New Deferred Compensation Rules for Faculty to Take Effect Next Year
August 7, 2007
Schools, colleges, and other institutions that spread compensation over 12 months for teaching staff who work for a 9-month period will have additional time to comply with recent changes to Internal Revenue Service rules on deferred compensation. The IRS clarified on August 7 that the rules requiring such employees to make an irrevocable election prior to the start of the academic year will not take effect until periods beginning on or after January 1, 2008. The IRS also provided answers to frequently asked questions about the applicability of the rules to teachers.
In April, the IRS issued rules on nonqualified deferred compensation plans to implement statutory changes enacted in 2004. While Congress was primarily concerned with corporate practices deferring executive pay into another tax year, the annualizing of pay by many educational institutions was also included under the definitions. The potential penalty for failure to comply with the rules for nonqualified deferred compensation is significant--an additional 20 percent income tax levied on the employee's compensation if the requirements of the section 409A regulations are not met.
Basically, under the rules, if the institution offers part-year employees an option to have their pay annualized over 12 months, the employee must make a deliberate election to have his or her compensation paid out across that time period. The election must be:
- in writing, including e-mail or other electronic means;
- completed prior to the beginning of the work period, such as the first day of classes for a teacher; and
- irrevocable, so that it cannot be changed once the work period begins.
Elections do not need to be restated each year. Nor is the institution required to offer employees the option of spreading out compensation. If employees are not provided with a choice and the institution mandates that all employees working a 9-month schedule will be paid over 12 months, the election form is not needed. The institution must have a written, nonqualified deferred compensation plan, but the plan need not be elaborate and can be incorporated into other documents or included on the election form. Certain employee W2 form reporting obligations apply to the deferred amounts.
If the institution offers a choice, however, and an employee fails to make the election prior to the start of the work period, the employee should be paid compensation as earned or he or she will be faced with a 20-percent income tax penalty. This may make it more difficult to collect employee contributions for employee benefit programs such as health insurance.
The American Payroll Association and others have worked to help the IRS craft rules that make sense for educational institutions and they will continue to do so. These efforts will be discussed in the workshop, "Nonqualified Deferred Compensation: Executive Pay in the Education Industry," at APA's Educational Institutions Payroll Conference, October 14-17.
Note: The special provision on "Elections to Annualize Recurring Part-Year Compensation" is discussed on page19254-55 of the April 17 Federal Register notice; the provision is found at sec. 1.409A-2(a)(14) on page 19304-05. On July 31, the IRS published four pages of corrections to the April 17 final regulations.
NACUBO Contact: Mary Bachinger, director, tax policy, 202.861.2581
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