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Client Alert:
Annualizing Pay for School Employees: What you need to know BEFORE the 2008-2009 School Year and what you need to know NOW
Many teachers and other employees have the opportunity to choose to be paid only during the school year, or to be paid throughout the 12 month period beginning with the first month of the school year (i.e., to “annualize” their income). When payments are spread over a 12 month period, some of the pay earned in the fall is actually deferred to, and paid in, the following year.
Example: Assume a school year starts August 1 2007, and ends May 31, 2008 (10 months), and that a teacher earns $5,400 per month ($54,000 per year). If the teacher were paid over 10 months, the teacher would receive $27,000 in 2007 for the five months of August through December, and would receive $27,000 in 2008 for the five months of January through May.
If instead, the teacher was paid over 12 months, the teacher would receive $4,500 per month. The amount paid to the teacher in 2007 would be $22,500, for the five months of August through December. The amount paid to the teacher in 2008 would be $31,500 in 2008 for the seven months of January through July. The difference is that on the 12 month cycle payment schedule, the teacher is paid $4,500 less in 2007, and this is the amount spread over the remaining pay periods in 2008. This is the amount of compensation earned in 2007, but deferred until 2008. |
This ability to choose the time frame over which compensation is paid triggers tax issues. Some of the issues need to be addressed immediately. Other issues need to be addressed prior to the start of the 2008-2009 school year. Both sets of issues are described below.
The Problem. Section 409A of the Internal Revenue Code (the “Code”) governs the deferral of compensation. It includes requirements deferred compensation programs must meet to avoid triggering immediate income tax and an additional penalty. Included is a special rule for annualized income that applies to school employees who receive their pay over a period longer than the period during which they actually provide services (e.g., the school year).
How the Rule Applies. If employees are given a choice to annualize their income, the following requirements must be satisfied:
- The employee must make an election in writing (or by e-mail);
- The employee must make the election before the beginning of the work period in which the compensation to be annualized will be earned (e.g., the first day the employee reports to school for the new school year);
NOTE: If no election is made before that date, the employee must be paid in the same manner as other employees who do not make an election. Late elections cannot be accepted. |
- The election must be irrevocable during the applicable 12-month period;
- The employer must state in writing how the compensation is going to be paid if an election is made (e.g., ratably over the 12 months beginning on the first day of the school year); and
- The employer must pay the compensation in full prior to the last day of the 13th month following the first day of the service period.
Note: An employer is not required to provide an employee an opportunity to elect the time period during which he/she will be paid. A school district may provide that all school year employees shall be paid only during the school year; or that such employees shall be paid over a 12-month period. If the employer requires payment only during the school year, no deferral of compensation occurs and Section 409A does not apply. If the employer requires payment over a 12-month period, Section 409A applies, but it is satisfied (without application of the special rule described above) if the employer has a written policy describing when and how the compensation is paid over the 12-month period. |
Compliance Date. In general, most rules under Section 409A of the Code are already effective. The Internal Revenue Service provided a special transition period within which schools could adjust their procedures to come into compliance with the new rules. Specifically, the rules apply with the school year that begins in 2008.
However, there is one requirement that is effective immediately. Beginning January 1, 2008, employers offering employees the opportunity to annualize their compensation must have a written policy regarding how employees who have made such elections are to be paid for compensation earned during the remainder of the school year.
Action Items. To ensure your District complies with the new rules, we recommend the following steps if you provide employees the choice between being paid only during the school year or during a longer period:
- Review your written personnel policies to ensure there is a written policy regarding how employees who receive annualized compensation are paid and, if not, immediately adopt such a written policy;
- Establish formal policies and procedures regarding elections to annualize compensation; and
- Create a written election form describing the rules applicable to elections.
Please contact us if you have any questions regarding the Section 409A rules or need assistance with the action items identified above.
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The information contained in this ALERT is intended for general information purposes only and does not constitute legal advice relative to a specific situation.
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Hitesman & Associates, P.A.