August 2000 Vol. V, No. 1
ERISA, EMPLOYEE BENEFITS AND EXECUTIVE COMPENSATION NEWSLETTER
This past year has been busy indeed as a result of numerous legal changes brought about by pronouncements by the Internal Revenue Service and the Department of Labor. For the benefit of our clients and business associates, this newsletter summarizes these important changes in the employee benefits area. The newsletter is not intended as, and cannot be considered to constitute, specific legal advice, as each individual circumstance is unique. However, we are prepared to assist our clients and business associates in reviewing their employee benefit programs and in making any necessary or desirable revisions to take into account changes in the law.
Since our last newsletter, Marcia S. Wagner has continued to lecture and write extensively and has taught a graduate course at Bentley College. Marcia Wagner and Deanna Niño have co-authored a well-received article regarding a newly-established voluntary correction program for fiduciary violations of ERISA. Christopher Sowden, a seasoned ERISA practitioner with 20 years experience, has joined our firm as a partner, as has our newest associate, Katharine Butler Nesta. To learn more about our team and practice, please visit our web site at www.erisa-lawyers.com.
In the event you desire legal advice or consultation or wish to discuss the appropriate timing of necessary plan amendments or any other benefits issues, please feel free to contact Attorney Marcia S. Wagner, Attorney Christopher J. Sowden.
TABLE OF CONTENTS
I. TAX-QUALIFIED PLANS
A. Extension of Remedial Amendment Period
B. Unified Master/Prototype Plan Program
C. Repeal of Combined Limitation for Defined Benefit Plans and Defined Contribution Plans
D. New Comparability Issues
E. Invalid Rollovers will not Necessarily Disqualify a Plan
F. 403(b) Plan Audits
G. Proposed Alternative Distribution Rules Anti-Cut Back Relief
H. Prohibited Transaction Exemption Allows Loans to Plans for Y2K Problems
I. Updates to Employee Plans Compliance Resolution System
J. Tax Relief Extension Act of 1999
K. IRS Clarifies New Definition of Highly Compensated Employees
L. Required Notice Regarding Plan Termination or Benefit Accrual Cessation
M. New Model Tax Notices
N. Distribution Notices Regulations Finalized
O. Employees Do Not Have Right to Surplus Defined Benefit Pension Plan Assets
P. Partial Termination Based on Related Transactions in Different Years
Q. Department of Labor Proposes Annual Audits for Certain Small Plans
R. Excise Tax Imposed for Untimely Contribution to Money Purchase Pension Plan
II. 401(k) PLANS
A. Safe Harbor Guidance
B. Negative Elections
C. Same Desk Issues
III. ALL EMPLOYEE BENEFIT PLANS
A. Department of Labor Establishes New Fiduciary Self-Correction Program
B. Newly Revised Form 5500
C. Automatic Extension for Certain 1999 Form 5500 Filings
D. Electronic Notices
E. Leased Employees Not Entitled to Benefits
F. Reclassifed Employees Not Entitled to Benefits
G. Non-Fiduciaries May Be Sued Under ERISA
H. HMO Not ERISA Fiduciary
I. Department of Labor Proposes Summary Plan Description Changes
J. Department of Labor Proposes Claims and Appeals Changes
IV. WELFARE AND FRINGE BENEFITS
A. Qualified Transportation Guidance
B. IRS Issues New COBRA Regulations
C. New Cafeteria Plan Rules Regarding Change-In-Status
D. Cafeteria Plan Audits
E. Qualified State Tuition Programs
F. Group Term Life Insurance Table Revised
G. Final FICA/FUTA Withholding for Non Qualified Deferred Compensation Plans
H. New Annual Report for Multiple Employer Welfare Arrangements
A. Social Security Penalty Repealed for Working 65 to 69 Year Olds
B. Congressional Estate Tax Legislation
I. TAX-QUALIFIED PLANS
A. Extension of Remedial Amendment Period
Plan qualification rules have been changed significantly over the past several years by (among other legislation) the General Agreement on Tariffs and Trade, Uruguay Round Agreements of 1994 ("GATT"), the Uniformed Services Employment and Reemployment Rights Act of 1994 ("USERRA"), the Small Business Job Protection Act of 1996 ("SBJPA"), and the Taxpayer Relief Act of 1997 ("TRA '97"), collectively referred to as "GUST."
Under Revenue Procedure 2000-27, the IRS has extended the deadline for qualified plans to adopt the amendments required by GUST until the end of the first plan year beginning on or after January 1, 2001 (i.e., until December 31, 2001 for calendar year plans). The GUST remedial amendment period for governmental plans has been extended generally until the last day of the first plan year beginning on or after
January 1, 2001.
The IRS has also expanded the scope of its review of determination letter applications to include all changes required by GUST that went into effect for plan years beginning after 1998 (prior to this expansion, the IRS would only issue determination letters for GUST amendments with earlier effective dates). Thus, plan sponsors now are able to obtain favorable determination letters for all GUST-mandated changes.
Comment: Our firm is available to assist in the amending and restating of tax-qualified plans and submitting such plans to the IRS for favorable determination letters.
B. Unified Master/Prototype Plan Program
The IRS has issued Revenue Procedure 2000-20 that revises and combines its master and prototype ("M& P") and regional prototype plan programs into a unified program for the pre-approval of pension, profit-sharing, and annuity plans. The IRS had found that it is no longer necessary or practical for it to maintain separate prototype plan approval programs for the institutional sponsoring organizations that were eligible to sponsor M& P plans (under Revenue Procedure 89-9) and the practitioner sponsors that were eligible to sponsor regional prototype plans (under Revenue Procedure 89-13). The new revenue procedure establishes a unified program that is available to both institutional and practitioner sponsors that seek approval of their master or prototype plans.
Any options that were available to sponsors or employers under earlier revenue procedures covering M& P plans and regional prototype plans will now be available to all sponsors or employers under the new program.
The revenue procedure simplifies the recordkeeping requirements that applied to regional prototype plan sponsors and applies these simplified requirements to all sponsors. Every sponsor will be required to maintain, or have maintained on its behalf, a list of the employers that have adopted its plan, but sponsors will not have to provide the annual notices that were required under Revenue Procedure 89-13. In addition, when a sponsor reasonably concludes that an employer's M& P plan may no longer be qualified and the sponsor does not or cannot submit a request to correct the qualification failure under the Employee Plans Compliance Resolution System ("EPCRS") (see Section I. I. of this Newsletter), the sponsor must: (i) notify the employer that the plan may no longer be qualified; (ii) advise the employer that adverse tax consequences may result from loss of the plan's qualified status; and (iii) inform the employer about the availability of EPCRS.
Changes in the areas of employer reliance and standardized plans include an exception from the requirement that a standardized plan benefit all nonexcludable employees of the employer. The exception will allow an employer to avail itself of the rule under Internal Revenue Code (the "Code") 410(b)(6)(C) relating to the minimum coverage requirements for a plan in the transition period following a merger, acquisition, or similar transaction.
C. Repeal of Combined Limitation for Defined Benefit Pension Plans and Defined Contribution Plans
A special annual benefit limitation under Code Section 415(e) had applied to an individual who participated in both a defined benefit pension plan and a defined contribution plan maintained by the same employer. However, the Small Business Job Protection Act of 1996 repealed the limitation for plan years beginning after 1999.
It should be noted that if a plan is not amended to take the repeal into account, the plan's existing provisions could result in automatic benefit increases for participants.
As a result of the repeal of the benefit limitation, many defined benefit plans may be amended to provide for benefit increases, if so desired by the employer. Moreover, some employers with only defined contribution plans may find it advantageous to adopt a defined benefit plan in addition to their defined contribution plan or plans.
Recommendation: Employers that have employees covered by both a defined benefit and a defined contribution plan should evaluate the impact of the repeal of the combined benefit limitation and determine whether they need or desire to amend their plans accordingly.
D. New Comparability Issue
According to Notice 2000-14, the IRS will review certain qualified retirement plans for possible violations of the qualified plan nondiscrimination rules. "New comparability" or "super-integrated" retirement plans tend to provide higher rates of employer contributions to highly compensated employees ("HCEs"). Whether this retirement plan design rises to the level of impermissibly discriminating against non-highly compensated employees ("NHCEs") will be the subject of a formal review.
Generally, under Code Section 401(a)(4), tax-qualified plans are prohibited from discriminating in favor of HCEs. However, for purposes of determining whether employer contributions under a defined contribution plan discriminate in favor of HCEs, the Treasury Regulations under Code Section 401(a)(4) allow contributions either to be tested on a present value basis or to be cross-tested on a future value basis. Cross-testing projects the benefits payable at retirement; contributions are converted to and tested as equivalent benefits payable at normal retirement age. Thus, cross-testing allows contributions under a defined contribution plan to be compared with the retirement benefits provided by such contributions, taking into account the ages of the individuals receiving the benefits. In Notice 2000-14, the IRS and Treasury expressed concern that cross-testing may result in disparities in the contribution rates between HCEs and NHCEs due to the differences in age among these two groups and, therefore, may violate the nondiscrimination rules. In other words, the IRS and Treasury question whether, by plan design, NHCEs, who tend to be younger, will ever have the opportunity to earn the higher allocation rates in the years they work for the employer.
Modifications may be necessary to meet the nondiscrimination rules, the IRS reports. However, IRS officials caution that no definite modifications or approaches have been developed at this time, and IRS officials have recently stated that any changes will most likely be for plan years commencing on or after January 1, 2002.
E. Invalid Rollovers Will Not Necessarily Disqualify a Plan
The IRS recently finalized Regulation Section 1.401(a)(31)-1, which provides guidance to plan administrators regarding actions to be taken if the administrator discovers that the plan has inadvertently accepted an invalid rollover.
Under the regulations, if a plan accepts an invalid rollover, the tax-qualified status of the receiving plan will not be jeopardized as long as the following conditions are met: (i) when accepting the rollover, the plan administrator "reasonably concluded" that it was valid; and (ii) after learning that the rollover was not valid, the plan administrator returns the rollover with earnings to the employee.
The final regulations state that the distributing plan is not required to have a favorable determination letter in order for the administrator of the receiving plan to reasonably conclude that the rollover is valid. More specific guidance is found in the examples provided in the final regulations. To simplify the examples, assume that "Plan A" is the original plan and "Plan B" is the new plan which accepts the rollover. The examples offer the following guidelines for when the administrator of Plan B may accept a rollover from Plan A.
