Recent Tax Law Changes Affect Teacher Compensation

Recently, the Internal Revenue Service announced a change in the way it will interpret tax laws relating to deferred compensation which will have an impact on the way professional employees are paid by school districts.  In general, Internal Revenue Code Section 409A discusses how income taxes are imposed on compensation which a person has earned, but which has not yet been paid.  Section 409A applies to anyone who has a legally binding right, during a taxable year, to compensation that is or may be payable in a future year.  This has relevance to teachers, who work until the end of a school year but are sometimes paid after the year is over for work already performed.  An election to defer under Section 409A may include either an affirmative election by the teacher or a deferral condition inherent in the terms of the contract.  If a school district allows a teacher the choice of being paid during the school year or over a twelve month period, and the twelve month period is chosen, under the recent change announced in Internal Revenue Bulletin T.D. 9321, the teacher is deemed to have deferred compensation and is now subject to an additional 20% tax on the deferred portion.  The application of this provision of Section 409A will affect teachers who elect to defer any portion of their compensation beginning in the 2008-2009 school year

However, with proper planning the additional tax penalty can be avoided, even while allowing elections to be paid over 12 months to continue.  Section 409A sets forth requirements and deadlines in order to defer compensation without tax consequences.  The new regulation provides that “with respect to recurring part-year compensation, an election to defer all or a portion of the compensation to be earned during a particular period of service may be made at any time before the period of service begins, provided that no amounts are deferred under the election to a date after the last day of the 13th month following the performance period.”  Plainly stated, if the school year runs, for example, from August 25, 2008 through June 15, 2009, a teacher may make an election regarding deferring their compensation any date prior to August 25, 2008.  For such an election to comply, 409A requires that before the first day of before the period of service begins:

  • a teacher must provide a written or electronic election notifying the district that they want their salary spread over twelve months;
  • the election must be made before the first day of the work period (i.e., the first day of the school year);
  • the election must be irrevocable; and
  • the election must state how the compensation is going to be paid (i.e., over the school year or the calendar year).

There is no requirement as to any specific form for the election to take.  Rules governing deadlines for filing the election and an employee’s inability to change the election can be provided in an employee handbook, in school board policies or in a collective bargaining agreement.

Whether or not your school district needs to act in response to the tax law change depends on whether you current Collective Bargaining Agreement or practice provides such an election.  If your current Agreement or practice does not permit teachers to elect whether to be paid over a school year or calendar year basis, no action is required and you are not required to offer any such election.  However, if teachers are currently permitted to elect how to be paid, some action must be taken.  You should schedule a meeting with the union to determine how the parties will comply with this regulation.  The matter can be resolved by pursuing several different options, namely:

  1. requiring that all professional employees collect their salary over the period of time during which school is in session;
  2. requiring that all professional employees collect their salary over a twelve-month period; or
  3. providing an election under the circumstances approved by the IRS.

If (3) above is elected or continued, as the case may be, to make a valid election, the teacher must notify the district before the beginning of the 2008-2009 school year with a writing that states that the election is irrevocable and sets forth how the teacher’s compensation will be paid in order to avoid the additional tax imposition.  Whichever measure you and the union settle on should be put in place so that employees can properly make any necessary election prior to the start of the 2008-2009 school year.

In the event you have additional questions regarding this tax law change and its impact on your district, you should contact your Solicitor or you can contact an attorney in our school law group.

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