457(f) Payment Timing and Inclusion in Income

Payout provisions of 457(f) plan state that deferred amounts will vest on July 30, 2019, provided Exec is employed on that date, and the vested amount will be paid by March 15, 2020.  Plan goes on to state that this payment is intended to be a short-term deferral under 457(f) and 409(A). 

The payment is taxable to the recipient in 2019, even if paid out in 2020, right?  The law seems very straightforward on this to me, but I am confused about what relevance the short-term deferral language has (if any)?

Any input would be appreciated!

short-term deferrals, which are amounts paid soon after vesting, are generally exempt from most of 409A

Yes, payment is taxable in 2019. CuseFan has it right; the language about short-term deferrals is trying to avoid application of the of 409A to a simple payment.

Wouldn't it also be a short-term deferral exempt from 457(f) as well?

I had understood exemption as a short-term deferral under the proposed 457(f) regulations to result in taxation in the year the payment is actually made (i.e., you avoid the "early" taxation rules under 457(f) and the payment is taxed when actually or constructively received). So if it vests in 2019, but is exempt from 457(f), it's taxable in 2020 if paid in 2020. No?

[I re-worded because I didn;t like it before!]

I worked on a DC Plan with a "big law firm" and their position is consistent with EBECatty.  In other words, if you are deferring payment/taxation for a "short-term" that is ok.  If it were taxable immediately even if paid a short time later, there would be no value (or really meaning) to the rule.

I agree with EBECatty as to what the proposed regs seem to say. It's easy to miss because there are other statements in the proposed regs that just repeat the rule of the statute that it's includible in income when vests, but other verbiage seems to say that if the arrangement meets the 409A definition of "short-term deferral," there is no "deferral of compensation" for purposes of 457(f), so the inclusion would be under Sections 61 and 451 (i.e., when paid or constructively received), not 457(f) (when vested) . Unfortunately, I don't think any of the examples actually nail this important and surprising point down. With any luck, IRS will illustrate with a clear example in the final regs. Even more unfortunately, I don't think the proposed regs have a provision clearly giving you reliance before they come final, and the rule in question seems contrary to the statute. On the other hand, the preamble seems to give you reliance, or at least contains the following two sentences, which to me seem somewhat contradictory:

"No implication is intended regarding application of the law before these proposed regulations become applicable. Taxpayers may rely on these proposed regulations until the applicability date."

Just focusing on the taxation aspect, wouldn’t FICA be due in 2019 and income taxes be due in the year paid in 2020?

Yes - and as someone pointed out this is a good thing!  You typically delay payment like this to defer payment into a year when there is no other income.

And if you defer payment into a year with no other income for FICA then all of a sudden you owe SS taxes.  If on the other hand you pay FICA taxes there is no longer a substantial risk of forfeiture, the exec will "almost certainly" be over the SSTWB.

You get the best of both worlds!

Cardscrazy, I don't know of anything that specifically covers this, but I will vote for/guess that FICA would also be delayed in this instance to 2020. Footnote 11 of the proposed regs says the proposed regs don't apply for 3121(v) FICA tax on deferred comp rules, but if there is no "deferral of compensation" under 457(f), I think you would just be under the general wage payment time rules for FICA, not the 3121(v) rules. Not completely clear, and again, the regs are only proposed, so follow your own counsel.

I see that austin3515 thinks FICA in 2019. He may be right. Not clear what IRS intended or that it thought about this, but again under the proposed 457(f) regs, if there is a 409A short-term deferral, there would be no "deferral of compensation" for 457(f) either. So if the 457(f) regs became final without change on that point, you would have to take the position that something that was not a "deferral of compensation" for purposes of 457(f) was for purposes of 3121(v) and its regs, which use exactly the same phrase, i.e., "deferral of compensation." Seems unlikely to me that IRS would do that. Interesting question though. Since FICA in 2020 would be an inference from proposed regs, and otherwise FICA would be imposed in 2019, there is probably support for inclusion in either year.

