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The American Payroll Association won a very important victory that allows educational institutions to continue to pay their employees over a longer period (such as one year) than the period during which they work (such as the 9-month school year) without the pay being subjected to an extra 20% tax under new rules on nonqualified deferred compensation (NQDC).
Under these rules, an employee choosing annualized pay must make an affirmative election with the employer before the first day of work in order to avoid the extra tax. APA was working with IRS on the details of this election process, but we were also stressing the limited time that remained for IRS and APA to inform employers, for employers to inform employees, and for employees to complete the election forms.
On August 7, IRS issued Information Release 2007-142, which suspends the election requirement for school years beginning before January 1, 2008.
APA appreciates the suspension, but we intend to continue our lobbying efforts to completely exclude the practice of annualizing teachers' pay from the definition of NQDC.
Why would this pay be subject to an extra 20% tax?
The annualizing of pay by many educational institutions got caught under the definitions of a law meant to address executive pay programs that defer compensation from one year to another, but that might evade taxation or take advantage of rank-and-file workers.
Congress passed the law in the wake of the Enron and other accounting scandals, and it has a stiff penalty (20% extra tax) if all the new rules aren't followed. These rules include obtaining employee elections prior to the period of service.
Many employees of educational institutions prefer to have their pay "stretched out" to make it easier to meet their monthly expenses over the summer months and to have their deductions for employer benefit programs, such as health insurance, evenly spread out over the year. A train wreck was headed their way, but APA kept the long-standing payroll practice on track!
Meanwhile, how does this affect you right now?
Here are answers to the most common questions APA been getting:
- Schools are not required to offer their employees a choice between being paid over just the school year and being paid over a longer period.
- If you do offer a choice, it can include multiple options besides being paid over just the school year, such as being paid over a 10-, 11-, or 12-month period.
- If you do offer a choice, you must set forth in writing by January 1, 2008, how the employees are to be paid for the compensation earned for the rest of the school year.
What about the 2008-2009 school year? - As the rules stand right now, if you offer a choice of pay plans, you will need to write a plan document and collect employee elections before the beginning of the work period.
- An employee's election is irrevocable with respect to that period of service (the school year).
- If you offer a choice of pay plans, you will need to determine one method by which you will pay all employees who do not submit an election before the beginning of the work period.
- If you don't offer a choice, then your pay plan will not be considered NQDC, whether you pay over the school year or over a longer period, and employee election forms will not be required.
- Read more details in the Information Release and the Frequently Asked Questions.
Further APA lobbying efforts will be revealed at APA's Educational Institutions Payroll Conference.
Falling under the definition of NQDC brings some other responsibilities, such as special reporting of amounts deferred on Form W-2 (box 12, Code Y). Because IRS has not yet issued specific reporting guidance, APA has won suspension of this requirement for tax-years 2005 and 2006, but the requirement will be implemented at some point. In addition, amounts deferred under a NQDC plan may be subject to Social Security and Medicare tax even before they are paid!
APA feels that the practice of annualizing of teachers' pay was not what Congress was worried about when it wrote the law on NQDC, and APA will further lobby IRS to exclude this practice from the definition of NQDC. 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 in Grapevine, Texas.
Read APA testimony and IRS final regulations
When Congress originally passed the law, APA recognized that educational institutions could be snagged by it. Knowing that IRS had to fine-tune the rules gave us the perfect opportunity to lobby for an exemption.
APA was the only organization to address this issue in either written comments or oral testimony. Read our testimony and be sure to read the last two paragraphs on page four. The mention of March 15 in the final sentence is significant because, generally, amounts deferred from one year to the next but paid by the 15th day of the third month of the second year will avoid definition as NQDC.
Read the final regulation defining NQDC here.
This topic is discussed in the preamble (page 22 of the pdf, bottom of the third column) and in the regulations themselves (page 72 of the pdf; bottom of the third column). IRS has published some technical corrections to this regulation, but this topic was not affected.
Although the regulation doesn't take effect until January 1, 2008, if it weren't for the recent relief from IRS, the election requirement still would have applied to the 2007-2008 school year, based on IRS's first guidance on NQDC, Notice 2005-1.
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