To:

Members, Board of Education

From:

Eric J. Becoats, Ed.D.
Sharon S. Ozment

Date:

May 16, 2008

RE:

Twelve-Month Pay Option

North Carolina General Statute 115C-302.1(b), requires the Local Education Agency (LEA) to offer any individual teacher who is not employed in a year-round school, a payment plan in 12 monthly installments, if the teacher so requests. Guilford County Schools (GCS) has offered such a payment plan to eligible 10 or 11-month salaried employees (hourly paid employees and employees paid as substitutes have not been eligible for this payment option).

In August 2007 Information Release 2007-142, the Internal Revenue Service (IRS) indicated that they had received questions concerning the application of Internal Revenue Code (IRC) Section 409A deferred compensation rules to teachers who are allowed to choose between being paid only during the school year or being paid over a 12-month period. The IRS indicated that if teachers choose the 12-month period, they are deferring part of their income from one year to the next and are likely subject to a possible 20% income tax withholding penalty.

IRS EXAMPLE #1:  A teacher who chooses to get paid over a 12-month period, running from August of one year through July of the next year, rather than over the August to May school year, is receiving deferred compensation under IRC Section 409A.

IRS EXAMPLE #2:  Assume a school year starts August 1, 2007 and ends May 31, 2008 (10 months), and that a teacher earns $5,400 per month or $54,000 ($5,400 x 10) per year. If the teacher were paid over 10 months, the teacher would receive $27,000 ($5,400 x 5) for the five months of August through December of 2007, and would receive $27,000 ($5,400 x 5) in 2008 for the five months of January through May. If instead, the teacher were paid over 12 months, the teacher would receive $4,500 ($54,000/12) per month. The teacher would receive only $22,500 ($4,500 x 5) in 2007 for the five months of August through December and would received $31,500 ($4,500 x 7) in 2008 for the seven months of January through July. In this example, $4,500 ($27,000 - $22,500) that the teacher earned in 2007 is paid in 2008. In other words, the $4,500 of 2007 pay is deferred until 2008 and the arrangement generally would be considered deferred compensation that is subject to IRC Section 409A.

Members of the GCS financial services staff have researched what other districts in the state have done or are planning to do in 2008-09 in order to avoid a possible 20% income tax withholding penalty imposed by the IRS on 10 and 11-month employees receiving their pay on a 12-month basis.

It is our intent to join the following 27 districts using an alternative 12-month salary option for the 2008-09 school year:

The alternative 12-month installment plan that we intend to use is the State Employees’ Credit Union (SECU) Summer Cash Account. The SECU Summer Cash Account allows employees to have money deducted from their check and forwarded to the SECU. In the summer months, the SECU deposits to the account specified by the employee one-half of the account balance in the first non-paid summer month and the remaining one-half of their account balance in the second non-paid summer month. This plan offers much needed flexibility that the traditional North Carolina Department of Public Instruction (NCDPI) plan did not allow in that hourly employees may participate in the Summer Cash Account. Also, employees that begin working after the beginning of the school year can enroll in the Summer Cash Account which was not allowed in the traditional NCDPI 12-month salary option. In addition, the Summer Cash Account program allows participating employees to receive interest on their contributions instead of the interest being earned by the state. The SECU is willing to send their representatives to our schools to assist with Summer Cash Account enrollments.

A chronology of the events leading up to this decision is outlined for you below.

• At the beginning of the 2007-08 school year, a new item was broadcast on one of the local television channels regarding a possible 20% income tax withholding penalty imposed by the IRS for 10 and 11 -month employees receiving their pay on a 12 month basis. The possible penalty was based on IRS guidelines for deferred compensation which is defined as income earned in one calendar year and paid in a different calendar year.

• Many of our employees saw the news item and began calling the GCS Payroll Department as well as contacting the Guilford County Association of Educators (GCAE) offices. We contacted the NCDPI as well as Mark Jewell who worked with his contacts in the North Carolina Association of Educators (NCAE) and the National Education Association (NEA) to try to get clarification and/or additional information regarding the possible 20% income tax withholding penalty.
• Shortly after the item appeared on the news, our points of contact provided us with information indicating that employees of a public school system would not be included by the IRS for deferred compensation compliance. At this point, we thought the issue had been resolved.

• However, in January of 2008 we received information from NCDPI informing us that if we continued to offer the 12 -month salary option, we would have to follow the IRS guidelines for deferred compensation.  With this additional information, we learned that all employees of the district receiving their pay on the 12 -month salary option would be subject to the 20% income tax withholding penalty if a single employee is allowed to revoke or change their pay from the 12 -month option in error. 

• GCS Financial Services Division representatives met with Mark Jewell in March of 2008 to discuss the information provided by NCDPI.  During this discussion, we outlined concerns with the continuation of the traditional 12 -month salary option system provided by NCDPI, the possible tax withholding penalties for our employees, the possible penalties that could be assessed to the district for incorrect income tax withholding, and the SECU Summer Cash Account alternative.  We advised Mark of our intent to contact NCDPI to get some information with regard to other school systems that were using an alternative 12 -month salary plan.  We also agreed to present this information to the April 2008 meeting of GCAE Representatives.

• In checking with NCDPI, we found that 27 school systems (including Mecklenburg and Wake County) were using an alternative 12 -month salary plan in the 2006-07 school year.  We also learned that 2 other school districts have already notified NCDPI that they would be changing to an alternative 12 -month salary plan for the 2008-09 school year and that several other school districts had inquired about implementing alternative 12-month pay plans for 2008-09.

• GCS Financial Services representatives met with the GCAE Representatives in April of 2008 and explained the possible penalties associated with the traditional NCDPI 12-month salary option as well as explaining the SECU Summer Cash Account as an alternative. This information was very well received and during the meeting, a motion was made to support the move to the SECU Summer Cash Account which was approved unanimously. In this meeting, the GCAE Representatives were told that the administration planned to make a recommendation to the Guilford County Board of Education to change to the SECU Summer Cash Account for the 2008-09 school year.

• On April 23, 2008 we received an additional interpretation from NCDPI indicating that only the person that was erroneously allowed to revoke or change from the NCDPI traditional 12-month salary option will incur the 20% withholding penalty instead of all employees in the district being subject to the 20% penalty.  However, as we understand this recent NCDPI interpretation, the Internal Revenue Code has not been changed which means the penalty could be assessed based on the interpretation by an individual IRS Field Agent. Remember IRS > NCDPI and IRS > GCS!

• Since the April meeting, both GCS and Mark Jewell have received a few questions about the possible change but these questions have been addressed. There have been very few concerns expressed about making a change to the SECU Summer Cash Account alternative 12 -month salary plan.