For rollovers The administrator of Plan B should receive a letter from the administrator of Plan A stating that: (i) Plan A has received a favorable determination letter; (ii) Plan A satisfies Code Section 401(a); or (iii) Plan A is intended to satisfy Code Section 401(a) and that the administrator is not aware of any provision or operation that would result in its disqualification. Moreover, for a rollover that is not a direct rollover, the employee must certify that to the best of his knowledge: (iv) he is entitled to the distribution from Plan A as an employee and not as a beneficiary; (v) the distribution is not one of a series of periodic payments; (vi) he received the distribution within 60 days of the date of the rollover to Plan B; and (vii) the entire amount would be included in his gross income if not rolled over.
From a conduit IRA The employee provides the information described in subparagraphs (iv) through (vii) above, and the employee certifies to the best of his knowledge that: (i) the contribution was made to the IRA within 60 days after the distribution from Plan A; (ii) no other amount has been contributed to the IRA; and (iii) the distribution from the IRA was received not more than 60 days before the rollover to Plan B.
Comment: These regulations are designed to increase the portability of pension benefits by providing specific rules under which the inadvertent acceptance of an invalid rollover contribution will not result in plan disqualification.
F. 403(b) Plan Audits
Code Section 403(b) tax-sheltered annuity plans are being increasingly scrutinized by the IRS. According to the IRS, there are over 200 IRS field agents actively involved in Code Section 403(b) plan examinations of public school districts, community colleges, health care institutions, private universities and other entities.
Previously, certain tax-exempt entities considered 403(b) annuities to be akin to individual retirement accounts ("IRAs") and, therefore, exhibited a lax attitude toward plan administration. However, since employers have a responsibility to withhold federal income taxes for excess contributions and exclusions, the IRS conducts examinations of plan sponsors. Common violations uncovered during examinations include exceeding the: 403(b) maximum exclusion allowance, Code Section 415 contribution limits (i.e., contributions may not exceed the lesser of 25% of compensation or $30,000), and Code Section 402(g) elective deferral limit ($10,500 for 2000). In addition, some schools may be violating the requirement for universal availability of salary reduction deferrals in the case of substitute teachers. Medical schools are also responsible for violations: medical residents may be improperly excluded from plans because they are treated as employees for FICA tax reporting purposes, but as students for purposes of providing benefits.
Comment: Sponsors might consider auditing their 403(b) plans for defects. As discussed in Section I. I., below, the IRS has made available the correction program known as the Employee Plans Compliance Resolution System to 403(b) plans.
G. Proposed Alternative Distribution Rules Anti-Cutback Relief
The IRS recently issued proposed regulations under Code Section 411(d)(6) providing "anti-cutback" relief for the elimination of certain optional forms of benefit under qualified plans. The regulations relax the anti-cutback rules of Code Section 411(d)(6) in a number of important respects, including: (i) permitting the elimination of alternative forms of distribution under defined contribution plans; (ii) permitting elective direct transfers between plans; and (iii) allowing plans to eliminate certain in-kind distributions.
1. Forms of Distribution Under Defined Contribution Plans. Plan sponsors often would like to eliminate forms of distribution under qualified plans. When plans are merged as a result of corporate transactions, many distribution options may need to be continued under the merged plan, even though some of the options may differ only slightly or may infrequently be elected by participants. For example, if a plan that offers participants the right to elect a distribution in the form of quarterly installments is merged with a plan that offers semi-annual installments, both of those optional forms of distribution are required to be continued.
The proposed regulations provide important relief in this area for defined contribution plans but not for defined benefit plans. The general rule under the proposed regulations is that a distribution option under the defined contribution plan, including annuity options, may be eliminated if (i) the remaining options include a lump sum and an "extended distribution" option; and (ii) the lump sum and extended distribution options are the same in all respects as (or provide greater rights than) the eliminated options, except as to the timing of payments. In other words, the lump sum and extended option must be available to commence at the same time as the eliminated benefits and be applicable to the same portion of the participant's account.
For purposes of the proposed regulations, an "extended distribution" option is: (i) an annuity payable over the life of the participant; (ii) substantially equal periodic payments which, at the election of the participant, are made (at least annually) over either the life expectancy of the participant or the joint life expectancies of the participant and the participant's spouse; or (iii) if a plan amendment does not eliminate any options described in (i) and (ii), the existing plan distribution option providing payments over the longest period.
Example: A profit-sharing plan offers a lump sum and various annuity distribution forms. Under the proposed rules, the plan could be amended to eliminate the annuity forms, and to provide that a participant may elect either a lump sum or installment payments over (i) the life expectancy of the participant; or (ii) the joint life expectancies of the participant and the participant's beneficiary.
2. Elective Transfers. The current 411(d)(6) regulations provide relief to certain voluntary "elective transfers" between plans. When such relief is available, the plan receiving the transfer is not required to preserve optional forms of benefit available under the transferor plan. The requirements for elective transfers include several restrictions. First, the participant must be currently eligible to elect a total distribution. Second, the relief only applies to transfers to plans within the same controlled group. Third, the participant must be fully vested in the benefit to be transferred.
The proposed regulations would grant relief from the controlled group and vesting requirements for both defined benefit and defined contribution plans, and from the distribution eligibility requirement for defined contribution plans. Some other conditions in the current regulations would also be modified.
Under the proposed regulations, elective transfers between defined contribution plans would be permitted if the following conditions are satisfied:
(i) the transfer must be conditioned upon a voluntary election by the participant to transfer the participant's entire accrued benefit. As an alternative to the transfer, the participant must have the right to leave the benefits in the plan, without any reduction of protected benefits;
(ii) the transfer generally must be to the same type of defined contribution plan (e.g., 401(k) plan, money purchase plan, employee stock ownership plan ("ESOP")). However, benefits under a stock bonus or profit sharing plan (other than 401(k) and ESOP benefits) may be transferred to any type of defined contribution plan; and
(iii) the transfer must be made in connection with (A) an asset or stock acquisition, merger, or other transaction involving a change in employer of the employees of a trade or business (i.e., a transaction qualifying under the minimum coverage transition rule for acquisitions and dispositions in Code Section 410(b)(6)(C)), or (B) the participant's transfer of employment to a different job not covered under the plan (e.g., transfer to another controlled group member).
Under current law, participants who transfer employment to a successor employer pursuant to a corporate transaction, but remain at the "same desk" generally are not eligible to elect a distribution of their 401(k) contributions. Since those contributions are not "immediately distributable," and the employee is employed by a different controlled group, the current 411(d)(6) regulations also would not permit a voluntary elective transfer. The preamble to the proposed regulations strongly implies that the substitution of the third condition above (i.e., that the transfer is made in connection with a corporate merger or acquisition) for the current "immediately distributable" requirement would permit elective transfers in situations where the 401(k) "same desk" rule prevents a distribution.
In addition, the proposed regulations would allow transfers between plans of the same type (e.g., defined benefit, 401(k)), regardless of whether the conditions described above are satisfied, if: (i) the election is voluntary; (ii) the participant's benefits are immediately distributable under the transferor plan; and (iii) the amount of the benefit transferred equals the employee's entire nonforfeitable accrued benefit. Since the elective transfer generally is treated as a distribution, the survivor annuity, spousal consent, and other rules applicable to distributions would apply to the transfer.
3. Elimination of In-Kind Distributions. The relief for in-kind distributions would apply to both defined benefit and defined contribution plans. Under current rules, it is generally not possible to amend a defined benefit or defined contribution plan to eliminate a participant's ability to obtain benefits in kind rather than in cash.
Under the proposed rules, defined benefit plans that allow participants to elect the distribution of an annuity contract could eliminate that feature, and, instead, make distributions only in cash. In addition, a defined contribution plan that allows participants to obtain distributions in the form of marketable securities (e.g., mutual fund shares) could eliminate that feature, except with respect to certain employer securities.
The proposed regulations also provide limited anti-cutback relief for defined contribution plans that allow distributions in the form of employer stock or non-marketable securities (e.g., non-publicly traded interests in a limited partnership). With respect to these types of property, a plan could be amended to limit the ability of a participant to elect to receive such property to amounts invested in that property (i) at the time of the plan amendment eliminating the right; or (ii) at the time of distribution.
H. Prohibited Transaction Exemption Allows Loans to Plans for Y2K Problems
The prohibited transaction rules generally prohibit transactions between employee benefit plans and certain persons (called "parties in interest") who have a special relationship with the plan (such as the employer that sponsors the plan). The Department of Labor has issued a temporary amendment to Prohibited Transaction Exemption ("PTE") 80-26. The nonmodified PTE 80-26 provides for interest-free loans from parties in interest to the plan if the money is used only for ordinary operating expenses of the plan and the loan lasts no longer than three (3) days. However, the new PTE would allow plans to accept interest-free loans from parties in interest for the purpose of resolving certain Y2K-related problems (such as computer malfunctions and related problems). The new PTE would apply only between November 1, 1999 and December 31, 2000 (for a maximum loan duration of fourteen (14) months).
I. Updates to Employee Plans Compliance Resolution System.
The IRS previously consolidated its plan correction programs into the Employee Plans Compliance Resolution System ("EPCRS"), set forth in Revenue Procedure 98-22. The IRS modified EPCRS to incorporate Revenue Procedure 99-13 (which applies EPCRS to 403(b) plans), to include the correction methods described in Revenue Procedure 99-31, and to reflect the new Tax Exempt and Government Entities Division ("TE/GE") of the IRS. As a result, EPCRS now sets forth all of the plan correction programs that apply to plans intending to qualify under Code Sections 401(a), 403(a) or 403(b). EPCRS now also includes all of the recommended correction methods for operational errors, as well as instruction on calculating earnings on corrective amounts. In addition to the Administrative Policy Regarding Self-Correction ("APRSC"), the Voluntary Compliance Resolution ("VCR") Program (which includes Standardized VCR ("SVP")), the Walk-in Closing Agreement Program ("Walk-in CAP") and the Audit Closing Agreement Program ("Audit CAP"), EPCRS now also includes the Tax Sheltered Annuity Voluntary Correction Program ("TVC"). The IRS plans to annually update EPCRS based on changes published during the preceding year.
