Deferred Compensation
New IRS Regulations Resolve Deferred Compensation Issues for Most Educators
In July 2008, the Internal Revenue Service (IRS) announced proposed changes to rules regarding deferred compensation plans that should exempt most, if not all, Texas educators from being subject to additional taxes under the Internal Revenue Code’s deferred compensation regulations.
Deferred compensation is a practice intended to make budgeting easier. Many educators work 10 or 11 months but receive their compensation spread over 12 months. For example, if you work from August to May but receive checks in June and July, you are receiving deferred compensation.
The proposed changes apply to rules released by the U.S. Treasury Department in 2007 that require either a written policy or a written agreement between an employer and an employee in order to defer compensation into the following tax year without penalty. This change was important to educators because most public school employees receive deferred compensation and would be possibly subject to penalties if the new regulations were not followed.
However, the changes proposed in July 2008, which the IRS says can be relied upon immediately, would exclude deferred compensation plans from these regulations when the following two conditions apply:
- First, all payments under a deferred compensation plan must be made by the last day of the 13th month after the start of the service period. That means a teacher with a standard 10-month contract that runs from August 2008 through May 2009 would have to receive all payments under that contract by the end of September 2009.
- Second, the amount of compensation deferred must be less than the allowable amount for a given year as prescribed by law. For 2008, the prescribed amount is $15,500.
To explain the second condition, consider this example: An educator earns $60,000 for a standard 10-month contract running from August 2008 through May 2009 (five months in each calendar year). That means the educator earned $30,000 in each year. But because the payments are spread out over 12 months, the educator only earns $5,000 per month. So even though she earned $30,000 for the five months of the 2008 calendar year, she is only paid $25,000, and the remaining $5,000 is deferred until 2009. This amount ($5,000) is less than the prescribed amount of $15,500. To provide a frame of reference, only educators who earn more than $186,000 in 2008-09 will exceed the prescribed allowable amount for 2008.
For more information, read
Internal Revenue Bulletin 2008-29.
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