Rev. Rul. 82-46

ISSUE

Are payments made under eligible state deferred compensation plans subject to income tax withholding, and under what circumstances are they to be treated as supplemental wage payments in computing the amounts to be withheld? FACTS

City X and City Y both maintain eligible state deferred compensation plans as defined in section 457 of the Internal Revenue Code. Under the plans, eligible employees who choose to participate agree to the deferral of part of their compensation. X and Y withhold the agreed amounts from current wages and credit them to the accounts of the individual employees. The accumulated amounts plus income earned are paid over upon termination of employment. Participating employees are also covered by the regular retirement plans maintained by X and Y. These retirement plans are not qualified pension plans under section 401 of the Code. X's regular retirement plan is administered by an insurance company, which has control of the payment of benefits. Y maintains and administers its own retirement plan.

LAW AND ANALYSIS

Section 3402(a) imposes on employers the duty to deduct and withhold income tax upon wages paid.

Section 3401(a) of the Code defines wages as all remuneration for services performed by an employee for an employer. There are no exceptions from income tax withholding under section 3401 for payments from deferred compensation plans as defined in section 457.

Section 3401(d)(1) of the Code provides that if the person for whom the individual performs services does not have control of the payment of the wages for such services, the term "employer" means the person having control of the payment of such wages.

Section 31.3402(g)-1 of the Employment Tax Regulations deals with income tax withholding on supplemental wages, such as bonuses, commissions, and overtime pay, which may be paid for either the same or a different period as the payroll period for regular wages, or may be paid without regard to a particular period. The amount of income tax to be withheld by the employer on such supplemental wages depends, in part, on whether or not income tax has been withheld from the employee's regular wages.

When an employer pays an employee wages in addition to regular wages and includes both amounts in a single payment, the amount of income tax to be withheld is determined on the basis of the aggregate amount, under the standard wage bracket or percentage method. See Rev. Rul. 67-88, 1967-1 C.B. 289.

Section 31.3402(g)-1 of the regulations provides that an employer who separately pays both regular wages and supplemental wages to an employee and withholds income tax on the regular wages may either (1) withhold tax on the supplemental wages at the flat percentage rate of 20 percent without allowance for any withholding exemptions the employee claimed on Form W-4, or (2) aggregate the supplemental wage payment with the regular wages paid or to be paid the employee in the same calendar year either for the last preceding payroll period or for the current payroll period, determine the income tax to be withheld as if the aggregate amount were a single payment, subtract from the amount of income tax so determined the income tax already withheld or to be withheld from the regular wage payment, and withhold the remaining tax from the supplemental wage payment.

Rev. Rul. 66-294, 1966-2 C.B. 459, provides that if the employer makes a supplemental wage payment to an employee and has not withheld on the employee's regular wages (as, for example, where an employee's withholding exemptions exceeded the employee's wages), then the employer must use the second method, so that the employee will receive the benefit of the withholding exemptions to which the employee is entitled. Thus, the employer must aggregate the supplemental wage payment with the regular wages paid or to be paid in the same calendar year either for the last preceding payroll period or for the current payroll period and withhold income tax thereon at the regular graduated rates as if the aggregate of the supplemental wages and the regular wages were a single payment for the regular payroll period.

HOLDING

Payments from the eligible state deferred compensation plans are wages subject to withholding, and payments are reportable on Form W-2, Wage and Tax Statement.

In the case of X, since the insurance company has control of payments under the retirement plan, it and not X is the "employer" for purposes of income tax withholding with regard to those wages. X is the "employer" as to payments from its eligible state deferred compensation plan. Therefore, X should not treat the payments from the deferred compensation plan as supplemental wage payments. They are payments of regular wages.

Because Y makes payments under both the retirement plan and the deferred compensation plan Y should treat the amounts paid employees under the deferred compensation plan as supplemental wage payments.