More on Announcement 2000-1

[Carol V. Calhoun]

I just got a call this morning from an individual from the IRS. He was obviously speaking only in his individual capacity and not as a representative of the IRS as a whole. (Insert all standard disclaimers here. ) However, he was able to tell me that the language in Announcement 2000-1 stating that no W-2 reporting is required for a plan which meets either the requirements of, or the exceptions to (e.g., the exception for bona fide severance plans), I.R.C. § 457(b) was not intended to create any negative inference concerning plans which fail the 457(b) tests and therefore are described in 457(f). Thus, it appears that TAM 199903032 remains the position of the IRS with respect to plans described in 457(f).

[Guest Frank Berrodin]

Assuming your analysis and the IRS agent's representation that Announcement 2000-1 was not intended to change the IRS's position in TAM 199903032 are correct, then what purpose could Announcement 2000-1 serve?

[Carol V. Calhoun]

Apparently, the purpose behind Announcement 2000-1 was to reassure school systems which provided severance packages to their employees. Although there is a provision in 457 that says that the section 457(f) requirements do not apply to "bona fide severance arrangements," no one had ever defined "bona fide." Some school systems had apparently feared that if their employees had to report the present value of future severance pay as income, the employees would not have enough cash to be able to pay the tax. Thus, employees might be forced to terminate employment so that they could get the severance pay and use it to pay the tax.

IRS responded in Announcement 2000-1 by setting up a broad safe harbor for existing severance plans. But since IRS was concerned just about severance plans for purposes of the Announcement, they didn't stop to think that saying that reporting was NOT necessary for severance plans might carry a negative (and false) implication that it WAS necessary for other plans which did not meet the 457(B) requirements.

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[Guest Frank Berrodin]

Thank you for the follow up. As you pointed out earlier, the combination of the TAM and the Announcement lead to a ludicrous result. Participants in a 457(a) plan or a bona fide severance plan as defined in the Announcement are taxed on the payments they receive when they receive them but participants in a 457(f) plan are supposed to pay tax when there is no substantial risk of forfeiture even though they will receive nothing from the payor indicating that the amounts are taxable (and no withholding will occur) until the amounts are actually paid. The reality is that no one will pay tax on amounts under a 457(f) plan until paid just like a 457(a) plan and a bona fide severance pay plan which makes Code section 457 meaningless. I suppose the IRS could try to impose interest and penalties on a participant who fails to report 457(f) income timely but a participant would have a pretty good defense if he never received anything indicating the amount was taxable in a prior year.

[JWK]

I think school districts that sponsor these types of "severance" pay plans have additional problems if they are designed as described in Notice 2000-1. Because these "supplemental" benefits reduce as an employee gets older and go away entirely if a participant does not actually sever employment before reaching a certain age (typically age 62), there is a serious question of age discrimination. See Solon v. Gary Community School Corp., 1999 US App. LEXIS 13174, 23 EBC 1113 (6th Cir. 1999).

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[Christine Roberts]

So if a school district wants to give a departing principal severance pay (e.g. 2 years salary, paid over three years)and the arrangement was not in existence on December 22, 1999, is not broad based, etc., and otherwise does not meet the requirements of Announcement 2000-1, is it essentially a Sec. 457(f) arrangement such that he must include the entire amount in his gross compensation in the year he terminates employment??

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[Carol V. Calhoun]

Maybe even before that. If there is a severance arrangement in place in which his or her rights are vested at some point before termination of employment, the value of the severance would be taxable in the year of vesting, not the year of actual termination of employment.

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Employee benefits legal resource site