Question on 457(f) Taxation of distributions

[Guest Moni.maker]

Several years ago a 457f was set up for executive by setting up a "rabbi" trust which was funded with a one-time investment.

The earnings of this investment would be used to pay deferred compensation to the executive assuming employee stayed with employer for XX years and the original investment would be returned to employer at the end of agreement.

The Executive reached age 65 on April 1st 2014 and thus became 100% vested.

For illustration purposes let's assume the total trust account is now worth $300,000. $200K is the employee's portion and $100K was the original investment.

The agreement calls for a series of five annual distributions with the first payment due on January 1, 2015. The first payment is calculated to be 1/5 of the $200K balance due or $40K

Since the risk of forfeiture ended April 1st 2014 should the employee's W2 for 2014 include the entire amount of $200K? or just the $40K?

If so, would the distributions made in years 2,3,4 & 5 not be reported at all?

Thanks in advance

Moni

[Guest Moni.maker]

How does the employer report the $200K? Would it be reported in 2014 even though the first distribution wouldn't be til 2015?

As for the executive, how does he handle the $40K on the W2 in 2015 since he was already taxed on it. How about the $64K in 2016?

Thanks for your help.

[K2retire]

If it is taxable, but not reported, does anyone ever do it correctly?

[jpod]

In my experience, if a non-profit employer discusses the implications of 457(f) in advance with a competent professional it will know how 457(f) works and as a result will usually structure the deferred compensation to be paid in full upon vesting, thereby matching W-2 reporting and withholding with the taxable event. Installment payouts are fairly rare in these cases.

[Guest Moni.maker]

In my experience, if a non-profit employer discusses the implications of 457(f) in advance with a competent professional it will know how 457(f) works and as a result will usually structure the deferred compensation to be paid in full upon vesting, thereby matching W-2 reporting and withholding with the taxable event. Installment payouts are fairly rare in these cases.

It was originally structured to be a lump sum payment. But was amended by the attorneys to the five annual distributions in order to bring it into compliance with 409a I think

[Carol V. Calhoun]

I've deleted my comments above, because apparently the IRS has changed its position on reporting. The current instructions to the Form W-2 state as follows:

Box 1—Wages, tips, other compensation. Show the total taxable wages, tips, and other compensation (before any payroll deductions) that you paid to your employee during the year. However, do not include elective deferrals (such as employee contributions to a section 401(k) or 403(b) plan) except section 501©(18) contributions. Include the following...

15. Amounts includible in income under section 457(f) because the amounts are no longer subject to a substantial risk of forfeiture.

The amounts are also subject to Social Security and Medicare withholding as of the later of when the services giving rise to the deferral are performed or when there is no substantial forfeiture risk of the rights to the deferred amount. However, under Technical Advice Memorandum 199903032 (October 2, 1998), amounts are still subject to income tax withholding only when paid or made available. So in your situation, the whole $200K would be subject to reporting and Social Security and Medicare withholding in 2014. However, it would not be subject to income tax withholding until 2015 and later years, when it was actually paid out.

Our experience is that most employers modify their plans to provide a payout in the year of vesting at least equal to the income taxes owed, in order to prevent hardship on the employee. The employee can then elect additional withholding to have the entire amount of such payment withheld. Of course, the employee will still have overwithholding in 2015 and future years, but can recover that amount when the income tax return for each year is filed.