Question

457 contribution confusion

Forum|Forum|5 years ago
March 27, 2021
1 reply
0 views

My employer is changing paid time off policies so that we can no longer accrue banks of time. As such, they are paying out the time to employees. I opted to have my payment deferred through a 457. I understand the basic mechanics of a 457 but don't understand how the taxes withdrawn will affect future taxes (this just happened and I won't get any W2 until this time next year); basically I think something is amiss. My example is below with hypothetical amounts just for illustration.

My deferred compensation (PTO) $10,000

social security and medicare taxes withheld $100 (again, not the actual, just illustrative)

income tax withheld $1,000

amount deposited into my pre-tax 457 $8,900

Here's my confusion. I understand that sick time payouts are subject to social security and medicare in the year the income is earned because of special rules. But, I thought the income tax would be deferred until I withdraw from this account.

My employer has said not to worry as I'll be refunded the $1,000 income tax. But this causes two issues: 1. my 457 account loses $1,000 and 2. wouldn't that $1,000 then technically be income that I would be taxed on next year? The payroll processor provided a lengthy email that was just said they have no way to process SSI and medicare taxes separate from income tax on income. None of this makes sense to me and I'm a bit concerned about how this will affect my taxes next year.

Any thoughts?

Not A Product Question

ReneeM7122

Section 457 plans are nonqualified, unfunded deferred compensation plans established by state and local government and tax-exempt employers. As originally enacted, the rules governing section 457 plans were developed based on nonqualified plan concepts. Section 457 plans therefore are subject to different, and often less stringent regulations than are funded, qualified plans, which must comply with complex rules to assure parity in who they cover, and how much can be deferred.

The tax consequences of nonqualified deferred compensation plans are governed by the constructive receipt doctrine embodied in the regulations under section 451 of the Code, and, in the case of state and local government and tax-exempt entities, by section 457. Section 451(a) of the Code and section 1.451-1(a) of the regulations provide that under the cash receipts and disbursements method of accounting, an item of gross income is includible in gross income for the taxable year in which the taxpayer actually or constructively receives it. Therefore, the tax would not apply in the following year, but in the year that the year that the $1,000 is refunded. Section 1.451-2(a) of the regulations provides that income is constructively received in the taxable year during which it is credited to the taxpayer’s account, set apart for him, or otherwise made available so that he may draw upon it at any time. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

Here is a link to the IRS 457 rules.