Can the Texas A&M University System offer employees a nonqualified 457(f) deferred compensation plan involving a transfer of property?

Plain-English summary

The chancellor of the Texas A&M University System asked whether the System could offer some employees a nonqualified deferred compensation program under section 457(f) of the Internal Revenue Code, including a part of the plan that consists of a transfer of property under section 83. The Attorney General concluded that a Texas statute, article 6228a-5, section 3(a), authorizes the System to do so, subject to a review step and to the IRS's authority over the tax treatment.

The System wanted to offer benefits beyond traditional retirement and deferred compensation, for example an option to buy mutual-fund shares at a discount that the employee could not exercise until completing a stated term of employment. Article 6228a-5, section 3(a) lets a "state agency" permit some or all of its employees to participate in an employer-sponsored program described by section 457(f). The term "state agency" is broadly defined as a board, office, commission, department, institution, court, or other agency in any branch of state government, and the opinion concluded it plainly includes the System, an agency of higher education.

The opinion then walked through the federal tax framework. Section 457 generally lets compensation deferred under an eligible plan stay out of gross income until paid. Subsection (b) covers eligible plans for governmental and tax-exempt employers, while subsection (f) is an income-recognition rule for plans that are not eligible under (b): the compensation is taxed in the first year there is no substantial risk of forfeiture. Subsection (f)(2) carves out exceptions, including the portion of a plan consisting of a transfer of property described in section 83, which has its own income-recognition rule keyed to when the property becomes transferable or free of a substantial risk of forfeiture.

Reading the Texas statute against that framework, the opinion acknowledged section 457(f) does not itself authorize benefit plans; it describes them. But because article 6228a-5 authorizes a program "described by" section 457(f), and section 457(f) describes a plan that consists of a transfer of property under section 83, the statute authorizes the System to offer such a plan. The opinion noted two practical points: the System must submit its proposal to the Employees Retirement System of Texas for review and comment, and it might also weigh the plan against the appropriations act, the state salary schedule, retirement provisions, and federal tax law, which the opinion did not address. Finally, whether any particular transfer of property qualifies for tax deferral under sections 83 and 457(f) is ultimately for the IRS to decide.

Currency note

This opinion was issued in 2001. Subsequent statutory amendments, court decisions, or later Attorney General opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here. Article 6228a-5 of the Texas Revised Civil Statutes and sections 83 and 457 of the Internal Revenue Code have been amended since 2001, so the specific provisions described here may no longer be current.

What the opinion meant for those who asked

The Texas A&M University System (what the opinion held): The opinion concluded the System has statutory authority under article 6228a-5, section 3(a) to offer employees a section 457(f) program, including a portion consisting of a transfer of property under section 83. It must first submit a proposal to the Employees Retirement System of Texas for review and comment.

State agencies and other institutions of higher education (what the opinion held for them): The opinion read "state agency" in article 6228a-5 broadly, so the same authority extends to agencies and institutions across state government that wish to offer a 457(f) program after the required ERS review.

Employees considering such a plan (what the opinion held for them): The opinion explained that section 457(f) and section 83 are income-recognition rules: compensation or property is generally taxed when there is no longer a substantial risk of forfeiture. It left the tax-qualification of any specific transfer to the IRS.

Common questions

Can a Texas public university offer a 457(f) deferred compensation plan?
The opinion concluded yes. Article 6228a-5, section 3(a) authorizes a state agency, including the Texas A&M University System, to let employees participate in an employer-sponsored program described by section 457(f) of the Internal Revenue Code.

Does that include a plan that transfers property like mutual-fund shares?
Yes. The opinion concluded that because section 457(f) describes a plan consisting of a transfer of property under section 83, the Texas statute authorizes the System to offer that kind of plan.

Is there a required approval step?
Before starting such a plan, the agency must submit a proposal to the Employees Retirement System of Texas for review and comment. The opinion also suggested considering the appropriations act, state salary rules, retirement provisions, and federal tax law.

