>The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) revises Chapter 24 of the Internal Revenue Code, to provide that, effective after December 31, 2001, distributions to an individual from a governmental 457(b) plan are subject to income tax withholding in accordance with the income tax withholding requirements of Section 3405 applicable to distributions from qualified plans, annuities, and individual retirement arrangements (IRAs).
>Thus, EGTRRA extends the § 3405(c) direct rollover and mandatory 20 percent withholding rules that have long applied to 401(k) plans to governmental § 457(b) plan distributions that qualify as eligible rollover distributions as defined under § 402(c)(4).
>Also included in IRS Notice 2003-20 is a shift in the liability of the withholdings from the payors to the plan administrators. However, a plan administer can shift the liability if the administrator instructs the payor to do so and provides the necessary information.
>Distributions from governmental plans are reported on Form 1099-R and income tax withheld from distributions is reported on Form 945. Distributions from a tax-exempt entity’s plan are wages and calculated in the same manner as other wage payments, and the withholding rules under Section 3405 do not apply. The person or organization in control of payment is responsible for income tax withholding on the distributions.
>While FICA taxes are still to be withheld, Federal Unemployment Tax Act (FUTA) taxes do not apply to governmental plans due to exemptions laid out in Section 3306(c)(7).
>But for those non-government 457(b) plans, deferrals are subject to FICA, FUTA, and Medicare taxes when deferred, unless they are subject to a substantial risk of forfeiture under Section 83, since the plans provide for annual deferrals to be immediately vested. If amounts deferred under an eligible plan are properly taken into account when deferred, or are no longer subject to a substantial risk of forfeiture, amounts that are attributable to those deferrals paid or made available to a participant or beneficiary are generally not subject to those taxes.
>When preparing taxes and writing out the check, employers must aggregate FICA and Medicare taxes associated with a Section 457(b) plan with all other FICA and Medicare taxes paid on behalf of employees and report them on Form 941. The same holds true for employers subject to FUTA taxes, who report those withholdings on Form 940.
Explanation of Changes
>Most of the changes made under EGTRRA are effective beginning in 2002, and the notice is applicable to deferrals and distributions after December 31, 2001. Prior to January 1, 2004, IRS says it will not assert a failure to comply with reporting and withholding requirements if requirements under the previous Notice 2000-38 have been satisfied.
Additionally, the IRS is soliciting comments on the notice and the administration of Section 457(b) plans in general. Comments can be addressed to the Internal Revenue Service, Office of Division Counsel/Associate Chief Counsel (TEGE), CC:TEGE:EB:QP2, Room 5201, 1111 Constitution Avenue, Washington, D.C. 20224. Notice 2003-20 will be published in Internal Revenue Bulletin 2003-19, dated May 12, 2003. It is currently available at http://www.irs.gov/pub/irs-drop/n-03-20.pdf .
For further information regarding this notice, you may contact the principal author of the notice, John Tolleris, at (202) 622-6060.