Magazine article Government Finance Review

Deferred Compensation and Other Issues

Magazine article Government Finance Review

Deferred Compensation and Other Issues

Article excerpt

Recently, the Governmental Accounting Standards Board (GASB) has proposed guidance on Internal Revenue Code (IRC) Section 457 deferred compensation plans, property tax revenue recognition criteria, and custodial credit risk classifications involving bank holding companies.

Deferred Compensation Plans

Deferred compensation plans are popular with employees because they allow employees to realize substantial tax savings by deferring taxation on a portion of their compensation until retirement. Legally, such tax savings are predicated on employees' avoiding the "constructive receipt" of the portion of their salary or wages contributed to the plan.

In most cases, employee contributions to deferred compensation plans are paid directly to a third party (e.g., the state or an insurance company) that administers the plan's assets for the benefit of the employees. Nonetheless, in the case of deferred compensation plans established in conformity with IRC Section 457, the resources of such plans have legally remained the assets of the government until they are made available to participants or other beneficiaries. This "legal fiction" of government ownership was designed to ensure the avoidance of constructive receipt by participating employees.

Until the mid-1980s, most governments did not report assets associated with IRC Section 457 deferred compensation plans in their financial statements. This approach was consistent with the general view that financial reporting should reflect economic substance rather than legal form. Concerns arose, however, that governments' failure to report IRC Section 457 deferred compensation plan assets on their balance sheet could be interpreted by the Internal Revenue Service as a de facto admission that plan assets were not, in fact, assets of the government, thus disqualifying the plans. To avoid this potential problem, the GASB issued Statement No. 2, Financial Reporting of Deferred Compensation Plans Adopted under the Provisions of Internal Revenue Code Section 457, in 1986. GASB Statement No. 2 specifically required that governmental entities sponsoring IRC Section 457 deferred compensation plans report plan assets in their financial statements, even if those assets are, in fact, administered by a third party.

The federal government recently changed the provisions of IRC Section 457 to eliminate the requirement that plan assets legally remain the assets of the government. Indeed, the new rules specifically require henceforth that plan assets be "held in trust for the exclusive benefit of participants and their beneficiaries." The changes take immediate effect for new plans; for plans already in existence, assets will need to be placed in trust before January 1, 1999.

Technically speaking, the provisions of GASB Statement No. 2 cease to apply to IRC Section 457 deferred compensation plans once their assets have been placed in trust. To reaffirm this fact, the GASB has issued an exposure draft (ED) called Accounting and Financial Reporting for Internal Revenue Code Section 457 Deferred Compensation Plans: A Rescission of GASB Statement No. 2 and an Amendment of GASB Statement No. 31. The ED proposes to rescind formally GASB Statement No. 2. It also would require that governments actually administering plan assets in a fiduciary capacity report those assets in an expendable trust fund. …

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