The proposed 457(f) regulations have been on our minds for the last several months. While a change in regulations seems all but certain, the IRS has now indicated it is highly unlikely the regulations will be finalized this year. The agency has been working to draft an adequate safe harbor for determining whether a leave plan is considered bona fide under the proposed tax-exempt deferred compensation regulations. According to a source within the IRS Office of Associate Chief Counsel, there has been an inability to reach an agreement on the terms of a safe harbor, delaying the ability to finalize the proposed regulations.
The proposed 457(f) changes can pose significant effects on both employers and employees, with additional taxation being perhaps the most noteworthy effect. To recap, IRS Code Section 457(f) provides rules to determine when an arrangement is a deferred compensation plan, and whether that plan qualifies for favorable tax treatment. It also clarifies the definition of a bona fide sick and vacation leave plan.
What’s the Possible Impact?
Many public sector employers offer generous programs that allow employees to exchange unused sick leave and vacation time for cash payout at retirement. If the IRS determines that payouts such as this are considered deferred compensation, both employees and employers would face a tax liability determined by the value of unused leave balances.
So what does this mean for you? Here are some of the major concerns:
- A portion of accrued leave in non-qualified plans may be subject to taxation.
- Employees may lose a valuable benefit, and employers could have difficulty attracting quality talent.
- The administrative, compliance, and staffing burden for HR departments may increase.
- Employees will likely feel compelled to use all of their sick and vacation days, creating an unstable environment in the workplace and HR hurdles.
What Have We Learned?
Fortunately, the same IRS source mentioned above expressed optimism about the guidance that will eventually be dispensed, offering that the IRS does not wish to ban “cash for employee leave” programs. The IRS does appreciate the need for a clear ruling and the organization is earnestly working to finalize an opinion. It is expected they will release guidance on the 457(f) regulations in conjunction with other related guidance, but it may be too ambitious to expect these releases would be made by the end of this year. Rest assured that MidAmerica will continue to monitor the situation, and provide updates on this topic as they become available.
For more information on potential implications of the 457(f) regulations, CLICK HERE to view our webinar.
If you have any questions on how you can prepare for potential regulatory changes, email Trent Teesdale, SVP of Business Development, at [email protected].