As we discussed in our September 1998 Newsletter (Vol. III, No. 1), the various IRS programs under EPCRS allow for correction of form, operational and demographic defects. A "form defect" is one relating to the plan document, such as a plan document not timely amended to be in compliance with tax law changes. An "operational defect" results when the terms of the plan have not been followed. A "demographic failure" occurs when a change in the employee population results in a plan failing to meet IRS rules (e.g., nondiscrimination). In some cases, EPCRS allows for correction of egregious defects.
The EPCRS incorporates the following IRS correction programs:
Administrative Policy Regarding Self-Correction ("APRSC"), which allows a plan sponsor to self-correct an insignificant operational failure without fee, sanction or IRS involvement.
Voluntary Compliance Resolution ("VCR") program, which allows a plan sponsor to voluntarily correct an operational plan defect before IRS audit with payment of a fixed fee and IRS approval.
Standardized VCR Procedure ("SVP"), which allows correction of specified operational defects in a prescribed manner with payment of a minimal compliance fee.
Walk-in Closing Agreement Program ("Walk-in CAP"), which allows a plan sponsor to disclose and correct form, operational or demographic failures voluntarily before an IRS audit and pay a compliance correction fee.
Audit Closing Agreement Program ("Audit CAP"), which allows correction of form, operational or demographic defects after an IRS audit has commenced, with payment of a negotiated sanction.
Tax Sheltered Annuity Voluntary Correction Program ("TVC"), which allows for the correction of Code Section 403(b) operational violations before IRS audit with payment of a fixed fee and IRS approval.
Revenue Procedure 2000-16 clarifies the application of FICA and FUTA taxes,
and the corresponding withholding obligations, when a correction to a plan is made. With regard to qualified plans under Code Section 401(a), if the corrections are made in accordance with the requirements of EPCRS, the IRS will continue to treat the plan as qualified for purposes of applying FICA and FUTA taxes. As for Code Section 403(b) plans, if the failure is corrected in accordance with APRSC, Walk-in CAP or Audit CAP, the IRS will not pursue income inclusion for affected participants or liability for income tax withholding that might otherwise apply because of the failure. Any income tax consequences to the participant as a result of a correction still apply (e.g., inclusion in gross income of 403(b) deferrals in excess of the applicable limits under the Code). Furthermore, distributions of excess amounts (such as deferrals in excess of the applicable limit) to a participant are generally treated as wages and, as a result, are subject to FICA and FUTA taxes.
There are also slight changes to the individual correction programs. Revenue Procedure 2000-16 clarifies that APRSC applies to small businesses. Two of the factors used to determine whether an operational failure is insignificant and correctable under APRSC (i.e, the number of participants affected compared to the number of total participants and the ratio of the number of affected participants to the number of participants who could have been affected) appear to prevent small businesses from taking advantage of APRSC to correct insignificant operational errors. The IRS clarified that APRSC is available to correct operational failures in plans of all sizes, but did not give small plans any relief from the two factors.
The VCR, Walk-in CAP and TVC programs were modified to include, in appropriate cases, a waiver of the Code Section 4974 excise tax applicable to a failure to comply with the required minimum distribution rules where the correction has been made. The IRS also amplified the correction methods under SVP by providing additional pre-approved correction methods subject to a lesser correction fee. SVP includes corrections for: (i) failure to provide the top-heavy minimum contribution for non-key employees; (ii) ADP/ACP/multiple use test failures under 401(k) plans; (iii) failure to distribute elective deferrals in excess of the limit under Code Section 402(g) ($10,500 in 2000); (iv) the exclusion of eligible employees from participation, (v) failure to timely pay required minimum distributions; (vi) failure to obtain participant and/or spousal consent for a distribution when required; and (vii) failure to satisfy the limitations under Code Section 415. Plan sponsors may also use Walk-in CAP for interrelated VCR and Walk-in CAP failures. In addition, the IRS added to the types of operational failures that may be corrected under TVC: (i) failure of an annuity contract or custodial agreement to provide participants with a right to elect a direct rollover; and (ii) failure of an annuity contract or custodial agreement to provide the limit on elective deferrals.
Comment: The purpose of EPCRS is to encourage plan sponsors to maintain their plan practices and procedures in accordance with the terms of their plans and IRS rules, and when defects are discovered, to encourage voluntary and timely correction. EPCRS allows sponsors to correct defects without fear of onerous sanctions or excessive fees. EPCRS outlines a consistent, consolidated scheme for correction of plan defects on which plan sponsors can rely.
The monetary sanctions that apply when disqualifying errors are discovered by the IRS can be harsh, and very adverse tax consequences may result for plan sponsors and participants. Plan sponsors should check with their attorneys for any required amendments, and review the operation of their plans for compliance with IRS requirements so any detected failures may be corrected in a timely and appropriate manner.
J. Tax Relief Extension Act of 1999
On December 17, 1999, President Clinton signed the "Tax Relief Extension Act of 1999" (PL 106-170).
The Act extends the provision permitting qualified transfers of excess defined benefit plan assets to provide retiree health benefits under Code Section 401(h). This provision, which was scheduled to expire for tax years beginning after December 31, 2000, is extended through December 31, 2005.
The Act also extends the tax exclusion from an employee's income for employer-provided educational assistance (for undergraduate-level courses only) through December 31, 2001. Educational expenses paid by an employer for its employees are generally deductible by the employer.
K. IRS Clarifies New Definition of Highly Compensated Employee
Code Section 414(q)(1)(B)(i) provides in relevant part that an HCE includes any employee who, for the preceding year (the "look-back year"), had compensation from the employer in excess of $80,000. This limitation is adjusted periodically, and has increased to $85,000 in the 2000 calendar year. The IRS has clarified the application of the increase in the compensation limit from $80,000 to $85,000 in determining highly compensated employee status. Generally, for plan years beginning in 2000, the compensation limitation for determining HCE status is $80,000, since the look-back years start in the 1999 calendar year. And for plan years beginning in 2001, the compensation limitation is $85,000, because the limitation is based on the look-back years beginning in 2000.
L. Required Notice Regarding Plan Termination and Benefit Accrual Cessation
The IRS has issued final regulations that provide guidance concerning the ERISA Section 204(h) notice. This notice must be provided to plan participants and beneficiaries when a defined benefit pension plan or money purchase pension plan is amended to provide for a significant reduction in the rate of future benefit accruals.
Changes in the law requiring plan amendments that affect future benefit accruals or allocations do not require 204(h) notices. In particular, the IRS has issued guidance stating that plans that are amended solely to comply with changes in the limits under Code Sections 415 (the maximum contribution limitations) and 401(a)(17) (the annual compensation limit or $150,000, as indexed) do not need to issue 204(h) notices. Further, employees who have not yet become participants in the plan need not be given a 204(h) notice.
The determination of whether a plan amendment triggers a 204(h) notice is based on reasonable expectations taking into account the relevant facts and circumstances at the time the amendment is adopted. For a defined benefit plan, a comparison must be made of the amount of the annual benefit at normal retirement age as determined under the terms of the plan before and after the amendment. For a money purchase pension plan, a comparison must be made of the amounts to be allocated in the future to the participant's account under the terms of the plan before and after the amendment.
In determining whether an amendment provides for a significant reduction in the rate of future benefit accrual or allocation, all plan provisions that may affect a participant's rate of future benefit accrual or allocation must be taken into account. For example, provisions that reduce benefit accruals may include those affecting: (i) the dollar amount or percentage of compensation on which benefit accruals or allocations are based; (ii) the amount of disparity between the excess benefit percentage (or excess contribution percentage) and the base benefit percentage (or base contribution percentage); (iii) the definition of service or compensation taken into account in determining benefit accruals or allocations; (iv) the method of determining average compensation for calculating benefit accruals or allocations; (v) the definition of normal retirement age in a defined benefit plan; and (vi) the exclusion of current participants from future participation.
Plan provisions that do not affect the rate of future benefit accrual or allocation are not taken into account in determining whether an amendment causes a significant reduction in the rate of accrual or allocation. Thus, for example, changes in vesting schedules or changes regarding optional forms of benefit do not require notices to participants. The regulations also indicate that early retirement benefits or retirement-type subsidies are to be ignored in determining the rate of future benefit accruals. Thus, changes with regard to these benefits would not require 204(h) notices.
The 204(h) notice must be distributed after the adoption of the plan amendment, but at least 15 days before its effective date. The final regulations provide guidance on the failure to provide the 204(h) notice to all affected participants on a timely basis. In general, if the 204(h) notice is not provided, then the amendments do not take effect.
If a plan administrator provides timely 204(h) notices to some participants required to receive such notice, the final regulations provide that the plan amendment becomes effective only with respect to those participants who actually receive the notice. In order for this rule to apply, the plan administrator must have made a good faith effort to comply with the requirements of Section 204(h).
Also, plan administrators who provide timely notices to all but a de minimis percentage of those required to receive them will be treated as complying with respect to all affected participants under the following conditions: (i) A good faith effort to comply with the notice requirement must have been made; and (ii) the 204(h) notice must be promptly distributed to all those who did not receive one. In such case, the plan amendment will take effect as originally intended - including for those individuals who received the notice late.
The final regulations state that "any method reasonably calculated to ensure actual receipt of the Section 204(h) notice" may be utilized (e.g., first class mail, hand delivery). Apparently, posting is not sufficient. Also, a Section 204(h) notice may be enclosed or combined with another notice provided by the plan administrator (e.g., a notice of intent to terminate).
M. New Model Tax Notices
In Notice 2000-11, the IRS issued an updated version of a safe harbor explanation that plan administrators may provide to recipients of eligible rollover distributions from qualified plans.
Code Section 402(f) requires a plan administrator to provide a written explanation to any recipient of a payment that is eligible for rollover to a qualified plan, a so-called "eligible rollover distribution." The written explanation must discuss: the direct rollover rules; the mandatory federal income tax withholding on distributions that are not directly rolled over; and the tax treatment of distributions not rolled over (including the special tax treatment available for certain lump sum distributions). The explanation must be provided no less than 30 days and no more than 90 days before the date on which a distribution is made.