Who decides whether the plan actually defers taxes?
The opinion was clear that the Internal Revenue Service, not the Attorney General or ERS, is the proper authority to determine whether a particular transfer of property qualifies for tax deferral under sections 83 and 457(f).

Background and statutory framework

Article 6228a-5, section 3 of the Texas Revised Civil Statutes provides that a state agency may permit some or all of its employees to participate in an employer-sponsored program described by section 457(f) of the Internal Revenue Code, that the agency must first submit a proposal to the Employees Retirement System of Texas for review and comment, and that "state agency" means a board, office, commission, department, institution, court, or other agency in any branch of state government. Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3 (Vernon Supp. 2001). The Texas A&M University System is an agency of higher education within that definition. Tex. Educ. Code Ann. § 61.003(3), (4), (6), (8) (Vernon Supp. 2001).

Under federal law, compensation deferred under an eligible deferred compensation plan is not includible in gross income until paid or made available. 26 U.S.C. § 457(a) (1994). Subsection (b) sets limits and rules for eligible plans, available to governmental and tax-exempt employers. Id. § 457(b) (1994 & Supp. V 1999); id. § 457(e)(1) (1994). Subsection (f) governs plans that are not eligible under (b): the compensation is included in gross income in the first taxable year there is no substantial risk of forfeiture, and amounts made available are taxed under section 72. Id. § 457(f)(1). Section 457(f) "is an income recognition rule which governs when compensation must be included in taxable income." MacGregor v. Bd. of Trs. of the Teachers' Ret. Sys. of the State of Ill., 636 N.E.2d 83, 86 (Ill. App. Ct. 1994). Subsection (f)(2) excepts the portion of a plan consisting of a transfer of property described in section 83, which includes such property in income in the first taxable year the rights are transferable or not subject to a substantial risk of forfeiture. Id. § 457(f)(2)(C); id. § 83. Whether a given deferred-compensation plan qualifies for tax deferral under section 457 is ultimately for the IRS. Arizona Governing Comm. for Tax Deferred Annuity & Deferred Compensation Plans v. Norris, 463 U.S. 1073, 1076 n.1 (1983).

Citations

Statutory provisions:

• Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3 (Vernon Supp. 2001)
• Tex. Educ. Code Ann. § 61.003(3), (4), (6), (8) (Vernon Supp. 2001)
• 26 U.S.C. § 457(a) (1994)
• 26 U.S.C. § 457(b) (1994 & Supp. V 1999)
• 26 U.S.C. § 457(e)(1) (1994)
• 26 U.S.C. § 457(f) (1994 & Supp. V 1999)
• 26 U.S.C. § 72
• 26 U.S.C. § 83 (1994)

Cases:

• MacGregor v. Bd. of Trs. of the Teachers' Ret. Sys. of the State of Ill., 636 N.E.2d 83 (Ill. App. Ct. 1994)
• Arizona Governing Comm. for Tax Deferred Annuity & Deferred Compensation Plans v. Norris, 463 U.S. 1073 (1983)

Source

• Landing page: https://www.texasattorneygeneral.gov/opinions/john-cornyn/jc-0431
• Original PDF: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/2001/jc0431.pdf

Original opinion text

Best-effort transcription from the official scanned PDF. Minor character-level errors from the source OCR have been corrected; the linked PDF is authoritative.

OFFICE OF THE ATTORNEY GENERAL - STATE OF TEXAS

JOHN CORNYN

November 6, 2001

Mr. Howard D. Graves, Chancellor
The Texas A&M University System
301 Tarrow, Sixth Floor
College Station, Texas 77840-7896

Opinion No. JC-0431

Re: Whether The Texas A&M University System is authorized to offer employees the opportunity to participate in a nonqualified program or plan under section 457(f) of the Internal Revenue Code consisting of the transfer of property (RQ-0396-JC)

Dear Mr. Graves:

The Texas A&M University System (the "System") has asked whether it "may offer some employees the opportunity to participate in an employer-sponsored program described by [section] 457(f) of the Internal Revenue Code of 1986, including that portion of any plan which consists of a transfer of property described in [section] 83 of the Internal Revenue Code of 1986."[1] We conclude that article 6228a-5, section 3(a) of the Texas Revised Civil Statutes authorizes the System to implement such a program. The System must submit a proposal for the program to the Employees Retirement System of Texas for its review and comment. The Internal Revenue Service is the proper authority to determine whether any particular transfer of property qualifies for tax deferral under sections 83 and 457(f) of the Internal Revenue Code.

