the on line tax programs(turbotax or taxact)?

Or are we just or are we just out of luck if the employer will not adjust the W2 for 2018.

Thanks for all of your help!

Rick S

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Not disagreeing with any of the above, but I will perhaps say more plainly that until the amount was no longer subject to a substantial risk of forfeiture (SRF), it was not includable in her income, and therefore FITW and FICA should not have been withheld. See 457(f)(1) and 3121(v). Timing is not optional, Should be taxed only when vested.

IRS instructions to Form W-2 starting at bottom of page 24 say "Use Form W-2c to correct errors on Forms W-2, ...." That's imperative language. IRS has statutory authority to command taxpayers to do certain things in forms, so yes, the W-2c is required.

Of course, your wife got the benefit of $3,000 or so in federal income tax withholding over the course of the year, and she also got FICA wage credit (which of course won't do her any good if she was already at or over the limit or has more than 35 years of wages at the limit). Unwinding that benefit will be complicated and, depending on what's done, will impact the corrected numbers on W-2c.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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Luke Bailey,

I appreciate your input and expertise regarding  457 (f's).

Yes, she will easily exceed the FICA income limit with the 457 (f) income counted (or not counted) as income.

I'm not certain I understand your statement "Of course, your wife got the benefit of $3,000 or so in federal income tax withholding.........."  I just don't fully comprehend the benefit of having extra gross income in your year end W-2 without the benefit of receiving the net income after taxes (Federal, Social Security, Medicare). We live and work in a state that does not tax income. 

As a next step, would you suggest my wife have a discussion with her HR department to see if they will remove this 457 (f) income from her year-end paystub and w-2? I am also assuming the employer (not the employee) needs to issue a W-2c if a W2 has already been issued?

Thank you for your help!

 

Rick S.  

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Luke Bailey is correct.  If your description is accurate, this employer needs to fix its administration of this entire program.

Patricia Neal Jensen, JD

Vice President and Nonprofit Practice Leader

|Future Plan, an Ascensus Company

21031 Ventura Blvd., 12th Floor

Woodland Hills, CA 91364

E patricia.jensen@futureplan.com

P 949-325-6727

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If your wife has not left yet, I call to HR is merited so the taxable amount can be reversed, and more importantly, the withholding can be reversed as well.

However it plays out, I'd double check the W-2.  If you don't see a reversal on the paystubs, at least make sure Box 1, 3, and 5 are lower than what's reflected on the paystub even if withholding amounts shown are the same.

If how they are "early-taxing" the benefit is any indication of how they are running the plan, I fear your wife and you will be following up quite a bit.

 - There are two types of people in the world: those who can extrapolate from incomplete data sets...

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Patricia and XTitan,

I appreciate the confirmation and feedback.

My wife has just sent a letter to HR with much of the information everyone has provided.

Thank you all for helping me sort through this issue.

Rick S. 

 

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  • 1 month later...

With respect to my Wife's 457 (f) plan, she emailed the employer and stated that her 457 (f) quarterly contribution should be pretax and not post tax (Federal, Medicare and FICA were deducted) and by taxing these contributions, the SRF has been met.

This is the response back from the employer---

Given the description you outlined, we felt it was important to conduct some additional due diligence and we have been advised that, with respect to the employer rather than employee contributions, the employer can establish the tax treatment of the benefit under the plan’s terms.  The plan provides that the employer amounts will be contributed on an after-tax basis.  Although you are forfeiting the benefit in connection with your termination, we believe the amounts already withheld on the contributions should cover your income tax liability.  If you have further questions about this or believe you will have some income tax liability, please let me know.

Does anyone know if the employer can tax a 457 (f) contribution upfront and then deposit the remaining money into a 457 (f) account only to state that the SRF conditions will not be met? 

By the way, their 457(f)  plan literature clearly states taxes will be withheld and the remaining money deposited into a 457(f) account.

Any feedback is appreciated.

Thank you,

Rick

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Rick S. I think what they're saying is that (a) the $3,000 was an employer contribution, and (b) they withheld the appropriate taxes when they included it on your wife's W-2, so she is not out of pocket. Including the amount in her income while it was still subject to an SRF (which apparently is what occurred) seems inconsistent with Section 457(f), but (i) the IRS is unlikely to be put out by the fact that they got their money sooner (or, in this case, at all) rather than later, and (ii) assuming that the amount the employer withheld and paid to IRS in fact was at least as much as the increase in your and your wife's tax liability, the argument that she was damaged by the employer's conduct is complicated at best.

Good luck.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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This sounds really frustrating.  I wonder if the "counsel" who provided the "advice" ever looked at IRC 457(f)(1)(A) which states:

the compensation shall be included in the gross income of the participant or beneficiary for the 1st taxable year in which there is no substantial risk of forfeiture of the rights to such compensation

I'd still hang my hat on the W-2 showing zero in box 1, 3, and 5 with respect to the net 457(f) contributions and that the resulting over-withholding can be recovered when filing your 1040. 

Subjecting the 457(f) contribution to state tax up front makes wonder if this is New Jersey we are talking about.  Some folks still think there is no tax deferral for non-qualified plans.

 - There are two types of people in the world: those who can extrapolate from incomplete data sets...

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Thank you Luke Bailey and XTitan for your responses. I really appreciate the feedback. I will go back and quote as you stated from IRC 457(f)(1) to see if I can determine why they wanted to have the 457 (f) plan be post tax dollars---but I'm not hopeful things will change.  

At a very high level, for 2018, the incremental tax increase (deducting the $6,000 457 (f) income from gross income versus keeping it in gross income) will probably result in about $265 extra we will pay in Federal taxes which means they did not withhold enough federal taxes from the 457 (f) contribution.   

Also, one thing it could impact eventually (I am on Social Security so I need to talk with Social Security) is Medicare part b premiums. As you may be aware, your premium for part b is based on your modified adjusted gross income and we will be close to this $6,000 pushing us into a higher premium bracket. If so, it may result in an additional $80 per month premium whenever they look at 2018 earnings. 

I also think we take a little hit on the Medicare Excise Tax (.09%) in 2018 (unless it was eliminated due to the Tax Act) for the extra $6,000 since we are over the $250,000 for married couples filing jointly. 

XTitan-- We are located in New Hampshire so thankfully individual State taxes do not apply.

Thank you again for your help!

Rick S.

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In a perfect world, there would be one additional paycheck showing the reversal of $6,000 and withholding is returned.  In an imperfect world, the $6,000 not received would still show on the W-2 and then you'd likely take a deduction on your 1040, though it used to be subject to the 2% miscellaneous deduction.  Rationally, W-2 income not received should reduce your MAGI.

Don't know if the 2% deduction rules changed post-TCJA.  The .9% was not repealed by TCJA.

 - There are two types of people in the world: those who can extrapolate from incomplete data sets...

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