This post is not intended to be tax advice. Firefly Admin Inc. does not provide tax advice, and all participants and beneficiaries who receive a LOSAP benefit are strongly encouraged to consult with a qualified tax professional regarding the information provided in this post. The information contained herein is accurate as of the date of the post. Guidance or publications issued by the Internal Revenue Service after the date of this post may invalidate some or all of the information provided.
 
The following information regarding LOSAP may be used to assist someone in preparing a tax return for an individual who received a payment from a LOSAP during the 2022 tax year. It may also be helpful to anyone who wants to understand why a LOSAP payment was reported on a particular form. It is intended primarily for New York State residents. If the payment recipient lives outside of New York State, or the LOSAP is sponsored by a municipality outside of New York State, please consult the State’s tax department for details on how LOSAP payments are taxed in your State.
 

• LOSAP is an acronym for Length of Service Award Plan/Program

 

• Section 457(e)(11) of the Internal Revenue Code (the “Code”) sets the limits on the benefits that can be provided and the qualifications of volunteers to participate in a LOSAP. A program that qualifies as a LOSAP under this section of the Code is exempt from having to comply with all the other requirements of Section 457.

 

• Section 3121(a)(5)(I) of the Code provides that a payment from a LOSAP is not treated as wages for purposes of Federal Insurance Contribution Act (FICA) taxes. In other words, payments from a LOSAP are not subject to FICA tax (i.e., self-employment tax).

 

• LOSAP payments are subject to ordinary federal income tax. In general, LOSAPs are administered so that an individual will include a LOSAP payment in his/her taxable income for the tax year in which it was paid to him/her.

 

• LOSAP is not a pension, annuity, retirement or profit-sharing plan, or an IRA. Therefore, based on the 2022 instructions for the 1099-R, payments from a LOSAP should not be reported on a 1099-R. However, in some instances LOSAP payments are made from insurance contracts (e.g., annuity contracts) and the correct form to report a payment from an insurance contact is a 1099-R. If you received a 1099-R or any other tax form besides a 1099-MISC reporting payments from a LOSAP, please contact the company that issued that tax form for more information.

 

• Payments issued from LOSAP Trust Fund assets that are not insurance contracts (which represents most Firefly Admin Inc. clients) are reported on IRS Form 1099-MISC in Box 3 (Other Income). In accordance with the 2022 Instructions for the 1099-MISC and 1099-NEC:
  
  Generally, amounts paid to individuals that are reportable in box 1 are subject to self-employment tax. If payments to individuals are not subject to this tax, report the payments in box 3 of Form 1099-MISC.

 

• Payments reported in Box 3 of a 1099-MISC should likely be reported on line 8z of Schedule 1 of the Form 1040. For the description, we suggest writing the applicable section of the Code, which is 457(e)(11).

 

• For New York State residents, New York State Tax Law Section 612(c)(41) provides that payments from a LOSAP can be subtracted from an individual’s New York State taxable income provided that (1) the taxpayer is over age 59 ½ and (2) the benefit was not paid as a lump sum.

 

• For eligible New York State residents to take advantage of this favorable tax treatment, use supplemental form IT-225 and list the amount received using subtraction S-130.

 

• The 1099-MISC form does not include a box to indicate if the payment was made as a lump sum or on a periodic basis. Therefore, an individual taking advantage of the New York State subtraction must make his/her own determination on his/her eligibility.

 
 Please contact Firefly Admin Inc. with questions. 

Towards the end of 2022, the IRS released Notice 2022-55, which made cost-of-living adjustments for the benefit limitations provided in certain sections of the Internal Revenue Code.

One of those limitations is the maximum benefit that can be accrued in a Length of Service Award Program. The maximum benefit was increased from $6,500 to $7,000 effective with calendar year 2023.

Long-time followers of this limitation provided for in Section 457(e)(11) recall that the initial benefit limitation was $3,000. Specifically in NY State, this created some challenges for certain defined benefit plans, as the NY State law allowed a sponsoring municipality to provide a benefit that was  typically valued in excess of $3,000.

