n-00-38.pdf

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Eligible Deferred Compensation Plans under Section 457
Notice 2000-38
I.PURPOSE AND SCOPE
This notice describes the withholding and reporting requirements applicable to
eligible deferred compensation plans described in ' 457(b) of the Internal Revenue
Code of 1986 ("' 457(b) plans").
Specifically, this notice addresses --
$ income tax withholding and reporting with respect to annual deferrals made to a
' 457(b) plan;
$ income tax withholding and reporting with respect to distributions from a
' 457(b) plan;
$ Federal Insurance Contributions Act (FICA) payment and reporting with respect
to annual deferrals under a ' 457(b) plan;
$ employer identification numbers (EINs) used in connection with trusts
established under ' 457(g); and
$ the application of annual reporting requirements to ' 457(b) plan administrators
and trustees holding assets of a ' 457(b) plan in accordance with ' 457(g).
This notice addresses only reporting and withholding rules that apply to ' 457(b)
plan participants who are or were employees of state and local governments or tax-
exempt organizations and does not cover special reporting rules that may apply to
§ 457(b) plan participants who are or were independent contractors.
II.BACKGROUND

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Section 457 provides rules for nonqualified deferred compensation plans
established by eligible employers. State and local governments and tax-exempt
organizations are eligible employers. They can establish either eligible plans that meet
the requirements of ' 457(b) or plans that do not meet the requirements of § 457(b) and
that are therefore subject to tax treatment under ' 457(f).
Section 1448 of the Small Business Job Protection Act of 1996, ("SBJPA"), 1996-
3 C.B. 155, 212, amended ' 457 by adding ' 457(g), which requires that ' 457(b) plans
maintained by state or local government employers hold all plan assets and income in
trust, or in custodial accounts or annuity contracts described in ' 401(f), for the exclusive
benefit of participants and their beneficiaries. Section 457(g) applies generally to assets
and income held by a governmental ' 457(b) plan on and after August 20, 1996.
However, with respect to a governmental ' 457(b) plan in existence on August 20, 1996,
a trust (or a custodial account or annuity contract) was not required to have been
established before January 1, 1999. Section 457(g) does not apply to a ' 457(b) plan
established by a tax-exempt organization that is not a state or local governmental entity.
Notice 98-8, 1998-1 C.B. 355, provides guidance regarding the amendments
made to ' 457(b) by the SBJPA. Following publication of the 1998 notice, the Service
received additional inquiries regarding the statutory changes made in ' 457(b) by the
SBJPA and the Taxpayer Relief Act of 1997, Pub. L. No. 105-34. Specifically,
taxpayers, employers, and plan administrators asked what employment and income tax
reporting requirements apply with respect to ' 457(b) plans and whether a trustee or
administrator of a trust established under ' 457(g) must file annual information returns
relating to the trust, such as Form 990, Return of Organization Exempt From Income

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Tax, or an appropriate version of Form 5500, Annual Return/Report of Employee Benefit
Plan.
III.INCOME TAX WITHHOLDING AND REPORTING ON ANNUAL DEFERRALS
Section 457(a) provides that annual deferrals under a ' 457(b) plan and any
income attributable to the amounts so deferred will not be includible in a participant=s
gross income until that amount is paid or made available to the participant or beneficiary.
Therefore, annual deferrals under a ' 457(b) plan are not subject to income tax
withholding at the time of the deferral. However, a participant’s annual deferrals during
the taxable year under a ' 457(b) plan are reported on Form W-2, Wage and Tax
Statement, in the manner described in the instructions to that form. “Annual deferrals”,
as used in this notice, means the amount of compensation deferred under the plan in
accordance with section 457(b) whether by salary reduction or nonelective employer
contribution, during a taxable year.

