Question: A public school district and the local teachers’ union have a contract that provides for a lump sum retiree stipend payment to teachers in the January following the year of retirement. The payment is based on the number of years of employment with the district. Should this payment be reported as wages on Form W-2, or is it reportable on a Form 1099 because the retiree is no longer an employee?
Answer: If the payment is from a qualified retirement plan it is reportable on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
However, as described, the retiree stipend is more likely trailing compensation akin to a bonus paid after the employee has left employment, severance pay, or a nonqualified length-of-service achievement award. The retiree stipend is paid for services performed during employment but is paid after employment has terminated.
Trailing compensation is usually taxable by the state in which it was earned even if the payee is a resident of another state at the time of payment.
Trailing compensation constitutes wages and should be reported on Form W-2, Wage and Tax Statement. The retiree is deemed to be an employee for reporting purposes even though the retiree is not currently an active employee providing services.
The payment is not reportable on Form 1099-NEC, Nonemployee Compensation, because the payment is based on prior service as an employee instead of from an independent trade or business operated by the employee. It is also not subject to self-employment tax. However, IRS Publication 15, Circular E, Employer’s Tax Guide, says the payment is subject to Social Security and Medicare taxes because “compensation paid to a former employee for services performed while still employed is wages subject to employment taxes.”
Since the payment does not constitute regular pay for a particular pay period, it is supplemental pay subject to the supplemental pay withholding rules.
If the retiree has not reached full retirement age for Social Security but will begin drawing Social Security benefits in the year the retiree stipend is paid, the payment may also qualify as a special wage payment for Social Security purposes.
A special wage payment is a distribution of an amount that was earned prior to retirement. It may be excluded from current-year income for purposes of the reduction of Social Security benefits prior to reaching full retirement age. Retirees, from age 62 until reaching full retirement age, are subject to a limitation on the amount annual income they can earn and still receive full benefits. If the limitation is exceeded, the retiree’s Social Security benefits are reduced by $1 for every $2 of earned income over the limit. For 2023, the earnings limit is $21,240.
A retiree stipend paid in January 2023 is a special wage payment and will not count as earned income in determining when the $21,240 limit is reached. Special wage payments are discussed in Social Security Administration Publication No. 05-10063, Special Payments After Retirement.
This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at firstname.lastname@example.org.
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