Thank you all for your input!  What I'm hung up on is that if the payment is taxable in 2020, and not 2019 when it vests, the short-term deferral rule seems to be sort of exempting the entire deferred compensation amount from 457(f). Isn't it?  My interpretation has been that the act of paying the amount in 2020, instead of 2019, is exempt under the short-term deferral rule from being considered another deferral, i.e. a subsequent deferral. I'm having a hard time wrapping my around the idea that by paying the payment within the first 2.5 mos of the 2020 the 457(f) requirement of taxation upon vesting would not apply.

And a provision in a plan allowing discretion to pay deferred comp in one year or another is not permissible. But interpreting this as allowing the payment to be taxed in 2020 if paid in 2020 is doing exactly that. Isn't it?

To be clear, an ERISA attorney wrote me a fairly lengthy email explaining her position as described above.  Because it is both more conservative and generally better for the participant, it seems like a good approach!

The payment is a deferred comp amount "promised" 4 or 5 years ago via a written agreement. How can application of the short-term deferral rule result in no deferral of income under 457(f)?  There's no further deferral of income, but that would make the payment taxable in the year it vests (2019), right?

Don't hesitate to tell me I'm wrong here! I just want to make sure we're all on the same page with the facts of the situation.

It's not "another deferral."  If something is not vested (i.e., someone has absolutely no right to it) it's not a deferral at all.  The only deferral is the delay between the date the benefit vests and the date it is paid.

3 minutes ago, kmhaab said:

The payment is a deferred comp amount "promised" 4 or 5 years ago via a written agreement

The promise that was made was "If you stay with us for 4 or 5 years" THEN we will give something to you.  There was nothing of any value provided on day 1.  Only the mere possibility of value in 5 years time.  And the IRS says that's not anything at all.  That's the whole point of the language "substantial risk of forfeiture."

2 hours ago, kmhaab said:

And a provision in a plan allowing discretion to pay deferred comp in one year or another is not permissible. But interpreting this as allowing the payment to be taxed in 2020 if paid in 2020 is doing exactly that. Isn't it?

Right, kmhaab. For the STD rule to apply, the participant cannot have a choice about when to land the income. For example, if the plan you are dealing with said that the amount would be paid when it vests, it would appear to be includable in 2019. We are assuming above that under the arrangement as written the payment could be made by the obligor no later than 3/15/2020, but is not required to be paid in 2019, i.e., the STD standard.

2 hours ago, kmhaab said:

What I'm hung up on is that if the payment is taxable in 2020, and not 2019 when it vests, the short-term deferral rule seems to be sort of exempting the entire deferred compensation amount from 457(f). Isn't it?  My interpretation has been that the act of paying the amount in 2020, instead of 2019, is exempt under the short-term deferral rule from being considered another deferral, i.e. a subsequent deferral. I'm having a hard time wrapping my around the idea that by paying the payment within the first 2.5 mos of the 2020 the 457(f) requirement of taxation upon vesting would not apply.

Look at Prop. Reg. Section 1.457-12(d)(2). It's on page 19 of the Federal Register .pdf, which you can easily Google. Again, these are proposed regs. They could be a lot clearer, as I stated earlier, and the principle is not illustrated by an example, but I think you will find that if there is no "deferral of compensation" for purposes of Section 457(f), then 61 and 451 are applicable, not 457(f). But (a) again, these are only proposed regs, and (b) maybe you will interpret the point differently.

For purposes of section 457(f) and this section, a deferral of compensation does not occur under a plan with respect to any payment for which a deferral of compensation does not occur under section 409A pursuant to § 1.409A–1(b)(4) (short-term deferrals), ...

Circling back here, I've looked at the proposed 409A/457(f) regs in more detail, and am even more unclear now, particularly on the short-term deferral aspect. I must be either misreading or misunderstanding some aspect. 

The proposed 457(f) regs say that a short-term deferral under 1.409A-1(b)(4) is also a short-term deferral under 457(f). (Set aside for now the differences in the definition of SROF between 409A and 457(f).)

At the same time, IRS issued proposed 409A regulations saying that for all purposes of 409A, including whether a "payment" is made for purposes of being a short-term deferral, income inclusion under 457(f) counts as a payment. 

In the situation discussed in the posts above, you have a "payment" (both actual and income inclusion) within the short-term deferral period. This seems to easily satisfy both the 409A and 457(f) short-term deferral exemptions.

