New 21% Excise Tax & Nongovernmental 457(b) Plans

Hoping someone can help clarify what I think I must be missing.

What's the impact of nongovernmental 457(b) plans under the new 21% excise tax on $1,000,000+ of compensation paid by exempt organizations. (All 457(b) distributions are excluded for the "excess parachute payment" tax.)

The new Code Section 4960 applies the $1,000,000 excise tax on "so much of the remuneration paid...by an applicable tax-exempt organization for the taxable year with respect to employment of any covered employee in excess of $1,000,000.... For purposes of the preceding sentence, remuneration shall be treated as paid when there is no substantial risk of forfeiture (within the meaning of section 457(f)(3)(B)) of the rights to such remuneration."

The term "remuneration" is defined as "wages (as defined in section 3401(a)), except that such term shall not include any designated Roth contribution (as defined in section 402A(c)) and shall include amounts required to be included in gross income under section 457(f)."

I've seen a few pieces of commentary saying that nongovernmental 457(b) plan balances will be included for purposes of the $1,000,000 excise tax when they are no longer subject to a substantial risk of forfeiture, i.e., when they become vested. However, the new Code Section 4960 only references immediate inclusion of amounts that become vested under Section 457(f). Separately, deferrals or contributions into nongovernmental 457(b) plans are not "wages" under 3401(a), but distributions from nongovernmental 457(b) plans are "wages" under 3401(a).

So it seems to me that all contributions (deferrals or employer contributions) into nongovernmental 457(b) plans would not be included, even when vested if later, but that all distributions from nongovernmental 457(b) plans would be counted in the year of distribution.

Am I missing something?

I agree.  The general rule is that an amount is tested when it is included in W-2 income.  In the case of a 457(b) plan, that would be when it is paid out.

That gives you more flexibility in the case of a 457(b) plan than in the case of a 457(f) plan.  The issue with the 457(f) is that you can't defer after it vests, which means that it will be included in income in a year in which the person also has income from employment--which means you're more likely to push total income over the $1 million cap.  Your best bet if that is an issue is probably to have the person become a part-time consultant after termination of employment, and have vesting under the 457(f) dependent on continued consulting services.  However, that's a delicate maneuver, since the consulting services required have to be substantial, but if they are too substantial, the income from them may still be high enough to trigger the $1 million cap.

By contrast, with a 457(b) plan, the employee can make an election to defer receipt until after termination of employment.

If you're interested, I wrote a piece on the application of the law, which included this.  Here is the link.

Thanks Carol. Glad to hear I'm not losing it...

I agree this provides some planning opportunities under 457(f) and appreciate the link. Very helpful.

Thanks for the thought provoking posts. I hadn't thought through 4960 from a 457(b) perspective very much to this point, and have yet to provide any advice to anyone on the subject, so I have no skin in the game, so to speak, on the how this issue should be resolved. 

With that, my two cents:

Perhaps I'm missing some principle of statutory construction, but I think there's as much (or more) room to argue that the phrase "remuneration shall be treated as paid when there is no substantial risk of forfeiture" clearly establishes the timing of recognition, while defining remuneration as "wages (as defined in section 3401(a))" is just that, definitional, and has nothing to do, by it's own terms, with timing. 

I get it that the structure of the statute as to 457(b) misses the mark - does 457(b) fall down between the chairs as not being remuneration because in the vast majority of cases the substantial risk of forfeiture lapses well before it is recognized as wages withing the meaning of 3401(a)? Do you "read in" that it is remuneration when the SRF lapses because at some future date it will be recognized as wages to keep 457(b) benefits from being excluded entirely (or "read in" the alternative, that it's recognized at the time that it becomes wages in spite of the explicit timing rule)? 

I'm hoping that some future technical corrections bill will clarify the timing (or, perhaps wishful thinking, exclude 457(b) entirely).

Interesting take, thanks. I don't have any skin in the game either; just trying to understand the right timing. I agree clarification would help, and hopefully we'll get some.

I see your point regarding the explicit timing rule in new section 4960 vs. the (existing, and unchanged) definitional rule that 457(b) plan distributions are wages under 3401(a).

Under that reading (1) remuneration is anything that falls under a type of pay that constitutes wages (as the term "wages" is defined in 3401(a)), and (2) any item of pay that falls under one of those categories is counted as "remuneration" as soon as it's no longer subject to a substantial risk of forfeiture, even if not paid until a later year.

That approach would also seem to include, say, a bonus that is declared and vested on December 15, 2018, but not paid until March 1, 2019. It would be exempt from 457(f) and would be reported for income and FICA purposes in 2019, but would be a type of pay that's defined as "wages" under 3401(a), and never subject to forfeiture, requiring inclusion as "remuneration" in 2018.

Seems like it will create headaches if we're counting "remuneration" before inclusion in W-2 wages (and then excluding it when reported on W-2).

Interesting point how taking one position as opposed to another would affect recognition of short term deferral items, such as bonuses. Illustrates all the more how problematic the wording of the statute is.

Maybe the fix is to recognize remuneration under 3121 rather than 3401? I believe the effect of that would be that 457(b) would be recognized in the year no longer subject to SRF, and short term deferral bonuses would get recognized in the year paid.

Would certainly benefit from some additional guidance. Hopefully we'll get it!