Notice 2000-11 reflects changes to the Code and regulations since the initial explanation was published in 1992. These changes include: (i) modifications to the rules governing minimum required distributions; (ii) the elimination of special five-year forward averaging tax treatment for lump sum distributions (although transition rules retain ten-year special averaging for individuals who satisfy certain requirements); (iii) the expansion of the exceptions to the 10% early withdrawal tax to include certain hardship distributions under 401(k) plans; (iv) the finalization of temporary and proposed regulations on rollovers from qualified plans; and (v) new regulations dealing with direct trustee-to-trustee transfers and paperless technologies.
As with the earlier safe harbor explanation, a plan administrator may customize the safe harbor explanation by omitting any portion that does not apply to the plan. For example, if the plan does not hold after-tax employee contributions, the paragraph headed "Non-taxable Payments" may be eliminated. A plan administrator also may provide additional information with the safe harbor explanation, if the information is not inconsistent with the safe harbor explanation.
In lieu of using the safe harbor notice, a plan administrator may satisfy Code Section 402(f) by providing distributees with a substitute explanation. The substitute explanation must contain the information required by Code Section 402(f), and it must be written in a manner designed to be easily understood.
Comment: Please contact us if you desire a copy of this Model Notice.
N. Distribution Notices Regulations Finalized
Under Code Section 411(a)(11), a qualified plan participant's accrued benefit with a value of more than $5,000 may not be distributed without the participant's consent. Code Section 401(a)(11) requires that distributions from qualified defined benefit and money purchase pension plans be made in the form of a qualified joint and survivor annuity ("QJSA"), unless the participant and spouse waive this form of benefit in accordance with the requirements under Section 417 (e.g., plan must provide explanation of joint and survivor annuity to each participant).
Prior to 1995, the notices associated with these requirements had to be given to the participant no more than 90 and no less than 30 days prior to the annuity starting date, or else the distribution election and/or QJSA waiver was invalid. In 1995, the IRS issued proposed regulations relaxing the 30-day requirement in both situations. The IRS has now issued final regulations that adopt the provisions of the proposed regulations.
The final regulations concerning the consent requirements for distributions of accrued benefits valued in excess of $5,000 allow a participant who has received notice of his distribution rights to elect and receive a distribution within a period of less than 30 days after the notice is provided. The regulations require that the notice specify that the participant has the full 30 days after notification to consider his distribution options.
The final regulations concerning the requirements for providing notice of the QJSA option under Code Section 417 permit a plan to make distributions (life annuities, qualified joint and survivor annuities, etc.) before the end of the 30-day period under certain conditions. Under the final regulations, a participant who receives a QJSA explanation, elects a distribution and provides a waiver (if applicable) may begin receiving a distribution no earlier than the eighth (8th) day after the QJSA explanation is provided to the participant as long as the distribution elected is revocable for that seven-day period.
O. Employees Do Not Have Right to Surplus Defined Benefit Pension Plan Assets
In Hughes Aircraft Company v. Jacobson, the Supreme Court has ruled that retired plan participants in a contributory defined benefit plan (i.e., a plan for which employees contribute after-tax dollars to receive a benefit thereunder) did not have a right to excess pension assets and that a plan amendment eliminating the contributory feature of the plan neither terminated the plan nor created a fiduciary liability claim under ERISA.
The Court ruled that the retired participants had no vested interest in the plan's surplus assets. It reasoned that the nature of a defined benefit plan is such that the risk of providing the benefit is the employer's a decline in the value of plan assets does not change the obligation to provide the accrued benefits. Concomitantly, any "upside" gains belong to the plan and may reduce future employer contributions. The participants under a defined benefit plan have rights only to their accrued benefits, which they in fact received in the present case.
Comment: The Supreme Court's unanimous decision reflects the well-established interpretation of ERISA with regard to surplus pension assets, but is nonetheless an important ruling for employers sponsoring defined benefit plans. It confirms that excess pension assets belong to the plan and not the participants.
P. Partial Termination Based on Related Transactions in Different Years
A district court in the Seventh Circuit in Matz v. Household International Tax Reduction Investment Plan concluded, if various corporate transactions that occurred in different years are proven to be sufficiently related, then the employee terminations from the different years can be aggregated for purposes of determining whether a partial plan termination has occurred. Thus, a plan participant who was only partially vested in employer-derived benefits when he lost his job could have been entitled to full vesting under Code Section 411(d)(3), by virtue of a partial termination resulting from job terminations that occurred mostly in years after the year in which he had lost his own job.
Q. Department of Labor Proposes Annual Audits for Certain Small Plans
Under current law, any tax-qualified plan with 100 or more participants at the beginning of a plan year must obtain an annual audit of the plan and its operations from an independent qualified public accountant. Small plans (those with fewer than 100 workers) are exempt from this requirement.
Concerned about the vulnerability of small plans to asset misappropriation and other abuses, the Department of Labor believes additional protection may be needed for the assets of those plans.
Under proposed regulations (Proposed Labor Regulations Section 2520.104-41; Proposed Labor Regulations Section 2520.104-46), a small pension plan may not claim the small plan exemption from the audit requirement, unless two new conditions are satisfied:
(i) At least 95 percent of the plan's assets are "qualifying plan assets" ("QPA") (generally, assets that carry very little risk of loss due to fraud or dishonesty, such as publicly traded stocks, bonds and mutual funds) or any person who handles plan funds is bonded for at least the value of the assets that are not QPAs. (Note: This is more onerous than current bonding rules, which generally require the bond value to be only 10 percent of the funds handled); and
(ii) The summary annual report provided to plan participants contains additional information specified in the regulations.
If a plan does not qualify for the exemption, an annual audit is required. Generally, this means an independent qualified public accountant will examine the plan's financial statements and provide a written report on its findings, which will be attached to the plan's Form 5500.
R. Excise Tax Imposed for Late Contribution to Money Purchase Pension Plan
In Wenger v. Commissioner, the Tax Court confirmed an excise tax imposed on a sole proprietor who failed to make a timely contribution to a money purchase pension plan, because the timing of the contribution failed the statutory requirements, although the timing of the contribution did meet the plan's requirements.
Mr. Wenger adopted a money purchase pension plan with a plan year ending on December 31. For the 1994 tax year, Wenger was granted a 2 _ month extension for filing the plan's Form 5500, allowing him until October 16, 1995 to file. He filed Form 5500 no later than October 16, 1995, and he made the required $18,000 contribution on October 16, 1995.
The IRS issued a deficiency notice to Wenger, after determining that for 1994 the plan had an accumulated funding deficiency of $18,000. In addition, the IRS determined that Wenger was liable for an excise tax equal to 10% of the funding deficiency under Code Section 4971(a). Code Section 412(a) requires that an employer sponsoring a money purchase pension plan satisfy the minimum funding standard every plan year. In order to meet the minimum funding standard, the plan must not have an accumulated funding deficiency for the plan year. Code Section 4971(a) imposes a mandatory 10% excise tax on any accumulated funding deficiency existing for any plan year.
There was no dispute that, for the 1994 plan year, Wenger was required to make an $18,000 contribution to the plan, and that Wenger's failure to make a timely contribution would result in an accumulated funding deficiency equal to this amount. The only issue in dispute was whether Wenger had made a timely contribution for the year.
For purposes of the minimum funding requirements, contributions can be made within 8 _ months following the end of the plan year and be considered to have been made on the last day of that plan year. See Code Section 412(c)(10)(B) and Regulations Section 11.412(c)12(b). If, in the absence of a waiver of the minimum funding standard for business hardship, the employer makes a contribution beyond the 8 _ month period, the contribution is untimely, thus resulting in an accumulated funding deficiency. This is the case regardless of whether the contribution, as here, is timely for purposes of the income tax deduction rules.
In Wenger's case, the 8 _ month period expired on September 15, 1995, so Wenger's contribution on October 16, 1995 was a month late. Wenger argued that there was no accumulated funding deficiency for the 1994 plan year because the plan provided that the employer contribution for each plan year could be made not later than the due date, including extensions, for filing the employer's income tax return for its fiscal year in which the plan year ends.
Wenger pointed out that he made the required contributions to the plan on or before October 16, 1995, the due date of his income tax return, including extensions. He argued that because the prototype plan document had received a determination letter approving the language of the plan, the language of the plan should control whether a timely contribution had been made. The Tax Court disagreed upholding the statutory and regulatory 8 _ month period and imposing the mandatory 10% excise tax.
Comment: Money purchase pension plan sponsors should be aware of this trap for the unwary.
II. 401(k) PLANS
A. Safe Harbor Guidance
Under Notice 2000-3, the IRS has issued additional guidance regarding the alternative safe harbor methods used to satisfy the 401(k) nondiscrimination requirements.
As discussed in our September 1996 Newsletter (Vol. I, No. 1), the Small Business Job Protection Act of 1996 added Code Section 401(k)(12) and Code Section 401(m)(11) to give 401(k) plans design-based safe harbor methods of satisfying the nondiscrimination requirements for elective deferrals and employer matching contributions (the ADP and ACP tests, respectively) for years beginning after December 31, 1998. A plan generally satisfies the safe harbor if it provides proper notice to participants, and the employer either: under the matching contribution requirement, matches employee elective contributions up to 3% of compensation dollar-for-dollar, matches contributions between 3% and 5% of compensation at a rate of $1 for every $2 contributed, and does not match contributions of highly compensated employees at a rate greater than the match rate for nonhighly compensated employees or; under the nonelective contribution requirement, makes a nonelective contribution to a defined contribution plan of at least 3% of the employee's compensation on behalf of each nonhighly compensated employee eligible to participate in the arrangement, without regard to whether the employee makes elective contributions.
Comment: Plans that use a safe harbor reduce administrative costs by avoiding the need to (i) conduct various nondiscrimination tests (i.e., the ADP and ACP tests), and (ii) make corrective distributions to highly compensated employees if the tests are failed.
The IRS previously issued guidance concerning the safe harbor nondiscrimination methods in Notice 98-52. The IRS has, in Notice 2000-3, provided additional guidance, as discussed below.
1. Notice Requirements. The safe harbor requires that an annual notice be provided to each eligible employee. The notice must satisfy content and timing requirements.
a. Content. The notice must be (i) sufficiently accurate and comprehensive to inform the employee of the employee's rights and obligations under the plan; and (ii) written in a manner calculated to be understood by the eligible employee. The notice must contain information covering: contribution formula, deferral election procedures, and the plan's withdrawal and vesting rules.
b. Timing. The notice must be provided within a reasonable period before the beginning of the plan year (or within a reasonable period before an employee becomes eligible). This requirement generally is deemed to be satisfied if the notice is given to each eligible employee in the 30- to 90-day period before the beginning of each plan year. For employees who become eligible after the 90th day before the beginning of the plan year, and for new plans, the timing requirement is satisfied if the notice is given no later than the day the employee becomes eligible, and no earlier than 90 days before the employee becomes eligible.
