Taxation of NQDC salary deferrals in New Jersey

[Steelerfan]

Does anyone have any knowledge of what's going on with the NJ Division of Taxation on this issue and what employers are doing?

It appears that NJ is attempting to tax salary deferrals at the time of deferral, unlike the timing for federal taxes (at distribution). This is contrary to their prior stance that they would tax deferrals at distribution if the plan is unfunded, etc. Their theory seems now to be that employees are in constructive receive of the amounts when they are earned since they can control their deferral percentages. The law and regs in NJ may support this view, but they have flip flopped on their approach, creating an inconsistency in published guidance, and now won't clarify when they should be taxed.

This poses a problem for employers who don't have certainty as to when the requirement to withhold income taxes arises.

Anyone know how companies are handling this problem, or if they are ignoring it, etc?

[Don Levit]

Steelerfan:

I can't comment on NJ specifically, but I am intrigued about NQDC as it relates to retiree health benefits for private and public employers.

I consider retiree health benefits very similarly to NQDC, in that neither benefit vests.

It is interesting that NJ wants to tax the deferrals before distributions, which is similar to the GASB and FASB declaring that retiree health benefits are actual liabilities, even if they are unfunded (and even if the benefits can be reduced or eliminated).

Don Levit

[Guest mjb]

Does anyone have any knowledge of what's going on with the NJ Division of Taxation on this issue and what employers are doing?

It appears that NJ is attempting to tax salary deferrals at the time of deferral, unlike the timing for federal taxes (at distribution). This is contrary to their prior stance that they would tax deferrals at distribution if the plan is unfunded, etc. Their theory seems now to be that employees are in constructive receive of the amounts when they are earned since they can control their deferral percentages. The law and regs in NJ may support this view, but they have flip flopped on their approach, creating an inconsistency in published guidance, and now won't clarify when they should be taxed.

This poses a problem for employers who don't have certainty as to when the requirement to withhold income taxes arises.

Anyone know how companies are handling this problem, or if they are ignoring it, etc?

What change in published guidance are you referring to?

NJ published guidelines in 2003 stating that employee contributions to all retirement plans including 457 plans and any other retirement plans other than a 401k plan were includible in income for NJ income tax. This statement has been included in the 2007 NJ 1040 resident return booklet on P 18 and has been included in the NJ 1040s for the last 2 years.

457 plans for non profit employers are treated the same as NQDC under 409A since the deferred amounts must be subject to the claims of the employer's creditors.

[XTitan]

I started looking into this last summer, and got as far as finding these old documents on the NJ web site that says NJ follows the federal law on constructive receipt for unfunded DCPs, but not for 457 plans. Hope this helps.

summer95.pdf

winter95.pdf

[Steelerfan]

mjb and XTitan have nicely laid out the problem. The earlier guidance follows federal constructive receipt rules and the later guidance, handbook, etc., state that contributions are taxed on the way into the plan. This is a massively unfair change in position with no discussion of the effect on employers who relied on the mid-90's guidance.

Now you can't even get through to anyone at customer service in the Division-there all busy taking gifts from vendors. And despite what mjb points out above, we recieved an email recently that verifies that salary deferrals in unfunded plans won't be taxed until distribution. NJ is a mess is many ways right now.

Don: good point, both are promises to pay a benefit in a future year, except keep in mind that accounting rules are separate from tax rules. Under a NQDC plan, employers can't recognize the liaility for purposes of tax deductions until the amount is acually paid to the individual. At least with retiree health care you have the option of immediate tax deductions.

[Guest mjb]

mjb and XTitan have nicely laid out the problem. The earlier guidance follows federal constructive receipt rules and the later guidance, handbook, etc., state that contributions are taxed on the way into the plan. This is a massively unfair change in position with no discussion of the effect on employers who relied on the mid-90's guidance.

Now you can't even get through to anyone at customer service in the Division-there all busy taking gifts from vendors. And despite what mjb points out above, we recieved an email recently that verifies that salary deferrals in unfunded plans won't be taxed until distribution. NJ is a mess is many ways right now.

Don: good point, both are promises to pay a benefit in a future year, except keep in mind that accounting rules are separate from tax rules. Under a NQDC plan, employers can't recognize the liaility for purposes of tax deductions until the amount is acually paid to the individual. At least with retiree health care you have the option of immediate tax deductions.

The 1995 NJ tax pubs misconstrue 457 plans as being solely a salary reduction plan where the employee selects the amount of the contribution which is not correct under IRS regs which provide that contributions can be made by employers instead of employees. I think the NJ tax dept opinion is based the NJ 457 plan for state employees which is funded solely by employee contributions without recognizing that NP 457 plans can permit employer contributions. Also why are 457f plan contributions taxed upon contribution under the 95 pubs when they are subject to the same risk of forfeiture as NQDC plans.

[Steelerfan]

Exactly, that rationale would apply to tax all NQDC salary deferrals, which is why my initial inclination had been to apply tax at the time of contribution. But the summer 95 bulletin made it clear they will follow the federal rules for all unfunded, etc plans. The later winter bulletin says, well, what we meant was we'll follow the federal rules except for 457 plans. I agree that it doesn't make sense, but it is what it is.

It's as if someone later realized they stuck their foot in their mouth and they won't acknowledge the gaffe. to top it off you still get inconsistent anwers. The other annoying thing is that the guidance you cited merely says that all employee contributions other than 401(k) are includible in income at time of contribution. As usual, rather than hit the problem head on, they buried a negative implication rule inside the guidance where most people don't even realizes it's there.

This mess has no clear answer, except that they seem to have, without explanation, concluded that they now won't follow the federal rules anymore. But is this enough to change an entire payroll practice?

The other thing about this is when PA tried to tax deferrals like this, there was practically a bloody revolution until they amended the statute to align with federal treatment. This is no small thing.