Compensation Ruling FAQ for Employers

Arizona Court Decision

The Arizona Court of Appeals wrote the following paragraph and legal holding which was affirmed by the Arizona Supreme Court.

A.R.S. § 38–711(7) defines the “compensation” on which employee and employer contributions to the Arizona State Retirement System (“Retirement System” or “ASRS”) are calculated. The Retirement System interprets that statute to exclude from “compensation” the City of Chandler's payment of contributions to an eligible deferred compensation plan, and the superior court upheld that interpretation. We disagree. We hold that § 38–711(7) defines “compensation” to include money paid by an employer to a deferred compensation plan, even if the employee could not elect to immediately receive the deferred compensation as cash-in-hand.

Q&A for Employers

On April 7, 2017, the Arizona State Retirement System (ASRS) posted a notification on its website to alert our members of a recent ruling from the Arizona Supreme Court.  On April 13, 2017, the ASRS sent an email to employers as a follow up to the website notification.  There have been a number of questions from employers seeking clarification of the effects of this ruling, so we have assembled a list of commonly asked questions and their answers, which we hope will address any additional questions you may have.

What happened?

On March 23, 2017, in the case of Wade and Paddock v. ASRS (No. CV-16-0087-PR), the Arizona Supreme Court held that employer-paid contributions on behalf of an employee to a tax qualified deferred compensation plan are compensation and therefore require ASRS contributions.  This Court opinion is written broadly to capture employer contributions to any tax qualified deferred compensation plans which includes plans such as a 457, 403(b) or 401(k) plan.

  Printable PDF: Compensation Ruling FAQ for Employers (Rev. 6/20/17)

What is included?

Q1: We have a 403(b) plan, or tax sheltered annuity, for some employees.  FICA applies differently to 403(b) than other types of plans.  Are 403(b) plans included in this ruling like 457 and 401(k) plans?

A: Yes.  This court opinion applies to employer contributions to a tax qualified deferred compensation plan other than the ASRSdefined benefit plan.  This does include 403(b) plans.  The Court did not address specific types of plans but instead broadly held that the phrase in the ASRS compensation definition in A.R.S. § 38-711(7) “including amounts that are subject to deferred compensation or tax shelter agreements” includes employer deferred compensation contributions on behalf of its employees.  

Q2: We are making payments into a deferred compensation plan for employees, but the payments represent things that are excluded in the definition of ASRS compensation (e.g., reimbursements, optional payments in lieu of a fringe benefit, health insurance subsidy payments, or termination payments).  Does this Court opinion mean these payments are now ASRS compensation and subject to ASRS contributions?

A: No.  If the payment type is excluded from the statutory definition of ASRS compensation, then the payment type is still excluded even though the employer may facilitate the payment via a deferred compensation account.  Compensation is defined in A.R.S. § 38-711(7).

Q3: In what kind of situation could this change be applicable?  Will you provide an example?

A: Here are two examples.

    • Employee A is paid $80,000 in gross wages on an annual basis.  Gross wages are ASRS compensation, so employer and employee ASRS contributions are remitted on the $80,000 as it is paid throughout the year by payroll.

In addition to Employee A’s wages, the employer contributes $10,000 per year into a tax sheltered annuity (TSA) for Employee A.  This $10,000 is paid into the TSA by the employer on behalf of Employee A; it is not part of Employee A’s $80,000 salary.  It is not paid to Employee A and then diverted to the TSA, and it is not reported as wages for Employee A. 

Prior to the Court’s decision on March 23, 2017, the ASRS agency interpretation was that this $10,000 is not compensation for ASRS purposes because it is not paid to Employee A as salary or wages and was instead an employment benefit.  Now following the Court’s pronouncement that this $10,000 employer contribution is ASRS compensation, the employer must treat the $10,000 as compensation for ASRS purposes going forward and looking backward through the CNW process.  Therefore the employer must pay ASRS employer contributions and must deduct and remit employee contributions to the ASRS on this employer payment to the TSA on behalf of Employee A.

    • Employee B is paid $50,000 in gross wages on an annual basis.  As with the first example, ASRS contributions are remitted on the gross wages in each payroll.

Employee B has a 457 deferred compensation plan and their employer pays a partial match on Employee B’s contributions to their 457 plan.  For Employee B’s contribution of $50 per pay period into their 457 plan, the employer pays $10 into the plan on Employee B’s behalf.  Employee B makes their 457 contribution through payroll deduction so the $50 Employee B is deferring into their 457 was included in their gross wages for that payroll and ASRS contributions were already made on their gross wages.  But previously, the employer match of $10 into Employee B’s 457 was not included in their wages and no ASRS contributions have been made on the employer matching funds to the 457.

Now as a result of the Court’s decision, going forward and looking backward through the CNW process, the employer must treat the $10 employer contribution as compensation for ASRS purposes.  Therefore the employer pays ASRS contributions and must deduct and remit employee contributions on these employer payments to the 457 plan on behalf of Employee B.

Is it mandatory to make these contributions from the past?

Q4: Is it mandatory that the employer make retroactive ASRS payments on the employer portion of their deferred compensation contributions? 

A: When less than the correct amount of contributions has been paid into ASRS, it is mandatory and not optional that the employer make the correction.  The Contributions Not Withheld (CNW) process is the only legally permissible method the ASRS has to make corrections, and this is detailed in A.R.S. § 38-738(B) - (D).  The ASRS must adhere to the statutes and does not have authority to grant flexibility regarding when to begin reporting contributions on compensation.

Q5: Would ASRS accept a release of liability from a member so that the contributions only started from July 1, 2017 and onward and would not involve CNW prior to that date?