2. Flexibility in time for adoption of 401(k) safe harbor nonelective contribution method. Generally, a plan that is intended to satisfy the 401(k) safe harbor requirements for a plan year must, before the beginning of the plan year, contain language to that effect and must specify the 401(k) safe harbor method that will be used. Notice 2000-3 provides a plan sponsor the flexibility of deciding no later than 30 days before the last day of the plan year that the 401(k) safe harbor nonelective contribution method will be used for the plan year.
Under this option, a plan may be amended no later than 30 days before the last day of the plan year to specify that the nonelective contribution safe harbor will be used for the year. Moreover, the notice required to be given to eligible employees before the beginning of the plan year must state that: (i) the plan may be amended during the plan year to provide that the employer will make a safe harbor nonelective contribution of at least 3% to the plan for the plan year; and (ii) if the plan is so amended, a supplemental notice will be given to eligible employees 30 days before the last day of the plan year informing them of the amendment. If the decision to adopt the safe harbor is made, a supplemental notice to this effect must be provided to all eligible employees no later than 30 days before the last day of the plan year.
A plan sponsor that takes advantage of the flexibility provided under Notice 2000-3 is not required to continue using the 401(k) safe harbor nonelective contribution method for the following plan year and is not limited in the number of years that it takes advantage of this flexibility.
3. Safe harbor matching contributions may be made on pay period rather than annual basis. The safe harbor requirements relating to matching contributions may be met for a plan year either: (i) with respect to the plan year as a whole; or (ii) if the plan so provides, separately with respect to each payroll period (or with respect to all payroll periods ending with or within each month or plan-year quarter). If the payroll period method is used, however, matching contributions with respect to elective or employee contributions made during a plan year quarter must be contributed to the plan by the last day of the following plan year quarter. Thus, in the case of a calendar year plan that uses the payroll period method, matching contributions with respect to elective or employee contributions made during the calendar quarter beginning July 1, 2000, must be contributed to the plan by December 31, 2000.
4. Reduction or elimination of matching contributions during plan year. A plan that uses the 401(k) safe harbor matching contribution may be amended during the plan year to reduce or eliminate matching contributions, provided: (i) a supplemental notice is given to all eligible employees explaining the consequences of the amendment, and informing them of the effective date of the reduction or elimination of matching contributions and that they have a reasonable opportunity to change their cash or deferred (401(k)) elections and, if applicable, their employee after-tax contribution elections; (ii) the reduction or elimination of matching contributions is effective no earlier than the later of (A) 30 days after eligible employees are given the supplemental notice, and (B) the date the amendment is adopted; (iii) the plan is amended to provide that the ADP test and, if applicable, the ACP test, will be performed and satisfied for the entire plan year using the current year testing method; and (iv) all other safe harbor requirements are satisfied through the effective date of the amendment.
5. Use of electronic media to satisfy the notice requirement. A plan may satisfy the safe harbor notice requirement if the employee receives the notice through an electronic medium reasonably accessible to the employee, provided that: (i) the system under which the electronic notice is provided is reasonably designed to provide the notice in a manner no less understandable to the employee than a written paper document; and (ii) the employee is advised that he may request and receive, at no charge, the notice on a written paper document.
B. Negative Elections
As discussed in our September 1998 Newsletter (Vol. III, No. 1), in Revenue Ruling 98-30, the IRS approved the use of automatic enrollment or negative elections in 401(k) plans. In a new ruling, Revenue Ruling 2000-8, the IRS addresses two variations of negative elections, as follows:
Situation 1: Under the terms of a 401(k) plan, if a newly hired employee does not affirmatively elect to receive all compensation in cash or does not specify an amount to be contributed to the 401(k) plan, the employer automatically withholds 3% of the employee's compensation and contributes it to the plan on the employee's behalf. The employee can elect not to make compensation reduction contributions or to contribute a different percentage of compensation at any time. At the time employees are hired, they receive a notice that explains the automatic compensation reduction feature of the plan and the employee's right to receive cash or contribute a different percentage. Each year, an employee receives notice of his compensation reduction percentage and the procedure to change the percentage.
Situation 2: The same facts as in Situation 1, except that the plan is amended to apply the automatic contribution rule to both new and current employees. Thus, if an existing employee has not elected compensation reduction contributions of at least 3% of compensation and does not affirmatively elect during a specified period to receive cash or have a specified amount contributed to the plan, his compensation is automatically reduced by 3% and this amount contributed to the plan. At the beginning of the election period, the employee receives notice explaining the automatic election and annual notice is given of the procedure to change the percentage.
The IRS determined that, in both Situations 1 and 2, the 3% contributions that are automatically withheld will be considered to be valid 401(k) elective contributions. The IRS concluded that a cash or deferred election will not fail to be a qualified cash or deferred arrangement when the employee fails to make an affirmative election, provided the employee had an effective opportunity to elect to receive cash. Under the ruling, an employee is given that opportunity since the employee receives notice of the right not to make contributions, has a reasonable period to make an election to receive cash, and can change the election.
Comment: Automatic enrollment increases plan participation and also results in more plans satisfying nondiscrimination rules. This has significant favorable implications for highly compensated employees, who may be denied full Section 401(k) benefits where a plan runs afoul of the nondiscrimination rules by failing to entice enough nonhighly compensated employees to participate.
C. Same Desk Issues
Under Code Section 401(k)(2)(B)(i), distributions from a 401(k) plan may not be made earlier than the occurrence of certain events, one of which is a "separation from service." Revenue Ruling 79-336 provides that an employee is not considered "separated from service" if the employee continues in the same job for a different employer as a result of the liquidation, merger, acquisition, or consolidation, etc., of the former employer. This is known as the "same desk" rule. Further, Revenue Ruling 80-129 provides that an employee is not considered "separated from service" when an employee of a partnership or corporation, whose business is terminated, continues the same job for a successor employer.
The Code (and regulations promulgated thereunder) provides the following exceptions to the same desk rule, the occurrence of which would give rise to a distribution event for a 401(k) plan: certain plan terminations, certain dispositions of at least 85% (which is considered to constitute "substantially all") of a corporation's assets, and the disposition of a corporate sponsor's interest in a subsidiary.
The recently issued Revenue Ruling 2000-27 concerns an employer maintaining a 401(k) plan, which provides that all elective deferrals (i.e., 401(k) contributions) are immediately vested and that no distribution may occur to an employee who has not reached the age of 59_, before the employee's retirement, death, disability, separation from service, financial hardship, or any one of three listed business-related events. The plan's employer sells less than 85% of its assets to an unrelated entity. Most of the employees associated with the transferred assets are terminated by the seller and hired by the buyer as of the date of the sale. These transferred employees continue to perform the same duties that they performed immediately prior to the sale.
After the asset sale, the plan administrator allowed all of the transferred employees to receive distributions of their account balances, including amounts attributable to their elective deferrals. The plan administrator permitted the transfer of plan assets from the seller's 401(k) plan to the buyer's 401(k) plan pursuant to direct rollovers.
IRS held that, because the asset sale involved less than 85% of the assets used by the seller in its trade or business, the sale did not constitute a disposition of "substantially all" of the seller's assets used in a trade or business. IRS held, however, that the change in the employment status of the transferred employees constituted a "separation from service." Consequently, the distributions to the transferred employees occurred after a "separation from service."
Comment: This revenue ruling, on its face, significantly relaxes the same desk rule. However, IRS and Treasury Department officials during an American Bar Association Section of Taxation conference in May emphasized there are four (4) important limits to the new interpretation.
First, the new interpretation is only applicable to sales of less than 85% of the assets used in a trade or business. If an employer sells more than 85% of the assets used in a trade or business, it may make distributions to employees affected by the sale only in accordance with a specific exception that previously existed under the law. Second, the new interpretation applies only if the seller plans to transfer affected employees' account balances from its plan to a plan of the buyer pursuant to a direct rollover elected by the employee. Third, employees of the seller must cease performing any services for the seller in order for the new interpretation to apply. As a result, the new interpretation does not cover "outsourcing" transactions in which employees are transferred to an unrelated buyer and then are leased back to the seller. Fourth, the new interpretation applies only to sales of assets (not stock). Joint venture transactions generally are not considered sales.
Thus, employers should take care in determining whether a particular asset transaction will qualify under the new interpretation, so as to permit the plan to make distributions to terminating employees. Impermissible distributions may disqualify the distributing plan, thereby preventing employees from rolling those distributions over to another plan or IRA or jeopardizing previously made rollovers.
III. ALL EMPLOYEE BENEFIT PLANS
A. Department of Labor Establishes New Fiduciary Self-Correction Program
The Department of Labor has published a notice informing the public of the newly established Voluntary Fiduciary Correction Program ("VFC Program"). This programenables plan officials to identify specific transactions that constitute violations of the fiduciary provisions of ERISA and to voluntarily correct those specific violations using the Department of Labor "blueprint" of approved correction methodologies as detailed in the VFC Program.
ERISA Section 409 provides that fiduciaries who breach their ERISA responsibilities, obligations, or duties are personally liable for losses the plan suffers from each such breach. Further, the breaching fiduciary must restore to the plan any profits made through the use of plan assets. The DOL enforces ERISA's fiduciary responsibility provisions, and is empowered to assess, under ERISA Section 502(1), a civil penalty equal to 20% of the amount recovered under any settlement agreement reached with a breaching fiduciary, or 20% of the amount that a court orders paid in a legal action initiated by the DOL.
To participate in the VFC Program, a plan official must: (i) identify any violations and determine whether they fall within the violations covered by the VFC Program; (ii) follow the process for correcting the specific violations identified; (iii) calculate and restore to the plan any losses and profits with interest, and distribute any supplemental benefits to beneficiaries; (iv) notify participants and beneficiaries of participation in the VFC Program; and (v) file an application, which includes documentation providing evidence of corrected financial transactions, with the appropriate DOL regional office.