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IV. INCOME TAX WITHHOLDING AND REPORTING ON § 457(b) PLAN
DISTRIBUTIONS
A. Income Tax Withholding on § 457(b) Plan Distributions
“Distributions” from a § 457(b) plan to a participant or former participant include
all amounts that are paid or made available under a § 457(b) plan. Distributions to a
participant or former participant from a ' 457(b) plan are wages under § 3401(a) that are
subject to income tax withholding in accordance with the income tax withholding
requirements of ' 3402(a). The pension withholding rules of ' 3405 do not apply. See
' 35.3405-1, a-23, Q&A of the Temporary Employment Tax and Collection of Income
Tax at Source Regulations.
Income tax withholding on distributions to a participant or former participant under
a ' 457(b) plan is calculated in the same manner as withholding on other types of wage
payments. For guidance on the use of the flat rate withholding method as a supplement
to regular wage withholding in cases where the payor is paying wages to the participant
in addition to the distribution from the ' 457(b) plan, see § 31.3402(g)-1(a) of the
Employment Tax Regulations and Rev. Rul. 82-46, 1982-1 CB 158. If an eligible payor
uses the flat rate of withholding as an alternative to regular wage withholding on a lump
sum payment, section 13273 of the Omnibus Budget Reconciliation Act of 1993, 1993-3
C.B. 1, 130 provides that a 28 percent flat rate must be used.
B. Person Responsible for Income Tax Withholding on Distributions

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Section 3402(a) requires every employer making payment of wages to withhold
income tax on these wages. However, § 3401(d)(1) provides that if the person for whom
an individual performed services as an employee does not have control of the payment
of the wages for those services, the person having control of the payment of the wages
is responsible for income tax withholding on those wages. See § 31.3401(d)-1(f). Thus,
if distributions are made by a ' 457(g) trustee of a plan established by a state or local
government, the trustee is responsible for income tax withholding and reporting on the
distributions. Similarly, if distributions are made by a ' 457(g) custodian or insurance
carrier treated as a trustee under ' 457(g), the custodian or insurance carrier is
responsible for income tax withholding on the distributions. Subsections C, D, and E of
this Section IV provide additional information regarding how the trustee (or custodian or
insurance carrier) should withhold, deposit, and report distributions.
When distributions are made under a ' 457(b) plan established by a tax-exempt
organization, the tax-exempt organization or any other person having control of the
payment of the distributions is responsible for income tax withholding on the
distributions.
C. Reporting on Form W-2 for Distributions from a § 457(b) Plan
Distributions to a participant or former participant during a taxable year under a
' 457(b) plan are reported on Form W-2, Wage and Tax Statement, in the manner
described in the instructions to that form. See also Rev. Rul. 82-46, supra. Income tax
withheld from § 457(b) plan distributions is reported quarterly on Form 941, Employer=s
Quarterly Federal Tax Return.
D. Reporting Death Benefit Payments

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Distributions to a beneficiary of a deceased participant under a ' 457(b) plan are
reported on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-
Sharing Plans, IRAs, Insurance Contracts, etc. See Rev. Rul. 86-109, 1986-2 C.B. 196.
No income tax withholding is required for distributions from ' 457(b) plans to
beneficiaries. See Rev. Rul. 59-64, 1959-1 C.B. 31. The instructions for Form 1099-R
describe how this form is completed for distributions made to a beneficiary from a
nonqualified deferred compensation plan, such as a ' 457(b) plan.
E. EINs and Income Tax Deposits with respect to ' 457(g) Trust Accounts
Generally, the income tax withheld on distributions should be reported on the
Form 941 of the person responsible for withholding, as described in section IV-B of this
notice, and aggregated with other amounts reported by that person on Form 941 to
determine the frequency of federal tax deposits under § 31.6302-1. This is the same as
the first alternative described in Announcement 84-40, 1984-17 IRB 31. Alternatively,
the IRS will permit trustees of ' 457(g) trusts, or custodians or insurance carriers treated
as trustees under ' 457(g)(3) to use the other two alternatives contained in
Announcement 84-40 for the tax administration of such withholdings:
1. The trustee, custodian, or insurance carrier may request an EIN solely
for the purpose of reporting the aggregated withholding from the distributions of
every ' 457(g) trust, custodial account, or annuity contract under its control,
making deposits and filing Form 941 accordingly.
2. The trustee, custodian, or insurance carrier may request and use a
separate EIN for each ' 457(g) trust (or custodial account or insurance contract),
making deposits and filing Form 941 accordingly.

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The trustee, custodian, or insurance carrier exercising any of the above
alternatives for depositing and reporting the tax withheld from ' 457(g) trust distributions
must also follow the same option in filing the related information returns, such as Forms
W-2 (in the case of distributions to participants or former participants) or 1099-R (in the
case of distributions to beneficiaries). That is, the trustee, custodian, or insurance
carrier must use the same name and EIN on Forms W-2 or 1099-R as that under which
the tax was deposited and the quarterly return filed. The trustee, custodian, or
insurance carrier must aggregate and deposit all taxes pursuant to § 31.6302-1 under
the EIN chosen. The above-described options relate only to trusts, annuity contracts or
custodial accounts established pursuant to section 457(g) for amounts deferred under
§ 457(a). For information on the remittance of social security, Medicare, and FUTA
taxes by the employer, see section V-D below.

