Deferred comp leads to IRS concerns, issues
By Bill Donovan
Special to the Times
WINDOW ROCK, Aug. 11, 2011
Thank or blame the Internal Revenue Service for that.
Under Navajo law, departing elected officials receive a nice little nest egg - or a big one, if they've been in office for a long time. In theory it's pay they earned but was set aside in recognition of the fact that it may take them some time to find a new job.
But deferred comp can also serve as collateral for a payroll advance and many delegates took advantage of this opportunity more than once, borrowing up to $15,000. Sooner or later the advances would be repaid, ultimately by deducting from their deferred compensation if they had not already made repayment.
For those who didn't repay their advances within a year, the IRS is saying they also owe tax on that money because it counts as income, according to Rodger Martinez, director of the tribe's Retirement Services Department.
The deferred compensation program, which is administered by the JP Morgan Retirement Plan Services, has been around since 1973, providing millions of dollars in benefits over the years to not only elected officials of the tribe but appointees as well.
For elected officials, an extra 20 percent of their base salary is put into a special account that they can only receive when they step down from office. Appointees - those who serve at the pleasure of the president or the Council - receive extra pay equal to 10 percent of their salary.
The money is put into an account each pay period and collects interest throughout their time in office. Morgan account managers determine how to invest the money, in theory getting the best return possible.
What this means, said Martinez, is that a delegate earning $25,000 a year would get $5,000 a year extra with interest providing several hundred additional dollars. At the end of a four-year term, his or her deferred comp would be $26,000 to $27,000, depending on how must interest was earned.
Tapping the money
But in 1998, after mulling it over for many years, the Council made a major change in the rules.
All that money was accumulating with no way to touch it.
Martinez said he explained to them that deferred comp was like a retirement fund, and letting it accumulate untouched was the whole idea.
He nevertheless got approached more than once to help a delegate use deferred comp as collateral for a vehicle loan. Martinez said he always refused, because if the person defaulted on the loan, there was no way the bank or the car dealer could get money out of the tribe's deferred comp program.
The Council then decided to allow delegates salary advances from their deferred comp funds. These could be repaid through biweekly payroll deductions or in one lump sum when they left office.
Martinez and others objected to this as well, pointing out that if the delegates were able to tap into their nest eggs early and not repay the money until they stepped down, it would defeat the purpose of the nest-egg program.
And then there was the matter of taxes. The IRS viewed payroll advances that were not repaid within a year as additional income, and therefore taxable.
Martinez said he kept stressing that the Council should not do anything that would hurt the integrity of the deferred comp program because it could hurt the tribe or those who benefit from it.
Despite these warnings, the Council approved the advances, first limited to $2,500 per delegate but increasing over time to $5,000, then $10,000 and finally $15,000 per delegate.
Martinez stressed that this was not a give-away because anything owed to the tribe would be repaid before the deferred comp was released.
But there was nothing to prevent a new delegate from borrowing the full amount possible - $15,000 - in essence borrowing against money they had not yet received. And if the person then left office early, the deferred comp program would have a hole to fill.
And, indeed, the IRS did take notice, saying that federal tax laws considered these payroll advances to be a "constructive receipt." If not repaid within a year, it would be considered additional salary and the delegate would have to pay taxes on it.
More tax woes
This wasn't the first time that people who received deferred comp found themselves in trouble with the IRS, Martinez added.
In the early days of the program, recipients had the option of taking all their deferred comp with them or having the tribe withhold the taxes they would owe on it.
Many decided to take it all with them, and no matter how large the amount, most seemed to go through it in a matter of months. Then they had no money to pay the taxes.
"They would come back and complain that we didn't tell them that they had to pay taxes on it, but we always did that," Martinez said.
So many delegates found themselves in serious tax trouble over deferred comp that eventually the tribe took away the option and now withholds the taxes before cutting the checks.
For many of the 88 who lost their seats in last year's Council downsizing to 24, their deferred comp was substantially reduced by tax withholding coupled with the belated repayment of cash advances, Martinez said.
The new Council has taken steps to correct the problems by tightening up the rules, he said.
Delegates can still get payroll advances but have to repay them within one or two pay periods. They can also get loans but they are required to repay them through payroll deductions within a year to avoid problems with the IRS.
This includes the 11 delegates who are carryovers from the previous Council. If they had outstanding advances, a repayment schedule was set up. If the loan was more than a year old, they are required to pay income tax on it. In either case, repayment is made through payroll deductions.
But the delegates may face still more heat from the IRS, courtesy of the charges involving millions in questionably spent slush funds.
In his legal filings, Special Prosecutor Alan Balaran claims that the delegates used millions of dollars of discretionary aid for their own personal benefit or that of their relatives.
Whether or not the claims are proven in court, the delegates and others who received large amounts from the slush funds could be taxed if the IRS agrees with Balaran's findings.
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