If a person files an application under the VFC Program, but the corrective action falls short of a complete and acceptable correction, the DOL may reject the application and pursue enforcement, including assessment of the ERISA Section 502(1) penalty. However, the penalty would be limited, and would not be imposed on any amounts restored to the plan before the filing of the VFC Program application. The penalty would only apply to the additional amount recovered, if any, for the plan under a court order or a settlement agreement with the DOL.
If an applicant has fully complied with all of the terms and procedures in the VFC Program, the DOL will issue a "no action letter." A no action letter is a letter from the DOL to the applicant confirming that the DOL will not commence a civil investigation under ERISA regarding the applicant's responsibility for any transaction described in the no action letter, or assess a civil penalty under ERISA Section 502(1) on the amount paid to the plan or its participants to correct the breach described in the application.
Relief under the VFC Program is limited to the transactions identified in the application and the persons who corrected those transactions. In cases where the DOL learns of possible criminal behavior, material misrepresentations or omissions in the VFC Program application, or other abuse of the VFC Program, relief will not be available and the DOL may initiate an investigation that may lead to enforcement action. Also, full correction under the VFC Program does not preclude any other governmental agency, including the IRS, from exercising rights it may have regarding the transactions that are the subject of the application.
Persons who may correct a fiduciary breach include not only the breaching fiduciary, but also plan sponsors, parties in interest or other persons who are in a position to correct a breach. However, persons or plans who are the subject of pending investigations for violations of ERISA or who have engaged in criminal violations may not participate in the VFC Program.
Many transactions eligible for correction under the VFC Program result in a loss to the plan or a profit to some party to the transaction. Determining the amount of the loss to the plan requires calculating how much money the plan would currently have if a particular transaction had not occurred. In general, the VFC Program requires the fiduciary or other plan official restore to the plan the "principal amount" (the amount that would have been available to the plan for investment on the date of the breach, had the breach not occurred), plus the greater of: (i) lost earnings as measured from the "loss date" (the date the plan lost the use of the principal amount) through the "recovery date" (the date the principal amount is restored to the plan); or (ii) the restoration of profits resulting from the use of the principal amount for the same period. The fiduciary, plan sponsor or other plan official, and not the plan, is responsible for paying the costs of the required correction.
Comment: The cost of correcting the breach is the only cost imposed under the VFC Program. The DOL does not assess a user or filing fee.
The applicant or the plan administrator must provide written notice of the correction to all plan participants. The notice must state that the correction was made as a result of the applicant's participation in the VFC Program, and that the individuals receiving the notice may obtain a copy of the application, including all supporting documentation, from the plan administrator upon written request.
Transactions eligible for correction under the VFC Program are those involving:
(1) delinquent participant contributions to pension plans (i.e., an employer fails to timely remit 401(k) contributions);
(2) Market rate loans made by a party in interest to a plan;
(3) Below-market rate loans made by a party in interest to a plan;
(4) Below-market rate loans made to a person who is not a party in interest with respect to a plan;
(5) Loans considered made at a below-market interest rate solely due to a delay in perfecting the plan's security interest;
(6) Purchase of an asset (including real property) by a plan from a party in interest.
(7) Sale of an asset (including real property) by a plan to a party in interest;
(8) Sale and leaseback of real property to an employer;
(9) Purchase of an asset (including real property) by a plan from a person who is not a party in interest for something other than fair market value;
(10) Sale of an asset (including real property) by a plan to a person who is not a party in interest for something less than fair market value;
(11) Payment of benefits without properly valuing the plan assets on which payment is based;
(12) Duplicative, excessive, or unnecessary compensation paid by a plan; and
(13) Payment of dual compensation to a plan fiduciary (e.g., payment to a fiduciary for services rendered to the plan when the fiduciary already receives full-time pay from an employer).
Comment: Marcia S. Wagner, Esq. and Deanna H. Niño, Esq. have authored a seminal article concerning the VFC Program entitled "Friend or Foe? The Pros and Cons of the New Department of Labor Voluntary Fiduciary Correction Program" which has been published in the June issue of the Bureau of National Affairs Tax Management Memorandum, and presented in May to the Tax Management, Inc. Advisory Board for Compensation and Benefits.
B. Newly Revised Form 5500
The IRS, DOL and the Pension Benefit Guaranty Corporation announced their adoption of a revised Form 5500 series of returns to be filed for employee benefit plans for plan years beginning in and after 1999. The new Forms 5500 are the result of a substantial overhaul of the Form 5500 filing system.
The new Form 5500 series is being adopted simultaneously with the implementation of a new computerized ERISA Filing Acceptance System ("EFAST") designed to simplify and expedite both the receipt and processing of the Form 5500 series by relying on computer-scannable forms and electronic filing technologies. A major change under EFAST is that filers will submit their returns to the DOL rather than to the IRS.
Comment: The costs of compliance should increase for the initial year because of the significant amount of time that will be needed to become familiar with the forms and the expenses incurred in rewriting or purchasing software to accommodate the EFAST changes.
The new Form 5500 series of forms and schedules departs radically from the pre-1999 series. A single streamlined Form 5500 replaces the pre-1999 Forms 5500 and 5500-C/R; a variety of new schedules now requires much of the information formerly required by the Form 5500 or Form 5500-C/R. Form 5500-EZ will continue to be available for one-participant pension benefit plans.
The new Form 5500 series of forms and schedules includes five pension schedules, seven financial schedules, and one fringe benefit schedule. No filer would file all of the 13 schedules on a single plan, although many will file five or more schedules as part of the Form 5500 series filing.
The forms and schedules under the new system are as follows:
o Form 5500, Annual Return/Report of Employee Benefit Plan;
o Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Pension Benefit Plan;
o Schedule A, Insurance Information;
o Schedule B, Actuarial Information;
o Schedule C, Service Provider Information;
o Schedule D, DFE/Participating Plan Information;
o Schedule E, ESOP Annual Information;
o Schedule F, Fringe Benefit Plan Information;
o Schedule G, Financial Transaction Schedules;
o Schedule H, Financial Information;
o Schedule I, Financial Information Small Plan;
o Schedule P, Annual Return of Fiduciary of Employee Benefit Trust;
o Schedule R, Retirement Plan Information;
o Schedule SSA, Statement Identifying Separated Participants With Deferred Vested Benefits; and
o Schedule T, Qualified Pension Plan Coverage Information.
Schedules B, E, R, T, and SSA are pension schedules. Schedules A, C, D, G, H, I, and P are financial schedules. Schedule F is the only fringe benefit schedule. The new schedules are Schedules D, H, I, R, and T. Schedules A, C, and G reflect a variety of revisions. Minimal or no changes were made to the existing Schedules B, E, F, P, and SSA.
C. Automatic Extension for Certain 1999 Form 5500 Filings
The DOL announced a two and one-half month extension of the deadline for filing certain 1999 Form 5500 series returns.
Currently, filers can get an automatic two and one-half month extension of time to file their Form 5500 series by filing IRS Form 5558 (Application for Extension of Time to File Certain Employee Plan Returns). In response to many filer requests, the DOL and IRS agreed to grant transition-year relief from the requirement to file an IRS Form 5558 to obtain that extension. Specifically, the agencies have agreed that for filers whose 1999 Form 5500 would be due on or before July 31, 2000, the deadline for filing will be extended to October 16, 2000, without filers having to file a Form 5558.
The agencies emphasized that this automatic transition extension cannot be extended further by filing a Form 5558. Also, filers whose normal due date is after July 31, 2000, and who are otherwise eligible to use the Form 5558, must still timely file the Form 5558 to secure a two and one-half month extension.
D. Electronic Notices
The Taxpayer Relief Act of 1997 directed the IRS and DOL to issue guidance by December 31, 1998 to explain how new electronic technologies (e.g., e-mail, internet, intranet and automatic telephone systems) could be used to meet ERISA and IRS requirements in retirement plans.
The IRS in Notice 99-1 has announced that for many qualified plan transactions, use of these media will not cause a plan to become disqualified. Separately, the IRS has issued proposed regulations that allow the use of electronic media for the transmission of certain required notices and consents in connection with qualified plan distributions.
In Notice 99-1, the IRS outlines employee benefit plan transactions that do not have statutory standards or rules regarding how they must be accomplished and therefore may be accomplished through electronic media. These transactions include (but are not limited to) enrolling in a plan, designating rates of elective and after-tax contributions, designating beneficiaries (other than those requiring spousal consent), electing direct rollovers, electing investment allocations for future contributions, changing investment allocations for amounts held under the plan, inquiring about general plan information and inquiring about account information.
The IRS proposed regulations would permit the use of electronic media for providing consent to cashouts of more than $5,000 under Code Section 411(a)(11), the notice of distribution options under Code Section 401(a)(11), the Code Section 402(f) rollover notice and the Code Section 3405(e)(10)(B) voluntary tax withholding notice. The IRS requires that the electronic notices must be as understandable to the participant as a written paper document and the participant must be able to receive a written paper notice from the plan on request at no charge.
Under Code Section 411(a)(11), an accrued benefit of more than $5,000 may not be distributed without a participant's consent. Current regulations require this consent to be in writing. They also provide that the consent will not be valid unless the participant is also given an explanation of the plan's distribution options and is advised of the right to defer the distribution. The proposed regulations would allow these requirements to be met through electronic media under the following conditions: (i) the electronic medium must be reasonably accessible to the participant or distributee; (ii) the notice must be as understandable as a paper document; (iii) the participant must be able to request a paper document of the notice or a confirmation of the terms of a consent at no charge; (iv) the participant must be given a reasonable opportunity to review and to confirm, modify or rescind the distribution before a consent becomes effective; and (v) the system must be reasonably designed to preclude an individual other than the participant from giving consent to a distribution.
Under Code Section 402(f), a plan administrator must provide a participant or distributee with notice of the 20% mandatory withholding tax requirements and the tax effects of distribution alternatives with respect to eligible rollover distributions no more than 90 days and no less than 30 days before the distribution. The proposed regulations would allow this notice to be provided through electronic media under the following conditions: (i) the electronic medium must be reasonably accessible to the participant or distributee; (ii) the notice must be as understandable as a paper document; (iii) the participant or distributee must be able to request a paper document of the notice at no charge; (iv) the examples provided in the proposed regulations indicate there must be some form of authentication of the participant (e.g., use of PIN number); (v) the participant must have access to a readable copy of the 402(f) notice (e.g., on the web site); and (vi) the participant must acknowledge that he or she comprehends the notice.
