July 11, 2008

Update: Revised 409A IRS guidance on salary deferrals

Source: President Dick Iannuzzi

In August 2007, the NYSUT Leader and the New York Teacher published an article, reporting on a new IRS requirement applicable to school employees who elect to defer a portion of their salary between tax (calendar) years. (See, August 2007 article titled "IRS Guidance on Tax Law Changes Affecting School Employees Who Opt to Receive Salary over 12 Months"). On July 1, 2008, the IRS published Notice 2008-62, which significantly revisesits prior 2007 guidance concerning the manner in which deferred compensation for 10-month school employees should be treated under Internal Revenue Code ("Code") Section 409A.

Under the IRS's revised guidance, effective beginning with the 2008-2009 school year, if a school employee receives compensation that is reasonably anticipated to continue over into a subsequent tax (calendar) year, the deferred amounts would notbe considered "deferred compensation" for purposes of Code Section 409A (which under the prior IRS rule required an election form to be signed), provided the following twoconditions are met:

  1. Payment by a school district of the deferred salary amount must be made by no later than the last day of the 13th month following the beginning of the service period (school year). Thus, for the 2008-2009 school year, payment of any portion of the salary earned during the period of September through December 2008, which is deferred beyond December 31, 2008, must be made by the school district by August 31, 2009.
  2. The salary amount deferred cannot exceed the applicable IRS elective deferral dollar limit in effect for the calendar year in which the service period (school year) begins. For the 2008 year, the maximum deferral limit is $15,500. After 2008, the maximum deferral amount may increase, based upon an applicable cost-of-living change.

Thus if the above two conditions are met, a school employee who defers a portion of his/her earned salary between tax (calendar) years, that employee would neither be subject to the potential extra taxes (under Code Section 409A), nor be required to sign the irrevocable election form which, as earlier noted, was required by the IRS in its previous (2007) guidance.

The following example reflects the impact of the revised IRS guidance:

Example: During a normal school year that starts September 1, 2008, and ends June 30, 2009, (10 months) a school employee earns $54,000 per year. Unless the school employee elects to defer a portion of his/her annual salary, the Education Law provides that the school employee must be paid over 10 months ($5,400 per month). Accordingly, absent a deferral, the school employee would receive $21,600 in 2008 for the 4 months of September through December, and would receive $32,400 in 2009 for the 6 months of January through June. If instead, the school employee elects to defer a portion of the salary earned during the 4 months of September through December to the following calendar year (in order to, for instance, receive a larger or multiple salary checks at or near the end of the 2008-2009 school year, but before August 31, 2009), unless the amount deferred to the 2009 tax (calendar) year is in excess of $15,500, the new IRS guidance eliminatesthe need for the school employee to execute a salary deferral election form to avoid income tax and potential penalties.

The revised IRS advisory should be applicable to virtually all school employees, since in order notto be covered by the revised IRS guidance, a 10-month school employee would have to have annual compensation exceeding $232,500 (for 2008).

The IRS guidance only pertains to the federal tax consequences of salary deferrals and the processes associated with that subject. Whether salary deferral election forms are required by local school district practice or by a local association's labor agreement remain unaffected by the IRS notice.

Additional information on this subject may be obtained through your local's NYSUT Labor Relation Specialist.

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