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V. FICA AND FUTA TAXES AND REPORTING
A. Scope
The rules described in this notice relating to FICA (social security and Medicare)
tax apply to employees of state and local governments only if they are subject to social
security or Medicare tax under section 3121(u) (relating to Medicare),
section 3121(b)(7)(E) (relating to agreements entered into pursuant to section 218 of the
Social Security Act), or other provisions of the Code, such as section 3121(b)(7)(F)
(relating to state and local government employees who are not members of a state or
local retirement system). The FICA rules discussed in this notice generally apply to
employees of tax-exempt organizations, unless a specific exclusion is applicable. The
FICA tax discussed in this Section V includes the employer’s share of the FICA tax
imposed under section 3111 as well as the employee’s share imposed under sections
3101 and 3102.
The rules described in this notice relating to the Federal Unemployment Tax Act
(FUTA) do not apply to service for a state or local governmental entity because section
3306(c)(7) provides a FUTA exemption for service performed in the employ of a state or
any political subdivision thereof or any instrumentality of any one or more of the
foregoing. The rules described in this notice relating to FUTA apply to service for a tax-
exempt organization other than a tax-exempt organization described in section
501(c)(3). See section 3306(c)(8).
B. Time Social Security, Medicare, and FUTA Taxes Imposed

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Sections 3121(a) (relating to social security and Medicare) and 3306(b) (relating
to FUTA) define Awages@ as all remuneration for employment, unless specifically
excluded (see section V-A, above). If social security, Medicare, or FUTA taxes apply,
sections 3121(v)(2) and 3306(r)(2) contain special timing rules that apply in determining
when amounts deferred under a nonqualified deferred compensation plan are required
to be taken into account. Under these sections, an amount deferred under a
nonqualified deferred compensation plan, including a ' 457(b) plan, is required to be
taken into account for purposes of social security, Medicare, and FUTA taxes as of the
later of when the services are performed or when there is no substantial risk of forfeiture
of the rights to such amount.
Thus, if a ' 457(b) plan provides that annual deferrals are fully and immediately
vested, annual deferrals are subject to social security, Medicare, and FUTA taxes at the
time of deferral. However, if the annual deferrals are not fully and immediately vested,
but are subject to a substantial risk of forfeiture, the annual deferrals (and earnings
thereon) are generally taken into account for purposes of social security, Medicare, and
FUTA at the time such amounts are no longer subject to a substantial risk of forfeiture.
For purposes of social security, Medicare, and FUTA taxes, the determination of
whether a substantial risk of forfeiture exists is made in accordance with the principles of
section 83 and the regulations thereunder. See '' 31.3121(v)(2)-1(e)(3) and
31.3306(r)(2)-1.
If amounts deferred under a ' 457(b) plan are properly taken into account as
social security, Medicare, and FUTA wages when deferred (or, if later, when they cease
to be subject to a substantial risk of forfeiture), the amounts subsequently paid or made

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available to a participant or beneficiary under the ' 457(b) plan are not subject to social
security, Medicare, or FUTA taxes. See '' 3121(v)(2)(B) and 3306(r)(2)(B) and
'' 31.3121(v)(2)-1(a)(2)(iii) and 31.3121(v)(2)-1(d)(2). If an amount deferred for a period
is not properly taken into account, distributions attributable to that amount, including
income on the amounts deferred, may be wages for FICA purposes when paid or made
available. See ' 31.3121(v)(2)-1(d)(1)(ii). Additional special rules apply to ' 457(b)
plans other than plans where benefits are based on a participant’s account balance.
See ' 31.3121(v)(2)-1(e)(4).
C. Examples
The application of social security and Medicare tax is illustrated by the following
examples:
Example 1. (i) State R’s ' 457(b) plan provides for elective deferrals from current
salary, as well as a one percent of salary nonelective contribution for each employee
who participates in the plan and who is employed with State R during the plan year. All
employees who participate in the plan are covered by an agreement under section 218
of the Social Security Act. All deferrals and contributions, including the state’s
contribution, are fully and immediately vested.
(ii) Because these contributions are not subject to a substantial risk of forfeiture
(and the services to which they relate have already been performed), the elective
deferrals are required to be taken into account as wages at the time of the deferral and
State R’s nonelective contribution is required to be taken into account as wages at the
time of the contribution for purposes of the social security and Medicare tax.

