Teacher Pay Treated As Deferred Compensation
School Advisor, 2007 Issue No. 3

IRS Indicates No Changes Are Required Before 2008

As a result of the corporate scandals at the beginning of the decade, Congress passed tough rules aimed at restricting many forms of deferred compensation, and the IRS issued final regulations covering these "409A" rules in April 2007.

Surprise: The new rules may affect teacher and other school employee pay. Yes, the rules are so broad that if a school employee — who works only during the school year and would normally receive pay over the school year — is allowed to elect to be paid over a 12-month period, then they will be affected by these rules.

The Issue

Under the 409A rules, if a teacher elects to be paid over 12 months instead of over the school year, then there is technically a deferral of some pay from one calendar year to another. For example, since services for the 2008 school year begin in 2007, some of the salary that would otherwise be paid in 2007 would be deferred until 2008.

Many districts default to paying all staff over a 12-month period, and allow those employees who only work during the school year to elect to be paid over that shorter period. The 409A deferred compensation rules still apply. In this case, the default pay method would be interpreted as deferred compensation, and the 409A rules generally limit the ability to accelerate compensation payment once services are performed. If teachers are allowed to initiate a change during the school year to be paid only over the school year, an impermissible acceleration could occur.

The penalty for a 409A violation is immediate taxation of the deferred amount, a 20 percent penalty tax, and perhaps an interest penalty. The penalties are assessed to the employee.

Safe Harbor

First, the IRS has indicated that since the 409A final rules are not applicable until January 1, 2008, no changes need to be made currently in the way employees are paid.

Second, IRS guidance indicates that a district will be in compliance with the 409A rules if:

• A default method of payment is established — generally this will be either pay over a 12-month period or over the school year.
• Employees who are allowed a choice must provide a written (or electronic) election of the alternative pay method that specifies payment amount and timing. For instance, an election to receive salary and other scheduled payments ratably over 26 biweekly pay dates.
• The election must be made before the employee performs services for the school year (before preschool preparation or "in-service" days begin in August, and before coaching duties begin, if an election is available to defer any coaching stipend past the end of the calendar year).
• The election must be irrevocable.

Employee "evergreen elections," which continue in effect year after year until changed, are permitted. If an employee misses the election deadline, then they must be paid with the default method of payment.

If you have questions, please contact Bruce Delbecq at 248.375.7276 or bruce.delbecq@plantemoran.com.

Additional guidance can be found on the IRS website at: http://www.irs.gov/newsroom/article/0,,id=172883,00.html.