Employment Law Update The Internal Revenue Service (IRS) Notice

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1 The Hisel Law Firm Your business is your livelihood. Helping you manage it is ours. Employment Law Update The Internal Revenue Service (IRS) Notice Mary Ann Hisel, Principal The Hisel Law Firm PLLC August 20, 2008 San Antonio, Texas Copyright 2008, The Hisel Law Firm. All rights reserved.

2 Employment Law Update The Internal Revenue Service (IRS) Notice The Internal Revenue Service (IRS) recently issued Notice which will eliminate most deferred compensation issues for school teachers, faculty members, and other employees who spread their compensation over a 12-month period even though they earn such compensation over a 9- or 10-month basis. Section 409A of the Internal Revenue Code treats compensation earned in one year but paid in a subsequent year as deferred compensation. In many cases, school teachers, faculty members, or other school year employees are paid over 12 months for services performed over a 9- or 10-month period. This type of arrangement, which is referred to as recurring part-year compensation, results in some of the compensation the teacher earns for working during one calendar year being paid in the next calendar year, at or after the end of the school year. Prior to the IRS Notice , it seemed that recurring part-year compensation would be considered deferred compensation subject to IRS Code Section 409A. Characterizing compensation in such a way meant that employees could suffer negative tax consequences where certain requirements are not met. Most notably, the school was required to develop a written policy on the time and method of paying salaries and any election to be paid over a 12-month period must be irrevocable and made prior to the first day of the school year. Copyright 2008, The Hisel Law firm. All rights reserved. Page 2

3 Under Notice , which was issued on July 21, 2008, recurring part-year compensation will not be treated as deferred compensation (and will not be subject to Code Sections 409A and 457(f)) if the following requirements are met: The arrangement does not defer payment of any of the compensation beyond the last day of the 13th month following the beginning of the service period; and The total amount of compensation earned in the first calendar year but paid in the second year does not exceed the annual Code Section 402(g) limits for elective deferrals ($15,500 in 2008). By way of example provided by the IRS, assume an employee works during a school year beginning on September 1, 2008 and ending on June 30, 2009 (a 10-month school year) but is paid over the 12-month period beginning September 1, Such an arrangement will not provide for deferred compensation unless the employee earns more than $232,500 for the school year. In this case, an employee whose salary for the school year is $232,500 earns $93,000 in 2008 and $139,500 in 2009, but under a 12-month payment schedule, the employee is paid $77,500 in 2008 (for the four months beginning September 1, 2008) and $155,000 in 2009 (for the remaining 8 months in the 12-month period). The amount earned in 2008 but deferred to 2009 would be $15,500 ($93,000 - $77,500). Accordingly, this arrangement would not be considered deferred compensation because the amount earned in 2008 but paid in 2009 does not exceed $15,500 (which is the (g) limit). Copyright 2008, The Hisel Law firm. All rights reserved. Page 3

4 Whether characterization as deferred compensation is allowed will depend on the number of months in the work-year and when the work-year begins. In the above example, if the 10- month work-year begins in August rather than September, salary in excess of $186,000 and paid over 12-months would provide for deferred compensation. Similarly, if the work-year was 9 months, beginning in September, then salary in excess of $139,500 and paid over 12 months would provide for deferred compensation. The IRS and the Treasury Department have opined that the proposed rule set out in Notice should exempt many arrangements with public school teachers, faculty and other school-year employees from being treated as deferred compensation. All academic institutions, however, are encouraged to review all of their salary payment schedules and compensation-spreading arrangements to ensure compliance with the IRS position. Related Links Copyright 2008, The Hisel Law firm. All rights reserved. Page 4

5 The Hisel Law Firm is devoted to providing first-class and cost effective labor and employment business counsel to San Antonio and South Texas businesses and governmental entities. Specifically, The Hisel Law Firm helps employers and business owners maintain their workplace productivity, avoid litigation, and engage in preventative and best practices strategies to enhance their bottom line. For the past three years ( ), the firm s founding partner, Ms. Mary Ann Hisel has been named by her peers as a Texas Rising Star in Labor and Employment. Attorney Bio Ms. Hisel represents employers in connection with administrative proceedings, including those involving the Equal Employment Opportunity Commission and the Texas Workforce Commission-Human Rights Division. Ms. Hisel has successfully litigated claims involving race, national origin, sex, age and disability discrimination, and retaliation cases under Title VII, as well as under the Age Discrimination in Employment Act, the Americans with Disability Act, and Chapter 21 of the Texas Labor Code. Ms. Hisel has also developed a specialty in advising on general governance issues and litigating labor and employment matters for public entities, including school districts, colleges and universities, municipalities, and cities. Ms. Hisel is admitted into the U.S. Court of Appeals for the 5th Circuit and the U.S. District Court for the Northern, Southern, Eastern and Western Districts of Texas. Ms. Hisel is a member of the San Antonio Bar Association, the American Bar Association, the State Bar of Texas School Law and Labor and Employment Sections, and the Texas Council of School Attorneys (CSA). Ms. Hisel is also active in the local community as a member of the National Association of Women Business Owners (NAWBO), the San Antonio Human Resources Management Association (SAHRMA), the San Antonio Greater and North Chambers of Commerce, serves as a member of the NW Area Business Council, is a Leadership San Antonio Graduate ( ), and is a Paul Harris fellow in the Stone Oak Rotary Club. Ms. Hisel received her B.A. degree from Texas A&M University and her J.D. from St. Mary s University. Contact Information The Hisel Law Firm, PLLC T: Colonnade I F: Bank of America Building 9901 IH-10 W, Suite 800 mhisel@hisellaw.com San Antonio, Texas Copyright 2008, The Hisel Law firm. All rights reserved. Page 5