How about a situation where payment is made after vesting, say employee is given a right during 2019 to a $100,000 payment on January 1, 2025, that is never subject to a SROF. My understanding has always been--and continues to be--that vesting results in taxation under 457(f) in 2019. The PV of the future payment is income in 2019, then the actual payment in 2025 is taxed under section 72.

But the proposed regs seem circular. If you have a vested right in 2019 to a payment that will not be made before March 15, 2020, it's taxed under 457(f) in 2019. But if you include the vested amount in the employee's income in 2019, it's taxed under 457(f) before March 15, 2020. If the amount is taxed under 457(f) within the 409A short-term deferral period (i.e., before March 15, 2020), it's also a short-term deferral under 457(f). If it's a short-term deferral it's not subject to 457(f). 

Footnote 2 of the 409A proposed regs seems to say that this would be a short-term deferral for 409A (except earnings accruing after vesting) but is not perfectly clear whether it's also a short-term deferral under 457(f). The first sentence suggests yes, but the ultimate outcome suggests no. 

Maybe it's a short-term deferral under 409A but not 457(f), i.e., the 409A definition incorporated in the proposed 457(f) regs does not circle back to create a 457(f) short-term deferral?

What am I missing?

EBECatty, I found this all very confusing as well when I read the 457(f) proposed regs way back when. I am reasonably sure that in your example, yes, the individual would be taxed in 2019, so there is no deferral at all. No NQDCP subject to 409A, no short-term deferral. Just income. And of course, the earnings on the unpaid amount (e.g., the whole thing in your example, or the after-tax amount if they paid the individual an amount equal to his/her taxes) would become NQDCP under the rule that doesn't include vested earnings until payment, so you'd want to comply with 409A for the earnings, which in your example you would since you have the fixed 2025 payment year.

EBECatty - Yes! Your second illustration is what is so confusing to me -

"But the proposed regs seem circular. If you have a vested right in 2019 to a payment that will not be made before March 15, 2020, it's taxed under 457(f) in 2019. But if you include the vested amount in the employee's income in 2019, it's taxed under 457(f) before March 15, 2020. If the amount is taxed under 457(f) within the 409A short-term deferral period (i.e., before March 15, 2020), it's also a short-term deferral under 457(f). If it's a short-term deferral it's not subject to 457(f)."

How could deferring payment of a vested 457(f) benefit payment into the following year cause the payment not to be subject to 457(f) at all? In addition to being circular, it doesn't make any sense to me.  In a scenario where the plan doc says payment vesting in June 2019 will be made prior to March 15, 2010, if the payment is taxed in 2020 when paid out in 2020 or taxed in 2019 when paid out in 2019, the employer has the discretion to determine the year of taxation which is generally contrary to 409A and 457(f) principles.

I have a client that really wants a payment vesting in 2019 to be paid and taxed in 2020, but I just can't get comfortable giving that advice. Am I being too conservative? 

kmhaab, I'm comfortable with the "true" short-term deferral that includes vesting in 2019 and actual payment before March 15, 2020. I think that's clearly exempt from both 409A/457(f) and can be taxed in the year of payment (provided the employee doesn't have the ability to choose). 

Luke, I'm glad it's not just me. Part of what still mystifies me is that, if we're assuming the payment is not subject to 409A (and meets the short-term deferral exemption, whether needed or not), then it's also a short-term deferral exempt from 457(f) under the proposed regs. Exemption from 457(f) would kick the payments back into the normal 61/451 timing rules, but in that case you wouldn't have taxed the payment under 457(f) upon vesting in 2019 (because it's not made until 2025), and therefore wouldn't be exempt from 409A as a short-term deferral because no "payment" has been made via 457(f) taxation, which would then take away the 457(f) short-term deferral, which would put you back under 457(f), which would require upon vesting taxation in 2019, which would exempt you from 409A, etc., etc. ad nauseam. 

I haven't read every word of every post here, but isn't this the analysis:

If it's a ST Deferral, it is not "deferred compensation" and, therefore, it isn't subject to 457(f) in the first place, the same result as 409A.  I also think the same rule is in the 3121(v) regs, i.e., it is not "deferred compensation" for purposes of 3121.      

jpod, with respect to the OP, yes I think that much is settled. 

The thread came back up again under slightly different circumstances today.