Short-Term Deferral Exception / 457f

[austin3515]

OK, I am missing something.  The new proposed regs indicate that Short-Term deferrals are not subject to 457f.  Short-term deferrals are deferrals that are paid shortly after they become vested.  Because 457f's are taxable when they vest, we always payout shortly after they become vested.

So what would be a 457f plan?  And why don't any of these articles address that question?

[jpod]

A short term deferral is not considered deferred compensation for purposes of Section 457(f); consequently, they are taxed when received (or constructively received), not when vested.  A deferral that is not a short term deferral is subject to 457(f) (unless it means another exception). 

[austin3515]

But do you see where my question is coming from?  If a plan puts away $50,000 a year for 5 years, the money vests on the 5th anniversary, and the plan pays out $250,000 plus interest 30 days after it vests, what kind of a plan is that?  I would have told you that was a plain vanilla 457f plan.  I didn't think there was any other way to run a 457f plan because the monies are taxable as soon as they vest.

By the way I know I am missing something simple and basic, so please do talk to me like I don't know anything!

[XTitan]

I've seen 457(f) plans with post-vesting distributions.  I've seen 457(f) plans with installment payments.  Expecting to see 457(f) plans with voluntary deferrals.  It may not make sense from a tax perspective (to the participant), but the employer may have their own reasons for the designs. 

On the other hand, a short-term deferral arrangement + an inadvertent operational error = possible need to comply with 457(f)/409A, so a catch-all provision might just make some sense.. 

 

[EBECatty]

I was working with a 457(f) plan just yesterday that vested an executive in 15 annual installments upon reaching age 65 while employed. The plan made a tax distribution upon vesting to cover the present value of the 15-year payout. I didn't design the plan, but there are definitely some out there that don't meet the short-term deferral exception. 

[Carol V. Calhoun]

A few thoughts:

• As others have discussed, some 457(f) plans pay out later than they vest, for non-tax-related reasons.
• Although deferrals are taxed when they become vested, income accrued thereafter is not subject to immediate taxation.  Thus, the payment of that income may be subject to 409A.
• A substantial risk of forfeiture can exist for purposes of 457(f) based on a noncompete agreement under certain circumstances.  Such an agreement can never postpone the SRF for 409A purposes.  So it is possible to have an agreement under which the amount is paid out when the SRF lapses for 457(f) purposes, and still have the agreement considered deferred compensation for 409A purposes.

[austin3515]

Very very helpful, thanks!  I had heard of all of these things, I guess I'm just surprised to hear that they are all that common. I guess I'm keeping it simple which is a good thing, though I do know enough to call in the experts when needed.

[austin3515]

Bumping up again with a follow-up...

Executive gets $50,000 a year for 5 years, which becomes vested on 6/30/2022.  Under the short-term deferral exception, I can have that paid say, 2/28/2023 and that is ok, correct? The distribution is taxed when received, in 2023?

[EBECatty]

Correct.

As a follow-up to your follow-up, I'm a bit confused about the related FICA short-term deferral rule. Using your same facts, FICA taxes would generally be due on all $250,000 on June 30, 2022 (later of the date of services performed or lapse of risk of forfeiture). This is true even if the amount is not paid until February 28, 2023.

There's a short-term deferral exception in 31.3121(v)-1(b)(3)(iii), but it defines the short-term deferral period a little differently than 457(f)/409A. It refers to 1.404(b)-1T, but the upshot is that a "short-term deferral" under the FICA rules seems to be defined only in terms of deferring compensation until shortly after the end of the year in which the services were performed (not the later of performance of services or lapse of risk of forfeiture).

So if the facts were "remain employed through December 31, 2017, and we'll pay you $10,000 on March 1, 2018," you could choose to pay FICA taxes on December 31, 2017, or March 1, 2018. But the short-term deferral aspect is tied to March 15 following the year the employee performs services, and doesn't seem to allow a short-term deferral based on the year of vesting.

Going back to your example, it seems then that the FICA taxes would always be due on June 30, 2022, and you wouldn't have the option to use the FICA short-term deferral even if you wanted.

Anyone have thoughts or authority otherwise?

[XTitan]

I think you have an argument for a discount factor on the $250,000.  Also, if you believe you can combine the rule of administrative convenience plus the lag rule, you might be able to wait until distribution to deduct the lump sum FICA.  Being in the later tax year may cause the FICA to include OASDI while keeping the payment at vesting may allow a deduction only for HI (assuming the exec is already at or above the SSWB in June).

Back to Austin's question - the exec should not be given the option to select the tax year to receive the distribution.  That goes to constructive receipt issues that still exist outside of 409A.

[EBECatty]

Thanks. I hadn't considered combining those two.

[austin3515]

So wait, do we all agree that the FICA is due on 6/30/2022?  My vesting date needs to be in June.

[EBECatty]

Under the default FICA rules, yes.