This situation was remedied when the Code was amended to increase the limitation from $3,000 to $6,000 beginning with calendar year 2018. The amending bill, HR 1, which was adopted during the 115th Congress (2017-2018), also included a cost-of-living adjustment provision (to be implemented in $500 increments).

As a result of the recent rise in interest rates, the $6,000 limit was increased to $6,500 in 2022. It was then increased from $6,500 to $7,000 beginning with calendar year 2023.

This change is merely a footnote for municipalities in New York State, as the maximum benefit allowed under State Law is less than $7,000. Specifically for defined contribution LOSAPs, the maximum contribution allowed into a participating volunteers account is $1,200, which is about 17% of the maximum allowed by the IRC. A more valuable benefit can be provided under defined benefit plans, with the actuarial value of those benefits that can approach $6,000 depending on the assumptions used. 

For readers of this blog outside of New York State, it is possible that a LOSAP could provide for benefit of up to $7,000 to be accrued in calendar year 2023 and beyond. It is still our desire to see the NY State law amended to allow sponsors of defined contribution plans to contribute a larger amount than the current limit of $1,200 - something more in line with the benefits provided by a defined benefit plan.

In a post from May 20, 2019, we discussed why a LOSAP benefit cannot be rolled over to a qualified plan. You can read that article HERE.

Additionally, since a LOSAP benefit is not earned income (for Firefly clients, the income is reported on a 1099-MISC in Box 3), it cannot be deposited into an IRA. 

So what alternatives exist? If you are receiving a LOSAP benefit and are still working and receiving W-2 income, or you are married and your spouse is still working and receiving W-2 income, here are some options:

• If  your employer offers a 401(k) (or similar deferred compensation plan if you work for a government, non-profit, or school), you can temporarily increase your contributions to the retirement plan to offset the LOSAP distribution. For example, if you receive a $10,000 LOSAP distribution, simply defer an extra $10,000 into your 401(k). This solution only works if you are not already maximizing your contributions to your 401(k), which for 2022 is $27,000 for anyone over age 50. 
  
  
• If you are married, your spouse still works, and you are already in the habit of co-mingling your combined income into joint accounts, you might obtain additional flexibility from a 401(k) (or similar) offered by your spouse's employer. You may have additional contributions you can now make (up to $27,000 per person for a total of $54,000 assuming your spouse is over age 50 also).  Or, if you are not working but your spouse is, a similar approach to the first bullet point could be followed but done by your spouse. You then use the LOSAP benefit to offset the contributions to the 401(k).
  
  
• You could also utilize a traditional IRA, though the contribution limits are much less and there are income restrictions. The maximum tax-deductible contribution to an IRA for 2022 is $6,000, provided you do not exceed the income restrictions. Similar to the previous two bullet points, you would contribute a tax-deductible amount into your IRA and then use the LOSAP distribution to supplement your income for that year. But again, this only works if you (or your spouse) are still working and has W-2 income to deposit into an IRA. Talk to a financial advisor for more details. 

In all three cases, you are simply deferring federal income tax to a later point in life. Unless the federal tax code is changed, you will ultimately pay federal income tax of some amount (the tax rate could be different) on this income when you receive a distribution from your 401(k) or IRA.

State tax is a little more tricky, in particular for those that live in NY State and plan on remaining here. Under current NY State tax law, a non-lump sum payment from a LOSAP to an individual over age 59 1/2 can be subtracted from your NY State taxable income in the year of distribution. Therefore, anyone who qualifies for this exemption will not pay NY State income tax on their LOSAP distribution. However, if you took one of the approaches above, once that income is deposited into the 401(k) or IRA the distribution you receive later will no longer be a LOSAP distribution. As such, you essentially lose the special tax exemption for a LOSAP distribution here in New York. There are other exemptions and tax-strategies that can be considered, so it is very important to review these possible strategies with your own tax and financial advisor. 

Firefly Admin Inc. does not provide income tax advice or legal advice. This article is general information, is not meant to be an authoritative or exhausted analysis of all possibilities, and is not legal or tax advice. You are strongly encouraged to seek the help of a qualified tax and legal professional before receiving a LOSAP distribution or implementing any strategies theorized in this article.