Choice of Pay Plan at Educational Institutions Is NOT Nonqualified Deferred Compensation

APA victorious just in time for school year

By Scott Mezistrano, CPP

APA recently won a very important victory in Congress that allows educational institutions to continue to give their employees a choice of pay schedule, without that choice creating nonqualified deferred compensation (NQDC). By avoiding definition as NQDC, the employer avoids the burdens of creating plan documents and pay schedule election forms and collecting those forms by the first day of the school year. The employee also avoids the possibility of an extra 20% tax on his or her wages if all the complex rules that govern NQDC are not followed.

Internal Revenue Service Notice 2008-62 describes a rule that the U.S. Treasury Department and the IRS plan to include in future regulations, but that employers may now rely on for the 2008-2009 school year.

Choice of Pay Plan

Many schools, colleges, and universities offer their employees a choice between being paid over the school year or a longer period (such as 10, 11, or 12 months). Many employees of educational institutions prefer to have their pay "stretched out" (also called "annualizing") 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.

Unfortunately, this choice of pay schedule got caught under the definitions in 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 of its rules aren't followed.

APA had been lobbying to get this practice, common among educational institutions, out from under the definition of deferred compensation, saying that the annualizing of teachers' pay was not what Congress was worried about when it wrote the law on NQDC.

Specifics of IRS Notice

Two conditions must be met in order for the annualizing of pay to be free from being considered NQDC:

*All wages for the year of service (which may begin before the first day of classes) must be paid by the last day of the 13th month following the beginning of the service period.
*The amount of wages that are deferred from one taxable year to the next taxable year (which is what IRS considers to happen when the wages are "stretched out") must not exceed the limit on employee contributions to Section 401(k), 403(b), and 457(b) plans for the calendar year in which the service period begins. For the 2008-2009 school year, you must reference the 2008 contribution limit, which is $15,500.

With regard to the second condition, the notice explains how it calculates how much is deferred from one year to the next, and it gives the following examples:

*For a 10-month school year beginning on Aug. 1, the annualizing of annual salaries up to $186,000 will satisfy this condition.
*For a 10-month school year beginning on Sept. 1, the annualizing of annual salaries up to $232,500 will satisfy this condition.

Our limited discussions with some APA members at educational institutions have revealed that while some of them do pay employees annual salaries greater than the above amounts, those employees generally work throughout the year. So those employees never get a choice of pay schedule, and their pay wouldn't have been considered NQDC even in the absence of the IRS notice.

APA Lobbied for This Determination

When Congress originally passed the law that governs NQDC (American Jobs Creation Act of 2004), 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 4. 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 being defined as NQDC.

Just One of Many APA Victories on NQDC

After IRS issued regulations on NQDC in 2007, they were going to require educational institutions that offer a choice of pay plans to collect election forms from employees before the first day of service for the 2007-2008 school year. APA was working with IRS over the summer of 2007 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. So, IRS waived the election requirement for the 2007-2008 school year. See IRS Information Release 2007-142.

Falling under the definition of NQDC brings some other responsibilities, such as special reporting of the deferred amounts on Form W-2 (Box 12, Code Y). Because the IRS has not yet issued specific reporting guidance, APA has won suspension of this requirement for tax years 2005, 2006, and 2007, but the requirement will be implemented at some point, and had we not won the exception from the definition for educational institutions, this would have become a requirement for them as well. In addition, amounts deferred under a NQDC plan may be subject to social security and Medicare taxes even before they are paid.

ETAAC Recommends Mandatory e-File of Forms 941

Read more about payroll deliberations at IRS and the U.S. Congress

IRS's Electronic Tax Administration Advisory Committee (ETAAC) recommended to the IRS and Congress that employers that are required to electronically file Forms W-2 should be required to do the same with their Forms 941. Currently, employers that file 250 or more Forms W-2 are required to submit them electronically (ETAAC also recommended lowering that threshold), but no employers are required to e-file their 941s.

You can read more about this in the July edition of Inside Washington.

APA's Government Relations team is monitoring and working on these issues to keep your administrative burden from growing or, better yet, to decrease it. This representation is one of the most valuable benefits of APA membership; APA's Government Relations team looks out for the best interests of APA's members and the payroll professional community.

Read more about how APA is acting on your behalf in Washington, D.C., and find out how you can get involved at APA's Government Relations page.

Your Reply Is Needed: Can You Report Employer Health Care Expenses on Employees' Forms W-2?

By Scott Mezistrano, CPP

How feasible would it be for you to include on each employee's W-2 the amount your employer spent on that employee's health care? That's what the Senate Finance Committee is considering, to create more awareness among employees of health care expenses.

The committee's thinking is that if employees better understood how much health care benefits cost, they might be more judicious in their use of their benefits. The hope is that such information would inspire employees to go to preventive medical appointments, or tend to a medical issue earlier instead of waiting for it to progress and require an emergency room visit.

So let me know and write to me smezistrano@americanpayroll.org with your reaction to this proposal and the potential work-around idea. Please use "HC on W-2" as your subject line (HC = health care).

Issues and Challenges

APA met with a Finance Committee staff member and explained the following issues and challenges:
* The W-2 is a wage and tax statement. Its purpose is to contain information that allows the employee (and the IRS) to determine his or her tax liability and allows the Social Security Administration to credit the taxpayer's account for future benefits.
* For many employers, there is currently no storage of employer contributions to health care on an employee-detail-level basis. This would have to be created.
* Such information may be stored in human resource systems, and complicated and costly interfaces may have to be designed to get it into payroll systems for inclusion on Forms W-2.
* The very definition of "employer health care costs" may vary from employer to employer (traditional insurance, self-insurance, stop-loss insurance, health reimbursement arrangements, etc.), and some may be very difficult to quantify on an employee-level. The staffer replied that the employer must have some sort of valuation, in order to come up with the amount for COBRA premiums.
* Many employees on employer-paid COBRA would not otherwise be getting a W-2 from the employer for that year. A W-2 required to report only nontaxable COBRA payments would add the burdens of ensuring the ex-employee's address is current and storing returned W-2s for those former employees who do not update their address.
* There would be problems for some employers in getting a year's data in time for closing, printing, and delivering the W-2s by the January 31 deadline. In many cases, the insurance company bills the employer and it may take some time to perform reconciliations to get the data correctly attributed to each employee.

A Work-Around That Might Keep Payroll Out