We understand that the System would like to offer some employees additional benefits above and beyond traditional retirement and deferred compensation plans. See Request Letter, supra note 1, at 1. For example, the System might give an employee an option to purchase a certain amount of shares in a mutual fund "at a discount at date of grant."[2] "The employee would not be able to exercise the option until such time as he or she completes a stated term of employment with the University or the System."[3] You ask whether article 6228a-5, section 3(a) authorizes the System to offer such a plan.

Section 3 of article 6228a-5 provides as follows:

            (a) A state agency may permit some or all of the employees of the agency to participate in an employer-sponsored program described by Section 457(f) of the Internal Revenue Code of 1986, including subsequent amendments of that law.

            (b) Before a state agency begins sponsorship of a program under Subsection (a) of this section, the agency shall submit a proposal for the program to the Employees Retirement System of Texas for its review and comment.

            (c) In this section, "state agency" means a board, office, commission, department, institution, court, or other agency in any branch of state government.

Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3 (Vernon Supp. 2001). This provision authorizes a "state agency" to "permit some or all of the employees of the agency to participate in an employer-sponsored program described by Section 457(f) of the Internal Revenue Code of 1986." Id. § 3(a). The term "state agency" is broadly defined to mean "a board, office, commission, department, institution, court, or other agency in any branch of state government," id. § 3(c), and clearly includes the System, an agency or institution in the state executive branch, see Tex. Educ. Code Ann. § 61.003(3), (4), (6), (8) (Vernon Supp. 2001) (defining The Texas A&M University System as an "agency of higher education" and including its universities within the meaning of "institution of higher education"). Therefore we conclude that article 6228a-5 authorizes the System to "permit some or all of [its] employees . . . to participate in an employer-sponsored program described by Section 457(f) of the Internal Revenue Code of 1986." Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3(a) (Vernon Supp. 2001).

Because the System would like to offer employees a plan that involves the transfer of property, such as shares in a mutual fund, we are asked more particularly whether the System may offer a plan under section 83 of the Internal Revenue Code. See Request Letter, supra note 1; System Letter, supra note 2. We conclude that article 6228a-5, section 3 permits the System to offer a plan consisting of transfers of property as "an employer-sponsored program described by Section 457(f)." Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3(a) (Vernon Supp. 2001).

Section 457 of the Internal Revenue Code provides that compensation deferred by a participant under an eligible deferred compensation plan is not includible in the participant's gross income until the taxable year in which the compensation is paid or made available to the participant. See 26 U.S.C. § 457(a) (1994). Subsection (b) sets forth the maximum amount of income that may be deferred under a plan for a tax year and establishes other rules for eligible deferred compensation plans. See id. § 457(b) (1994 & Supp. V 1999). Employers eligible to offer a deferred compensation plan under section 457(b) include state and local governments and tax-exempt organizations. See id. § 457(e)(1) (1994).

The Texas statute at issue, article 6228a-5, refers to subsection (f) of section 457, which governs the tax treatment of a participant in a plan offered by an eligible employer that is not a qualified plan under subsection (b). As one court has noted, section 457(f) "is an income recognition rule which governs when compensation must be included in taxable income." MacGregor v. Bd. of Trs. of the Teachers' Ret. Sys. of the State of Ill., 636 N.E.2d 83, 86 (Ill. App. Ct. 1994). In general, when an eligible employer, such as a state agency, offers a plan deferring compensation that is not an eligible deferred compensation plan under section 457(b),

            (A) the compensation shall be included in the gross income of the participant or beneficiary for the 1st taxable year in which there is no substantial risk of forfeiture of the rights to such compensation, and

            (B) the tax treatment of any amount made available under the plan to a participant or beneficiary shall be determined under section 72 (relating to annuities, etc.).

