IRS Issues Real Relief to School Districts from New Deferred Compensation Rules
2008-07/02 Mary Ellen Schill

In a communication dated August 20, 2007, we alerted our school district clients and friends about an IRS press release which postponed until the beginning of the 2008 school year the applicability of the “new” deferred compensation plan rules under Code Section 409A to compensation paid to school district employees where an election to “annualize” their compensation is offered.  It is a common practice for school districts to allow employees to make an annual election to have their 9 months of salary paid over a 12-month period.  Final regulations under Code Section 409A issued in April 2007 have been interpreted to subject this practice to the election rules of Code Section 409A.  Today, the IRS has issued Notice 2008 62 which states that the IRS intends to issue proposed regulations under both Code Section 409A and Code Section 457(f) which would exclude from both Code Sections arrangements where employees are paid part year compensation over a period which exceeds that part year service period.  Code Section 457 governs deferred compensation plans maintained by school districts.  The exclusion would apply in the cases where the payment over the longer period is made at the employee’s election, or is automatic.

In order for an “annualized” compensation payment method to be exempt from both Code Section 409A and 457(f), the arrangement 1) cannot defer payment of any of the recurring part year compensation beyond the last day of the 13th month following the beginning of the service period (i.e. the beginning of the school year), and 2) cannot defer from one taxable year to another the payment of more than the applicable dollar amount under Code Section 402(g)(1)(B) in effect for the calendar year in which the service period begins ($15,500 for 2008).  The limit under Code Section 402(g)(1)(B) is the limit on employee deferrals under 401(k) plans and 403(b) plans.  For the standard teacher compensation arrangement then, generally this means that so long as the amount that is paid in the second calendar year that was earned in the first calendar year does not exceed the Code Section 402(g)(1)(B) limit, then the arrangement is exempt.

As an example, the Notice states that if the service period begins August 1, 2008, and ends on May 31, 2009, the teacher is paid over the 12 month period beginning August 1, 2008 and ending July 31, 2009 (whether because the district automatically pays that way or the teacher elects to be paid that way), then so long as the teacher earns no more than $186,000 for the 10 month school year, the arrangement should be exempt.  This is because for 5 months’ work in 2008 the teacher earned $93,000 (1/2 of $186,000), but was paid only $77,500 (5/12 of $186,000).  Therefore, $15,500 ($93,000 -  $77,500) was deferred from 2008 to 2009, and $15,500 is the maximum deferral allowed to still meet the exception.  The example is based on the assumption that compensation is paid ratably over the year, back loading of compensation would result in larger deferral into the second calendar year and a greater likelihood of going over the $15,500 limit (for 2008).

Until the proposed regulations under Code Sections 409A and 457(f) are issued, taxpayers can rely on this Notice retroactive to January 1, 2008.  This means that provided the requirements for the exemption as described above are met, teachers will NOT have to make written irrevocable elections as to how their compensation is paid for the 2008 2009 school year prior to the beginning of the school year, as previously required under the IRS guidance issued last August.

Attorney Mary Ellen Schill prepared this alert.  Please direct your questions regarding the content of this alert to any of the attorneys within the Employment, Labor & Benefits Practice Group:  Ron Rutlin, Dean Dietrich, Jeff Jones, Mary Ellen Schill, Chris Toner, or Sara Ackermann.

© 2008 Ruder Ware, L.L.S.C. Accurate reproduction with acknowledgment granted. All rights reserved.
This document provides information of a general nature regarding legislative or other legal developments. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations, or issues, and additional facts and information or future developments may affect the subjects addressed.