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Example 2. (i) Assume the same facts as in Example 1, except that the plan has
three-year vesting for State R’s nonelective contribution. Therefore, an employee=s
rights to the nonelective contributions (and the associated earnings) are subject to a
substantial risk of forfeiture until the employee has been employed by State R for three
years.
(ii) State R’s nonelective contributions (and earnings thereon) are not wages for
purposes of the social security and Medicare tax until the employee has completed three
years of service. At that time, the aggregate amount of State R’s nonelective
contributions, plus earnings thereon, is required to be taken into account as wages for
purposes of the social security and Medicare tax. Once an individual has met the
vesting requirements, future nonelective contributions by State R are required to be
taken into account as wages for purposes of the social security and Medicare tax at the
time of the contribution.
D. Deposit and Reporting of Social Security, Medicare and FUTA Taxes
The employer must aggregate and deposit social security and Medicare taxes
associated with a ' 457(b) plan (including the employer’s share of social security and
Medicare taxes under section 3111) with all other social security, and Medicare taxes
and withheld income taxes paid on behalf of its employees in accordance with
' 31.6302-1 and must report these taxes on Form 941. Employers subject to FUTA
must aggregate and deposit FUTA amounts associated with a ' 457(b) plan with all
other FUTA amounts paid on behalf of its employees in accordance with ' 31.6302(c)-3
and must report these payments on Form 940.
VI. ANNUAL REPORTING FOR § 457 PLANS

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A. Section 457(b) Plans of Tax-Exempt Organizations
Annual deferrals and payments to certain participants in a § 457(b) plan of a tax-
exempt organization are reported on the organization’s Form 990 in the manner
described in the instructions to that form.
B. § 457(g) Trusts
A trust described in § 457(g) is not required to file Form 990, Return of
Organization Exempt From Income Tax, Form 1041, U.S. Income Tax Return for Estates
and Trusts, Form 1120, U.S. Corporation Income Tax Return, or Form 5500, Annual
Return/Report of Employee Benefits Plans. See, for example, Rev. Proc. 95-48, 1995-2
C.B. 418, which provides that governmental units and affiliates of governmental units
that are exempt from federal income tax under § 501(a) are not required to file annual
information returns on Form 990, Return of Organization Exempt From Income Tax. A
trust described in § 457(g) may be required to file Form 990-T, Exempt Organization
Business Income Tax Return. See §§ 1.6012-2(e) and 1.6012-3(a)(5) for the
requirements for filing Form 990-T.
VII. OTHER INFORMATION AVAILABLE
Further information regarding the reporting, payment and deposit of employment
taxes such as social security, Medicare, FUTA, and withheld income tax can be found in
Publication 15, Circular E, Employer’s Tax Guide; Publication 15-A, Employer’s
Supplemental Tax Guide; and Publication 963, Federal-State Reference Guide: Social
Security Coverage and FICA Reporting by State and Local Government Employers.
These publications will be revised, as appropriate, to reflect the proper treatment of
trusts under section 457(g).

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VIII. EFFECTIVE DATE
This notice is applicable with respect to deferrals and distributions made after
December 31, 2001. Plan sponsors, plan administrators and taxpayers may rely on this
Notice for distributions and deferrals before January 1, 2002.
IX. REQUEST FOR COMMENTS
The Internal Revenue Service requests comments concerning this notice, and
welcomes comments on any other useful approaches the Service might consider
regarding the administration of § 457(b) plans, including alternatives to Form W-2
reporting. Comments can be addressed to the Internal Revenue Service, Office of
Associate Chief Counsel, CC:TEGE:EB:QP2, Room 5201, 1111 Constitution Avenue,
Washington, D.C. 20224. In addition, comments may be submitted electronically via the
Internet by sending them in an e-mail to: joel.s.rutstein@m1.irscounsel.treas.gov and
specifying that the comments concern Notice 2000-38.
DRAFTING INFORMATION
The principal author of this notice is John Tolleris of the Office of the Associate
Chief Counsel/Division Counsel (Tax Exempt/ Government Entities). However, other
personnel from the IRS and Treasury participated in its development. For further
information regarding this notice, contact John Tolleris at (202) 622-6060 (not a toll-free
number).