A: No. The ASRS has a duty as fiduciaries under the law to act solely for the benefit of members and beneficiaries and is required by the Arizona Supreme Court to administer the Court decision. 

Q6: Will an employer who does not timely pay their CNW invoice incur interest?

A: Yes. Once the ASRS has calculated the employer portion of a CNW (which will include interest on both employee and employer contributions), the employer will have 90 days to pay the entire amount.  If the employer does not pay the full amount within 90 days, the unpaid amount will accrue additional interest until it is fully paid as required by Arizona statute.

Is it mandatory to make these contributions from the past (cont.)?

Q7: What consequence is there to an employee-member who does not pay their CNW invoice?

A: If the employee does not pay their CNW invoice, then the additional compensation will not be added to their ASRS compensation history and therefore will not be included in the average monthly compensation at the time their pension is calculated.  If the employee decides to pay the CNW at a later date, their cost will be recalculated to include interest from their original due date as required by Arizona statute.

Q8: We have already been treating employer payments into our employees' deferred compensation plans as compensation for ASRS purposes because we did not realize this was contrary to the way the statute was interpreted prior to this case.  Will the ASRS require us to correct this by reversing those contributions that occurred prior to April 13, 2017, and then go through the CNW process to pay them back?

A: No.  Prior to this ruling, the ASRS would have required employers to reverse contributions that had been submitted on these monies, because they were not ASRS compensation.  But because the ruling changed the definition so these monies are ASRS compensation, there is no error to correct.

How is this handled for prior pay periods?

Q9: What payment options will be available to the member once they receive their invoice from the ASRS?

A: Employees will receive information about their payment options at the time they receive their invoice.  The options will include a direct rollover from another qualified plan or an after-tax check.  These can be combined (i.e., an employee can pay a portion with an after-tax check and pay the remaining portion by direct rollover).  A Payroll Deduction Agreement (PDA) is not an eligible payment option for employees in this situation because the CNW is for additional compensation for time periods during which the employee already contributed and earned service credit.  A PDA is only available when the CNW or Service Purchase includes the purchase of ASRS service credit.

Q10: If we have an employee for whom we have been making these employer payments for longer than 15 years, when exactly would the 15-year CNW period begin?

A: The ASRS initiated the request for correction with the email sent to employers on April 13, 2017.  The CNW period begins 15 years prior to that date, or April 14, 2002.

Q11: How would former employees and/or retirees be handled?  Do we still need to complete the CNW process for them?

A: Yes.  Please see the answer to Q4, which also applies here.  When a member who has already retired from the ASRS completes the payment of their CNW invoice, the member’s pension benefit will be recalculated and adjusted if the additional compensation history resulted in a higher average monthly compensation for retirement.

Q12: This expense is not in our budget.  Can we begin submitting contributions on these amounts prospectively from July 1, 2017 instead of the current pay period? 

A: If contributions are not begun on this compensation until the next fiscal year, the amount owed as CNW will increase and the employer will incur additional interest cost as stated in statute.  

Q13: We have a large number of employees for whom we now have to complete CNW forms.  Can we just send a spreadsheet instead of filling out hundreds of paper forms?

A: Yes.  An Excel file in lieu of the actual CNW form is acceptable as long as all of the same information that is required on the CNW form is included on the spreadsheet.  ASRS staff have created a template workbook that you may use for this purpose. To request this template, send a Secure Message to the ASRS. If you are creating your own Excel file, do not group more than one employee on the same spreadsheet.  You may include all applicable years of the CNW on an employee’s spreadsheet as long as the totals for each fiscal year are visible.  If an employee’s pay period amounts are not consistent, each pay period needs to be listed separately. 

How is this handled for Return-to-Work Retirees?

Q14: We have a return-to-work retiree and we currently pay an Alternate Contribution Rate (“ACR”) on the retiree’s compensation.  We also make employer-only payments into a deferred compensation account for the retiree.  Does ACR apply to the deferred compensation payments?

A: Yes.  The definition of compensation for active contributions is the same for alternate contributions.

Q15: Do we need to pay ACR for prior pay periods?  If so, is that the same process as a regular CNW?

A: The alternate contribution rate became effective July 1, 2012 with A.R.S. § 38-766.02.  Alternate contributions that were not paid on all eligible compensation since ACR began do need to be paid.  However, ACR is an employer-only cost and does not impact employees, and therefore does not follow the CNW form or process.  Use the alternate contribution reporting process to report ACR for past pay periods that occurred July 1, 2012 and later.

How is this handled for current and future pay periods?

Q16: Should these contributions be reported differently from regular wages?

A: Yes. When reporting contributions on these employer payments into employees' deferred compensation plans, use the Pay Type 07. This pay type is labeled Performance, Bonuses, Longevity and Stability Pay. The label will be adjusted in the future to include Employer Paid Deferred Comp or Tax Sheltered Plan.

Q17: Since we started reporting these contributions in April 2017, we reported them as Pay Type 01 (Base pay/Leave pay). Do we have to make an adjustment for this?

A: No. Begin reporting these contributions as Pay Type 07 going forward. You do not need to make any adjustments for prior pay periods on which you reported them as Pay Type 01.

How should this be handled on an Ending Payroll Verification (EPV)?

Q18: Should this compensation be reported a particular way on the EPV for a new retiree?

A: Yes. In the future, the EPV for new retirees will be enhanced to add a separate compensation type for these contributions on employer-paid deferred compensation. When that feature is released, the ASRS will communicate the change to employers. In the meantime, when completing an EPV for a new retiree for whom your employer has made payments into a deferred compensation plan (and ASRS contributions were paid on those employer payments), report the compensation as Stability Pay in the Other Compensation section and add a comment to explain what the stability pay is.
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