Magazine article The CPA Journal

Tax Implications of Teachers' Compensation Plan Choices

Magazine article The CPA Journal

Tax Implications of Teachers' Compensation Plan Choices

Article excerpt

There have been recent changes to federal tax law that could affect college faculty and other schoolteachers who are paid under an optional compensation plan allowing them to receive their nine-month salary over a 12-month period. To avoid negative tax consequences, individuals should plan ahead and document the election.

IRC section 409A, a relatively new provision that became law in 2004 (but with a delayed effective date), imposes federal income tax on deferred compensation, that is, amounts earned in one year but not paid until the next IRC section 409A generally provides that (subject to narrow exceptions) any income earned in one taxable year but not paid until a subsequent taxable year is nevertheless taxable in the year earned.

Adverse Effects

IRC section 409 A has potentially adverse implications for faculty members who are paid under a nine-month teaching contract but elect to receive their salaries over a 12-month period. Such an arrangement effectively defers until the summer months, after the end of the academic year, a small portion of salary accrued during the previous fall term or fall semester. Here is an illustrative example:

Assume a school year starts September 1, 2008, and ends May 31, 2009 (nine months), and that a teacher earns $6,000 per month ($54,000 per year). If the teacher were paid over nine months, she would receive $24,000 in 2008 for the four months of September through December, and would receive $30,000 in 2009 for the five months of January through May. If, instead, the teacher were paid over 12 months, she would receive $4,500 per month. The teacher would receive only $18,000 in 2008 for the four months of September through December and would receive $36,000 in 2009 for the eight months of January through August. In this example, $6,000 that the teacher earned in 2008 is paid in 2009. In other words, the $6,000 of 2008 pay is deferred until 2009, and the arrangement generally would be considered deferred compensation that is subject to taxation in 2008 under IRC section 409A.

Effective Now

By regulation, the effective date of IRC section 409 A, with respect to compensation for teachers and faculty members, was delayed for several years following the statute's enactment Section 409A finally went into effect for teachers and professors on January 1, 2008. Starting with the 2008-2009 academic year, educators should be aware that they run the potential risk of additional tax liability if they 1) are paid under a nine-month contract 2) have the option as a matter of institutional policy to be paid over 12 months, and 3) elect the 12-month payment option.

If a faculty member is not paid a nine-month salary over 12 months (in other words, the nine-month salary is received over nine months), or if the institution requires the teacher to spread the nine-month salary over 12 months, then the faculty member does not need to worry about potential tax consequences. Faculty members who are offered the option of spreading nine months' compensation over 12 and choose that option should be cognizant of potential tax liability under IRC section 409A.

Deferred Liability

Individuals can avoid tax liabilities for deferred compensation if their employer complies with certain conditions prescribed in Treasury Department regulations. Generally, an educator is not subject to additional tax liability under a 12-month salary plan if he executes an election that satisfies the following preconditions:

* Written (or electronic) notice must be given to the institution indicating a wish to exercise the option to spread the compensation over a 12-month period. …

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