Under Code Section 3405, a participant must be informed that he may elect no withholding on a distribution (other than an eligible rollover distribution) from a plan. The proposed regulations would allow this notice to be provided through electronic media under the following conditions: (i) the electronic medium must be reasonably accessible to the participant; (ii) the notice must be as understandable as a paper document; (iii) the participant or distributee must be able to request a paper document of the notice at no charge; (iv) there is authentication of the participant (e.g., use of PIN number); and (v) the participant acknowledges by his receipt, review and comprehension of the notice.
The IRS does not allow a spousal waiver of a joint and survivor benefit to be accomplished electronically. The IRS does not address the use of electronic media in providing the 401(k) and 401(m) safe harbor notices, or in the context of plan loans.
E. Leased Employees Not Entitled to Benefits
In Wolf v. Coca-Cola, the Eleventh Circuit ruled that a leased employee was not entitled to ERISA benefits or COBRA coverage under Coca-Cola's benefit plan because the plan terms specifically excluded temporary, seasonal and leased employees from coverage. The facts of this case are straightforward: an employment agency placed a leased employee with Coca-Cola. The employee signed a contract with the agency, which was renewed annually for six years. The work she performed at Coca-Cola was done pursuant to contracts between the agency and Coca-Cola. Any changes relative to her responsibilities and assignments were made between Coca-Cola and the agency. Coca-Cola treated her as a leased employee, provided her with "temporary employee" identification and did not include her in regular employee functions. After the end of the sixth contract year, Coca-Cola terminated her assignment. Since Coca-Cola's benefit plan specifically excluded temporary, seasonal and leased employees from coverage, she was not provided with termination benefits.
The employee sued Coca-Cola. She claimed she was a common law employee and thus entitled to ERISA benefits and COBRA coverage. The appellate court held in favor of Coca-Cola. The court explained that two requirements must be met in order for individuals to be plan participants under ERISA; they must prove: (i) that they are participants or "regular" employees, and (ii) that they are entitled to benefits under the terms of the plan. The court ruled the leased employee had not demonstrated that an employment relationship existed with Coca-Cola. Since the terms of the Coca-Cola benefit plan specifically excluded leased employees, the plaintiff was not entitled to benefits.
Comment: If an employer decides to exclude leased employees from benefit eligibility, the plan documents must be appropriately drafted to so provide. Employers that currently exclude leased employees may want to review their plan documents for adequacy.
F. Reclassified Employees not Entitled to Benefits
An unreleased IRS technical advice memorandum ("TAM") suggests that a plan document may exclude from plan participation employees not reported on a company's payroll as common law employees, even if a court or administrative agency determines that such individuals are common law employees and not independent contractors (as happened in the Microsoft cases).
The unreleased TAM concludes that Code Section 410(a) does not preclude a qualified plan from excluding retroactively reclassified employees from participating in the plan.
Comment: If an employer desires to exclude independent contractors from benefit eligibility, the plan documents must be appropriately drafted to so provide. Employers that currently exclude independent contractors may want to review their plan documents for adequacy.
G. Non-Fiduciaries May be Sued Under ERISA
The Supreme Court has held in Harris Trust and Savings Bank v. Salomon, Smith Barney, Inc., that a suit for equitable relief to redress violations of ERISA can be brought against nonfiduciary parties-in-interest involved in prohibited transactions.
The fiduciaries of a pension trust purchased interests in motels from a nonfiduciary party-in-interest, which constituted a prohibited transaction as defined by ERISA Code Section 406(a). The fiduciaries brought suit against the nonfiduciary when they discovered that the interests were virtually worthless, claiming that they were worthless all along and that the nonfiduciary was liable on account of its participation in the transaction as a nonfiduciary party-in-interest.
The claims were brought under ERISA Section 502(a)(3) which authorizes a participant, beneficiary, or fiduciary to bring a civil action to enjoin any act or practice that violates ERISA. The nonfiduciary argued that an action brought under ERISA Section 502(a)(3) to remedy a prohibited transaction was authorized only against the fiduciary who caused the plan to enter into the transaction, since that is the only party given a duty under ERISA Section 406(a), and not against the counterparty to the transaction.
The Court held that a suit can be brought against a nonfiduciary party-in-interest involved in a prohibited transaction, stating that just because no express duty is imposed on such persons under ERISA does not mean that they are free from being sued. The Court noted that ERISA Section 502(a)(3) does not set a limit on who can be a defendant in a case to remedy a prohibited transaction.
H. HMO Not ERISA Fiduciary
An HMO whose physicians make treatment decisions is not an ERISA fiduciary with regard to those decisions and may not be sued for breach of fiduciary duty, according to the unanimous Supreme Court decision in Pegram v. Herdrich. Nor is the HMO an ERISA fiduciary simply because it gives financial incentives to doctors to contain costs. This is the case even though the HMO may have financial interests adverse to the interests of plan participants and beneficiaries.
Cynthia Herdrich was an HMO plan participant under a health plan offered by her husband's employer. Her HMO physician found an inflammation in her abdomen. Instead of ordering an ultrasound test at a local hospital, the physician chose to have the ultrasound performed at a hospital more than 50 miles away. This meant that Herdrich had to wait eight days before the procedure could be performed. Before the eight days were over, her appendix ruptured, causing peritonitis and endangering Herdrich's life.
Herdrich sued the HMO and its physicians alleging that the HMO is an ERISA fiduciary and is obligated to discharge its duties solely in the interest of plan participants. She further alleged that, by financially rewarding its physicians/owners for limiting medical care, the HMO committed an inherent breach of its fiduciary duty.
The Supreme Court declined to find that the financial arrangements offered by the HMO that treated Herdrich were different from those made at other HMOs. All HMOs seek to control costs by rationing services, the Court noted, and the incentives paid to physicians at the HMO in question had to be viewed in the same light as any other HMO's rationing techniques.
Further, the Court found that the question concerning fiduciary responsibility is not whether the actions of a person providing services under the health plan adversely affected a plan participant, but rather, whether the person performed a fiduciary function when taking the actions that gave rise to the complaint. The Court understood that Congress did not intend HMOs to be treated as fiduciaries when eligibility or treatment decisions were made by physicians. When considering the potential consequences of finding in favor of Herdrich, the Court was swayed by Congress's intent in encouraging HMOs, the fact that eliminating the profit in managed care organizations would cause upheaval, and the potential profusion of malpractice claims and fiduciary actions.
I. Department of Labor Proposes Summary Plan Description Changes
The DOL's proposed regulations for summary plan descriptions with respect to tax-qualified plans are presented as clarifications of existing rules. The DOL emphasizes that detailed information must be provided to participants concerning plan amendment and termination procedures. The summary plan description must state that the plan's qualified domestic relations order procedure will be made available upon request without charge. In addition, the PBGC model statement for defined benefit plans and the ERISA rights model statement have been updated.
With respect to welfare benefit plans, the proposed regulations require group health plans to include a description of (among many other things): (i) any cost sharing provisions that are the responsibility of participants (e.g., deductibles, co-payments, etc.); (ii) any caps on benefits (annual or lifetime); (iii) composition of and rules governing use of network providers; and (iv) a statement concerning the plan's procedures for qualified medical child support orders ("QMCSOs").
Comment: These proposed rules will be effective 60 days after they are published as final rules. Plans would be required to comply by the earlier of: (i) the date as of which the first update to the summary plan description is required to be provided participants; or (ii) the beginning of the second plan year after the effective date of the final rule. This delayed effective date should allow sufficient time for updated summary plan description booklets to be updated. Since these rules become effective after the proposed revisions are finalized and the revisions have not as yet been finalized and might be further modified, we are not advising that summary plan descriptions be updated at this time.
J. Department of Labor Proposes Claims and Appeal Changes
The DOL has proposed a new regulation for plans that would replace the current ERISA claims and appeals rules with new guidelines for how plans handle and decide participants' and beneficiaries' claims for plan benefits.
The new regulation, if finalized, would affect every aspect of claims processing, including how and when claims are received by a plan, who makes the initial decision regarding a claim and how quickly, and who makes appeals decisions.
The new rules would be applicable to "group health plans" and pension and disability plans. Multi-employer plans and health plans sponsored by individual employers would have to follow the new rules, whether they provide self-insured, insured or managed care coverage.
The proposed regulation requires all plans to establish and maintain "reasonable" procedures governing the filing of benefit claims, notice of benefit determinations and appeal of "adverse benefit determinations." To be reasonable, a claims procedure: (i) would have to be described in the summary plan description ("SPD"), with a description of all rules and deadlines; (ii) could not require a participant or beneficiary to submit an adverse benefit determination to arbitration or to go through more than one level of appeal (e.g., appeal to the health maintenance organization ("HMO") and then appeal to the plan sponsor); (iii) could not unduly inhibit or hamper claims or appeals (e.g., by requiring that participants pay fees to make claims or appeal an adverse benefit determination); and (iv) could not stop or limit a representative (including an attending physician) from acting on behalf of the claimant.
Plans have always treated claims for payment of benefits as claim for purposes of starting the time running for decisions to be made. Under the proposed regulation, "claims" would also include requests for coverage determinations (e.g., whether the participant or beneficiary is covered under the plan), pre-authorizations or approvals of plan benefits and utilization review determinations.
For claims or appeals involving "urgent care", health plans would have to provide for an expedited process that permits verbal requests for decisions by participants and telephone or fax response by the plan. Urgent care would be any claim for medical care or treatment that could not be decided under the normal time frames because: (i) it could seriously jeopardize the life or health of the claimant or the ability of the claimant to regain maximum function; or (ii) in the opinion of a physician, would subject the claimant to severe pain that could not be adequately managed without the care or treatment.
The proposed regulation also creates a new rule that applies when a claimant requests a benefit but does not follow the plan's claims procedures. Under this rule, if a claimant makes a benefit request that fails to comply with the plan's claims procedures the plan administrator must notify the claimant of the failure and of the plan's claims procedures that must be followed. For pension, disability and non-urgent health care benefit requests, notice would be required within a reasonable time period, not to exceed five days. For urgent care benefit requests, the period could not exceed 24 hours.
