Really appreciate the feedback . . . some further thoughts:
“As long as the employee is immediately vested in their deferred compensation plan, the deferred wages are subject to social security and medicare withholding at the time the wages were paid into the deferred compensation plan.”
Yes, but as cited section B details, there are numerous timings of 457 vestings, each with its respective timing of imposition of social security and medicare taxes. One particular timing is that the risk of substantial forfeiture does not end until the moment(s) of distribution. Under that scenario and your subsequent argument, wages could be earned ONLY at the moment of distribution, likely in the event of an RMD. I conclude that “As long as the employee is immediately vested . . .” is just one of several cases and does not support a broad determination of when earned income occurs. This section B simply details the timing of SS/M taxation; it does not address earned income. And of course, this matter is central to the question of whether a 457-distribution-based Roth contribution can legally occur.
“That means that withdrawals from a deferred compensation plan are not subject to social security and medicare tax at the time of withdrawal, which in turn means they don't count as "earned income" or "compensation" earned from working.”
Certainly, if social security and medicare taxes are imposed at the time of deferral, they won’t be imposed again. But as reasoned above, social security and medicare taxes might not have been imposed at deferral; in fact, they might be imposed at distribution. Based on the converse of your argument above, the distribution in that situation would have to be earned income.
But more importantly, I question the assertion “which in turn means that they don’t count as “earned income . . . from working”. To my reading of the cited section, and other reading, I find nothing that defines earned income as existing at the moment of and solely because of the imposition of social security and medicare taxes. “Which in turn” sounds like conjecture, not policy or regulation. But I remain most open to a written IRS definition that irrefutably backs this up, in which case my argument weakens.
Further, note the language on page 4, IV.A “stating Distributions to a participant or former participant from a ' 457(b) plan are wages under § 3401(a) that are subject to income tax withholding in accordance with the income tax withholding requirements of ' 3402(a)”. That’s a pretty definitive statement speaking to the key issue of earned income.
“And that means that in the end, a distribution from a 457 plan does not count as compensation that would allow the taxpayer to make a new contribution to a Roth IRA. 457 assets can be rolled over to a Roth IRA, but a 457 distribution does not count as compensation to allow new Roth IRA contributions. And that was the original question.”
Yes, one would have to go to that conclusion, but if you’ve followed me, a significant flaw lies in the “which in turn means . . . “ assumption. Therefore, I disagree with this conclusion.
Let me turn from these principles to my own recent experience. In the current year I received a 457 RMD (single payment) and its related tax documentation. The tax document I was issued is not a 1099, which one would expect for reporting of unearned income. (Interesting to note that if a distribution goes to a beneficiary, s/he must receive a 1099). I received a Form W-2 “Wage and Tax Statement“, as required in section IV.C of the cited note. Box 1 of the Form W-2, “Wages, tips, and other compensation”, contains the full amount of my RMD. I will assert (not cite) that a W-2 is the government’s definitive instrument of reporting earned income, hence the clear requirements contained in the note and the distinction noted above regarding an earner’s documentation and a beneficiary’s documentation.
With this tax document, prepared by a world-class trustee, in hand, I conclude that I have earned income (“wages”!) in 2021, for compensable work that I actually performed well over a decade ago. This makes abundant sense to me given the regulatory understandings I entered the deferred compensation program with. In short, I received exactly what I expected, taxable earned income. The only SS/M tax implication is that the IRS is diligent to withhold SS/M the moment the risk of substantial forfeiture is gone. But I re-assert that that trigger and imposition of SS/M are immaterial to the question of earned income.
With reported earned income now in hand, I’m not seeing why I can’t contribute to my Roth, subject to its usual rules and limitations. What have I missed? Be assured that I will not receive any comments as tax advice.
Love the “conversation”!