26 U.S.C. § 457(f)(1) (1994). The rights of a person to compensation are subject to "a substantial risk of forfeiture" if such person's rights to such compensation "are conditioned upon the future performance of substantial services by any individual." Id. § 457(f)(3)(B). In subsection (f), the term "plan" includes "any agreement or arrangement." Id. § 457(f)(3)(A).

Subsection (f)(2) of section 457 provides several exceptions to the general rule for certain types of plans, including: "that portion of any plan which consists of a transfer of property described in section 83." Id. § 457(f)(2)(C) (Supp. V 1999). Section 83, in turn, establishes an income recognition rule for transfers of property. See id. § 83 (1994). As with ineligible deferred compensation plans under section 457(f)(1), section 83 provides that the value of property transferred from an employer to an employee shall be included in the employee's gross income "in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture." Id. § 83(a). The rights of a person in property "are subject to a substantial risk of forfeiture" if "such person's rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual." Id. § 83(c)(1).

Again, article 6228a-5, section 3(a) of the Texas Revised Civil Statutes authorizes the System to "permit some or all of [its] employees . . . to participate in an employer-sponsored program described by Section 457(f) of the Internal Revenue Code of 1986." Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3(a) (Vernon Supp. 2001) (emphasis added). As we have noted, section 457(f) is an income recognition rule and does not authorize employer-sponsored programs, deferred compensation plans, or other employee benefits. It does, however, in the words of the Texas statute, "describe" deferred compensation plans that are not eligible for tax deferral under section 457(b). And subsection (f)(2) specifically describes a plan involving the transfer of property, the taxation of which is governed by section 83. See 26 U.S.C. § 457(f)(2)(C) (Supp. V 1999). Although the Texas statute is somewhat awkwardly worded, we have no doubt that the Legislature intended article 6228a-5, section 3(a) to authorize state agencies to offer plans deferring compensation that are not eligible plans under section 457(b). Because section 457(f) describes a "plan which consists of a transfer of property described in section 83," id. § 457(f)(2)(C), we conclude that article 6228a-5, section 3 authorizes the System to offer such a plan.

We note that article 6228a-5 requires a state agency to submit a proposal for a section 457(f) plan to the Employees Retirement System of Texas for its review and comment. See Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3(b) (Vernon Supp. 2001). Before establishing a section 457(f) plan, a state agency might also want to consider the plan in light of other statutory schemes, such as the appropriations act, the state salary schedule system, applicable state retirement provisions, and federal tax laws, none of which we address here. The Internal Revenue Service, rather than this office or the Employees Retirement System, would be the proper authority to determine whether any particular transfer of property qualifies for tax deferral under sections 83 and 457(f). See Tex. Att'y Gen. Op. No. JC-0197 (2000) at 3 ("Whether a given deferred-compensation plan qualifies for tax deferral under 26 U.S.C. § 457 is a determination ultimately to be made by the Internal Revenue Service.") (citing Arizona Governing Comm. for Tax Deferred Annuity & Deferred Compensation Plans v. Norris, 463 U.S. 1073, 1076 n.1 (1983)).

                                  SUMMARY

            Article 6228a-5, section 3(a) of the Texas Revised Civil Statutes authorizes state agencies, including The Texas A&M University System, to offer a program "described by Section 457(f) of the Internal Revenue Code of 1986." Tex. Rev. Civ. Stat. Ann. art. 6228a-5, § 3(a) (Vernon Supp. 2001). Because section 457(f) describes a deferred compensation "plan which consists of a transfer of property described in section 83" of the Internal Revenue Code, see 26 U.S.C. § 457(f)(2)(C) (Supp. V 1999), article 6228a-5 authorizes the System to offer such a plan.

                                         JOHN CORNYN
                                         Attorney General of Texas

HOWARD G. BALDWIN, JR.
First Assistant Attorney General

NANCY FULLER
Deputy Attorney General - General Counsel

SUSAN D. GUSKY
Chair, Opinion Committee

Mary R. Crouter
Assistant Attorney General, Opinion Committee