The zeal to address problems with non-qualified deferred compensation for these big fish has increased our ability to keep watch. But it soon became apparent to the American Payroll Association (APA) that some smaller fish were unwittingly caught up in the net, too.

"The problem came up with the American Jobs Creation Act of 2004," says Scott Mezistrano, Senior Manager of Government Relations at the APA. "Congress was worried about big, fancy executives doing shady things to defer pay." And rightfully so. One group they didn't have in mind? "School teachers," he says.

Often, educators who work fewer than 12 months each year prefer to have their pay annualized, in order to more easily budget their expenses. The details of the American Jobs Creation Act (AJCA) meant that payments delayed due to this annualizing meet the definition of deferred compensation. Under the AJCA, employers must create plan documents and pay schedule election forms for any deferred compensation that isn't part of an exception from the rules. Worse, the employee with deferred compensation that doesn't meet the rules is subject to a 20% tax on the wages.

Recognizing these issues, the APA (www.americanpayroll.org) successfully lobbied the IRS for an exemption specifically aimed at this kind of annualized pay. IRS Notice 2008-62 describes the exemption, and can be relied upon for the current school year. The intention is to make the exemption permanent.

In order for pay to avoid being considered non-qualified deferred compensation under the AJCA rules, two conditions must be met. First, all wages for the year must be paid by the last day of the 13th month following the beginning of the service year. And second, any wages deferred from one year into the next, as happens when pay is annualized, cannot exceed the employee contribution limit under IRC Section 401(k), 403(b) or 457(b) for the calendar year in which the service period begins. The limit for the 2008-09 school year is $15,500.

Generally, educators who are highly paid also work year around, and are therefore not subject to these rules. But some educators working fewer than 12 months have high enough incomes that they could exceed the limits. In the Notice, IRS provides this example: The pay for an employee earning $186,000 and working a 10-month school year beginning August 1, 2008 and ending May 31, 2009 will not be considered non-qualified deferred compensation, because the deferred amount will not exceed the 2008 $15,500 limit. Five months of the school year are in 2008 and the other 5 months are in 2009. For each of those 5-month periods, the employee would earn $93,000 if the pay was not annualized. But, because the employee has chosen to annualize pay, he actually receives $77,500 for the months worked in 2008, and $108,500 for 2009. The amount the employee earned in 2008 but receives in 2009 does not exceed the limit ($93,000 - $77,500 = $15,500), so the deferred amount is not non-qualified deferred compensation.

Mezistrano says that March 15th is an important date to remember for anyone deferring compensation. "If you delay pay from one year to the next, but you pay it out by March 15th, then it is not non-qualified deferred compensation," he says.