The AAUP has issued a Tax Alert on the impact of § 409A on faculty on 10-month contracts who elect to be paid over a 12-month period:

Section 409A, a relatively new provision that became law in 2004 (but with a delayed effective date), imposes federal income tax on deferred compensation—amounts earned in one year but not paid until the next. Section 409A generally provides that (subject to narrow exceptions) any income earned in one taxable year but not paid until a subsequent taxable year is nevertheless taxable in the year earned.

Section 409A has potentially adverse implications for faculty members who are paid under a ten-month teaching contract but elect to receive their salaries over a twelve-month period. Such an arrangement effectively defers until the summer months after the end of the academic year a small portion of salary accrued during the previous fall term or fall semester. Here is the IRS’s illustrative example:

[A]ssume a school year starts Aug. 1, 2007, and ends May 31, 2008 (10 months), and that a teacher earns $5,400 per month ($54,000 per year). If the teacher were paid over 10 months, the teacher would receive $27,000 in 2007 for the five months of August through December, and would receive $27,000 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 per month. The teacher would receive only $22,500 in 2007 for the five months of August through December and would receive $31,500 in 2008 for the seven months of January through July. In this example, $4,500 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 [taxation in 2007 under] § 409A. [Emphasis added.]

By regulation, the effective date of Section 409A with respect to compensation for teachers and faculty members was delayed for several years following the statute’s -2- enactment. Section 409A finally went into effect for teachers and professors on January 1, 2008.1 Starting with the 2008-09 academic year, college and university faculty members should be aware that they run the potential risk of additional tax liability if they (1) are paid under a ten-month contract, (2) have the option as a matter of institutional policy to be paid over twelve months, and (3) elect the twelve-month payment option.

(Hat Tip:  Jim Hart.)