Defer from pay received after termination of employment?

[MR]

I am aware of a q&a wherein an IRS rep confirmed that an employer may not allow an employee to defer from severance pay. We have a situation where a company goes through some tough times and reduces officer compensation with a promise to make it up to them when things turn around. The officer subsequently terminates, but is still entitled to the promised make-ups. Can the officer defer from this? The compensation is attributable to a year in which he worked, so I'm not sure its treated the same as severance pay. Any thoughts?

mr

[Guest Bud]

If it's pay for work, then it's deferrable. If it's pay to not work (i.e., severance pay), then it's not deferrable. That was the principle I got from the IRS Q&A session. The timing of the payment is important. The greater the time between termination and payment, the greater the suspicion. The greater the suspicion the harder to prove that the pay is deferrable.

Seems to me the make-up pay is deferrable. But if it takes a long time to pay it, I wouldn't allow it be deferrable. If the officer complains, I would say the IRS is likely to challenge the tax deferred status of the deferral and if the Service wins, amended returns with increased taxes and penalties will apply. The deferral may not be worth a fight with the IRS, so allowing it to be deferrable may not be prudent.

As far as plan qualification, there's a risk that plan operations did not conform to the plan terms; however, I think that risk is slim.

[Kirk Maldonado]

Bud:

I'm not sure that I completely agree with your characterization of the IRS rationale.

I think that the doctrinal underpinnings of the IRS position is that only employees can make Section 401(k) contributions. After their employment is terminated, they are, by definition, no longer employees.

If you allowed them to make contributions following termination of employment, then, in the case of an individual who immediately went to work for another employer, the individual could make contributions simultaneously to two plans. That makes no sense.

Of course, there has to be some slack given because of natural delays in processing payroll.

[david rigby]

Kirk's summary appears to be consistent with most similar prior discussions on these Message Boards. And has been suggested before, a consensus here is (or should be) just as good as statutory authority.

[mbozek]

two Options:

1. If the ee is a non hce why not amend the plan to provide for a special er contribution equal to the amount of the make up?

2. Otherwise why not defer the day of termination as an ee to cover the period of time that it takes to make the special payment. Ee can take vacation or leave of absence. Also there is no contradiction for an individual to contribute to two plans at once because the controlled group rules explicitly permit a person to participate in two plans of unrelated employers at the same time and the salary reduction amt is a max of 12k for all 401(k) plans in which the individual participates in the same year.

[QDROphile]

Be careful about sham leaves of absence. Vacation is better if the employee is entitiled to it.

[mbozek]

I would not worry about the IRS as long as the employee follows the procedures for a leave of absence. Employees frequently terminate employment after a LOA to pursue other interests.

[QDROphile]

I think that employers who use leave of absence as a bridge usually do it in a way that is so sloppy and internally inconsistent that it is easy to see the sham. That is why care must be taken when using leave of absence for what is really not a leave of absence, even putting aside the moral issue.

[mbozek]

The "Moral issue" are the complex restrictions that the govt places on employees who want to save for retirement. As another thread on this topic disclosed most emplyees dont rollover their distributions. The IRS should support a leave of absence policy that can be used to permit an employee to make additional contributions. Morality aside the leave of absence policy is only an audit issue.

[david rigby]

I am saddened to see such phrases as "morality aside" and "putting aside the moral issue"?

Morality is always relevant. True, there might be differences of opinion, but that does not negate the issue.

[QDROphile]

You are correct. The issue is an audit issue. The audit issue arises when the employer calls something a leave of absence when it is not a leave of absence. In conventional parlance, this is also called a "lie."

[Kirk Maldonado]

I agree with PAX.

[mbozek]

I agree that there is no Sanity Claus in the IRC.