FREQUENTLY ASKED QUESTIONS
REGARDING DEFERRED PAY
Why are we changing?
After a detailed review of our current deferred payroll
process, we found that it is in conflict with the IRS
Regulations for reporting of income. Our practice has been
to deduct income taxes as paid (over 12 months), not as
earned (over 10 or 11 months). Because the 12-pay option is
at the employee’s discretion, it is “constructively
received” during the 10 or 11 months of the contract period.
As a result, our process must be modified to comply with IRS
regulations and salaries must be taxed over the contract
year. As a side note, we have always processed STRS and PERS
deductions on an “as earned” basis, a requirement of both
retirement programs.
Is this a
new requirement?
IRS constructive receipt requirements are not new. This has
come to our attention recently because a Southern
California, Quintessential School Systems (QSS) client was
audited by the Internal Revenue Service (IRS) and told that
the method with which they handled their employee deferred
payrolls was not correct. The district in question gives
their employees a choice of a non-deferred (paid during the
months worked) or deferred pay schedule (paid over 12
months). The IRS found that, because of the choice, the
deferred pay schedule was subject to constructive receipt.
As indicated by the IRS, wages are deemed “constructively
received” when the employee has access to the funds, not
necessarily when they are paid. Consequently, taxes should
be withheld in the period in which wages are constructively
received. This finding prompted Sacramento County Office of
Education, districts and other QSS clients to re-evaluate
the practice of deducting income taxes from employees’
deferred paychecks. In response to the finding, QSS has
enhanced their software to include additional options for
handling deferred pay.
When
will this change take affect?
We will be implementing the new deferred payroll process at
the beginning of the 2008-09 school year. However, we need
to start the process NOW to begin informing each affected
employee to assure there is adequate time to prepare for the
impact of the change. Deferred pay applies only to employees
who are on a 10 or 11-month contract and who elect to have
their compensation spread over a 12-month period.
Here are some important facts
about the new deferred payroll process:
• 12-pay option is still allowed
• Beginning June 2009, the summer deferral warrants will
have:
o No
deduction for income taxes
o No deductions for 403b or 457b (tax sheltered annuity -
TSA) contracts
o No deductions for Section 125 agreements
• Non tax related voluntary deductions will still be allowed
in all 12 months
• There will be a temporary slight increase in taxable gross
income in the first calendar year (2008) reflected on the
employee’s W-2 due to timing differences
• Although total net
paychecks for the fiscal year will stay the same,
monthly net paychecks may vary from current depending on an
employee’s individual TSA deductions, Section 125
deductions, voluntary deductions, etc.
Employees will need to take action on several items:
• Change TSA
deductions to months worked (10) schedule
• Change Section 125 deductions to months worked (10)
schedule
• This includes deductions for health benefits
• Change withholding, if desired
Employees may wish consult a tax specialist regarding
withholding or tax-sheltered deductions.
How will this affect my TSA/403B?
• All deductions will be taken out of the first 10 pay
warrants of the school year.
• If you want a specific amount of money deposited into your
TSA/403B account per year you will need to make changes to
your salary reduction agreement.
o Example: An
employee wants $12,000 per year deposited into their TSA.
Instead of $1,000 per month for 12 months, a deduction will
need to be made for $1,200 per month for 10 months.
A sample of the old and new pay
methods are demonstrated in the following table:
|
CURRENT METHOD |
|
NEW METHOD |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
YEARLY
SALARY |
60,000.00 |
|
60,000.00 |
|
|
|
|
|
|
|
|
|
|
MONTHLY GROSS CALC |
5000.00 |
(60000/12 months) |
6000.00 |
|
(60000/10 months) |
|
|
|
|
|
|
|
|
DEDUCTIONS |
|
|
|
|
|
|
Fed Tax |
400.00 |
|
480.00 |
|
|
|
State Tax |
185.00 |
|
222.00 |
|
|
|
STRS |
500.00 |
|
500.00 |
|
|
|
Dues |
95.90 |
|
95.90 |
|
|
|
Medicare |
72.50 |
|
87.00 |
|
|
|
Medical |
360.00 |
|
432.00 |
|
|
|
403B/TSA Contribution |
500.00 |
|
600.00 |
|
|
|
Dental |
128.40 |
|
154.08 |
|
|
|
|
|
|
3429.02 |
|
|
|
CURRENT DEFERRED NET |
2758.20 |
|
571.62 |
* |
|
|
|
|
|
2857.40 |
|
NEW DEFERRED NET |
|
SUMMER
DEFERRED PAY |
3354.10 |
OLD METHOD |
2858.10 |
|
NEW METHOD |
|
|
|
|
|
|
|
* This is the amount of your pay
set aside by the district on a monthly basis to issue your
summer deferred pay. You can achieve the same results by
receiving 10 checks, saving the money yourself AND
accrue interest on your money.
