IRC 457 provides rules for nonqualified deferred compensation plans established by eligible employers. IRC 457(b) and 457(e) define "eligible deferred compensation plan" as including those plans which are established and maintained in both form and operation, in accordance with relevant regulations, by a state, political subdivision of a state, and any agency or instrumentality of a state or political subdivision of a state. Employer contributions to section 457(b) plans may be subject to Social Security and Medicare ("FICA") tax. IRC Section and Treas. Regulation IRC 457; IRC 3121(v)(2); 26 CFR 31.3121(v)(2)-1(a)(2)(iii) Resources (court cases, Chief Counsel Advice, Revenue Rulings, internal resources) Notice 2003-20, 2003-1 C.B. 894 Analysis In some cases, employers are not withholding, paying, or reporting Social Security and Medicare ("FICA") tax on employer contributions to section 457(b) plan. IRC 3121(a) defines wages for FICA tax purposes as all remuneration for employment, unless specifically excluded. If the employment is subject to FICA tax (see note below), IRC 3121(v)(2) contains special timing rules that apply in determining when amounts deferred under a nonqualified deferred compensation plan (including employers' contributions to a section 457(b) plan) are required to be taken into account. Notice 2003-20 describes, among other things, the U.S. federal income tax and FICA tax withholding and reporting requirements applicable to eligible deferred compensation plans described in IRC 457(b). Section VI of the notice addresses the FICA tax requirements for annual deferrals under a section 457(b) plan. Section VI-B of the notice addresses special timing rules that apply in determining when amounts deferred under a nonqualified deferred compensation plan (including employers' contributions) must be taken into account for FICA tax purposes. An employer must take amounts deferred under a nonqualified deferred compensation plan, including a section 457(b) plan, into account for FICA tax purposes as of the later of when the employee performs the services or when there is no substantial risk of forfeiture of the rights to such amounts. Issue indicators or audit tips Issue indicators To determine if a state or local government entity is providing employer nonelective or employer matching contributions to a section 457(b) plan: Ask the taxpayer if they offer a section 457(b) plan to their employees and if they make employer contributions to the plan. Also, ask the taxpayer about when the employee is fully vested, that is, does the employee have to work a certain number of years prior to being vested in the employer contributions? If the taxpayer does make employer contributions, and the employee is immediately vested in those contributions (i.e., there is no substantial risk of forfeiture with respect to those contributions), then review the payroll records to determine if the taxpayer properly reported, withheld, and paid FICA tax on the employer contributions. Review Form W-2, Box 14-Other and ask for an explanation of any amounts shown in this box. You should also analyze the taxpayer's: Collective bargaining agreements Employee handbook Individual employment contracts Certified audit reports and Deferred compensation plan summary plan description Any other related employee benefit information Determine if mandatory Social Security and/or Medicare apply or whether the employees are covered by a Section 218 agreement.