When a claim is filed, the plan administrator would have to notify a claimant of the plan's benefit determination within a reasonable period of time, which is significantly shortened from the current 90- to 180-day period to 72 hours (for urgent care) to 90 days (for pension benefits).
Under existing law, every ERISA-governed plan must establish and maintain a procedure that gives a claimant a reasonable opportunity to appeal an adverse benefit determination to an appropriate named fiduciary of the plan; the claimant must receive a full and fair review of the claim and the adverse benefit determination. The proposed claims procedure requires that, in deciding appeals of any adverse benefit determination involving a medical judgment, the fiduciary decision maker consult with an independent health care professional who has appropriate training and experience in the relevant field of medicine.
Under current law, plans that provide benefits through federally qualified HMOs may use the HMO claims and appeals procedures rather than the ERISA procedures. The proposed regulation would require that plans offering HMOs use the new ERISA claims and appeals rules. In addition, under current law, a plan established and maintained pursuant to a collective bargaining agreement (other than Taft-Hartley plans) may include a claims and grievance and arbitration procedure in its collective bargaining agreement. The proposed regulation would eliminate this exception and require all plans to follow the ERISA plan rules.
Comment: If the proposed regulations are adopted in final form, claims processing for health plans would need to be revised. Employers and multi-employer plans that self-administer health benefits would have to ensure that systems are in place to decide urgent care claims within 72 hours. In this respect, it is important to note that claims include requests for pre-authorization of care, not just requests for payment. Plans that do not provide written notice to the participant or beneficiary of utilization review or pre-authorization decisions would have to change these procedures. If the appeal involves a medical judgment, plans would have to obtain the opinion of an independent medical expert in the relevant field of medicine before deciding the appeal. These time frames are very short, and some might argue unreasonable.
IV. WELFARE AND FRINGE BENEFITS
A. Qualified Transportation Guidance
The IRS recently issued proposed regulations on the income tax exclusion for "qualified transportation" fringe benefits. Qualified transportation fringe benefits are the following benefits provided by an employer: (i) transportation in a commuter highway vehicle if the transportation is in connection with travel between the employee's residence and the place of employment (e.g. van pools); (ii) transit passes; and (iii) qualified parking.
The proposed regulations explain that there are two categories of qualified transportation fringe benefits for purposes of determining the amount of the benefit that is excludable from the employee's income. The first category is transportation in a commuter highway vehicle and transit passes. The second category is qualified parking. There is a statutory monthly limit on the value of the benefits from each category that is excludable from an employee's gross income. For 1999 and 2000, the statutory monthly limit is $65 for transportation in a commuter highway vehicle and mass transit passes and $175 for qualified parking.
Comment: An employee may receive benefits from each category provided the applicable statutory monthly limit for the category is not exceeded. The amount by which the value of qualified transportation fringe benefits provided by an employer to an employee exceeds the applicable statutory monthly limit is included in the employee's wages for income and employment tax purposes.
The proposed regulations provide that the salary reduction election for any month in a year may not exceed the aggregate monthly maximum for that year (e.g., $240 for 1999 and 2000 - $175 plus $65 permitted for the first and second categories of benefits). The salary reduction election must be made before the employee is currently able to receive the taxable compensation that he or she is agreeing to reduce.
Comment: This means that an employer can offer employees qualified transportation fringe benefits as one of the benefits under a Code Section 125 cafeteria plan.
Code Section 132(f)(3) requires that transit pass vouchers be used (rather than cash reimbursement) where such vouchers are "readily available" for direct distribution by an employer to its employees. The IRS previously interpreted "readily available" for direct distribution to mean "if an employer can obtain the [voucher] on terms no less favorable than those to an individual employee and without incurring a significant administrative cost." Under the proposed regulations, administrative costs are "significant" if the average monthly administrative costs paid to fare media providers incurred by the employer for a voucher (disregarding delivery charges less than $15 per order) are more than 1% of the average monthly value of the vouchers for a transit system.
The proposed regulations also provide clarity with regard to how unused transportation plan reimbursement account balances under a Code Section 125 cafeteria plan must be treated. The IRS has provided that unused amounts may be carried forward month-to-month and year-to-year. The proposed regulations are clear that retroactive elections are not permitted. The proposed regulations also provide that the election must be made before the employee is eligible to receive the compensation from which the deduction will be made to pay for the transportation benefit. The election must specify that the period (such as a calendar month) for which the transportation benefit will be "provided" must not begin before the election is made.
B. IRS Issues New COBRA Regulations
On February 3, 1999, the IRS published comprehensive COBRA regulations. The February 1999 regulations fall within two categories. There is a lengthy set of final regulations (the "Final Regs"), as well as a shorter set of new proposed regulations (the "'99 Proposed Regs").
The Final Regulations apply to COBRA qualifying events occurring in plan years beginning on or after January 1, 2000.
1. Treatment of Health Flexible Spending Arrangements. Of all the changes made by the new regulations, the change that is likely to benefit the largest number of employers involves COBRA's application to health flexible spending arrangements ("health FSAs"). These are arrangements under which an employee may make pre-tax contributions to an account, from which amounts may then be withdrawn to reimburse the employee for medical expenses. The IRS had made clear that health FSAs are "group health plans," and therefore subject to COBRA's requirements. Although the Final Regulations reaffirm this position, the '99 Proposed Regs substantially limit the circumstances under which participants in health FSAs must be permitted to maintain COBRA coverage beyond the end of the plan year in which a qualifying event occurs.
This special rule limiting availability of COBRA applies to any health FSA satisfying the following conditions: (i) The health FSA must constitute an "excepted benefit" for purposes of the portability provisions described in the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). This condition is satisfied if the employer sponsoring the health FSA also provides another group health plan offering comprehensive medical benefits and the maximum reimbursement under the health FSA does not exceed the greater of twice an employee's salary reduction contributions or the amount of those salary reduction contributions plus $500. Typically, this will be the case any time an employer permits an employee to allocate no more than $500 in nonelective employer contributions to the employee's health FSA; and (ii) The maximum COBRA premium permitted to be charged under the health FSA must equal or exceed the maximum benefit available under that arrangement. As under an indemnity plan, the maximum permissible COBRA premium for health FSA coverage includes both the amounts contributed by an active employee and any nonelective employer contributions to the employee's account. Therefore, this second condition should be satisfied in virtually every case.
Hence, in most instances, health FSAs will not have to provide COBRA coverage beyond the end of the plan year in which a qualifying event occurs.
2. Core/Non-Core Distinction. The older regulations under COBRA promulgated in 1987 ("'87 Regs") drew a distinction between "core" coverage and "non-core" coverage. "Non-core" coverage was defined to include dental and vision benefits, while "core" coverage included all other benefits offered under a group health plan. If a single group health plan offered both core and non-core benefits and if the cost of providing the non-core benefits would have exceeded 5% of the total cost of coverage under the plan the plan was required to offer each qualified beneficiary the option of continuing either all of the plan's benefits or only the plan's core benefits. This core/non-core distinction is entirely absent from both the Final Regulations and the Proposed Regulations.
3. Counting of Part-Time Employees. An employer is not subject to COBRA's requirements if, during the preceding calendar year, the employer normally employed fewer than 20 employees on a typical business day. Under the '87 Regs, all employees both full-time and part-time counted toward this 20-employee threshold. The '99 Proposed Regs modify the treatment of part-time employees. Although such employees must still be considered, they may be counted at their full-time equivalents: each part-time employee may now be counted as a fractional employee, with the numerator of the fraction equal to the number of hours worked by that employee (during either a typical business day or a regular pay period), and the denominator of the fraction equal to the number of hours worked (during the same time frame) by a full-time employee.
4. Reduction in Work Hours Followed by Termination of Employment. Under a special rule for multiple qualifying events, an 18-month period of COBRA coverage due to an employee's reduction in work hours or termination of employment may be extended by an additional 18 months if another qualifying event occurs during that first 18-month period. Since COBRA's enactment, however, there has been uncertainty as to whether this rule applies only when the second qualifying event would otherwise entitle a qualified beneficiary to 36 months of COBRA coverage, or also where the second qualifying event would otherwise entitle a qualified beneficiary to only 18 months of coverage (i.e., because it is either a reduction in work hours or a termination of employment).
The Final Regs clearly adopt the position that the multiple qualifying event rule applies only when the second event would otherwise entitle a qualified beneficiary to 36 months of COBRA coverage.
5. Dropping Coverage in Anticipation of Divorce. After stating that COBRA coverage must be identical to the coverage a qualified beneficiary received immediately before a qualifying event, the '87 Regs note that "[a]ny elimination or reduction of coverage in anticipation of a qualifying event is disregarded ." The most common situation in which coverage is terminated in anticipation of a qualifying event is a soon-to-be divorced employee electing to drop coverage for the employee's spouse.
Most plans have offered COBRA coverage to such a spouse, assuming the administrator receives timely notice of the eventual divorce or legal separation. The Final Regs confirm this approach specifically listing "an employee's eliminating the coverage of the employee's spouse in anticipation of a divorce or legal separation" as an example of coverage elimination that must be disregarded in determining the level of coverage to be continued under COBRA. The preamble states that, "upon receiving notice of the divorce or legal separation, a plan is required to make COBRA continuation coverage available, effective on the date of the divorce or legal separation (but not for any period before the date of the divorce or legal separation)." Thus, the IRS clearly contemplates that a spouse might be left without coverage for the period of time between an employee's dropping of spousal coverage and the date of the divorce or legal separation. Presumably, however, the COBRA coverage offered to such a spouse may not impose any preexisting condition limitation or exclusion as a result of this gap in coverage.
6. Mergers and Acquisitions. The '87 Regs signaled the IRS's position that both parties to a corporate transaction might have COBRA liabilities. Over the years, parties (seller and buyer) to such transactions have grappled with the uncertainties created by this reference to "successor" liability. Generally, one of the parties usually agrees to provide COBRA coverage.
The '99 Proposed Regs would impose COBRA liability on a selling employer (or its controlled group) in both stock and asset sales, unless the buyer of assets meets a fairly explicit definition of a "successor employer." For purposes of these rules, the buyer is a successor employer if the seller ceases to provide group health coverage to any employee in connection with the sale, and the buyer continues the business operations purchased from the seller without interruption or substantial change. If the buyer qualifies as a successor employer and provides health coverage, it would have to make COBRA coverage available to qualified beneficiaries.
The '99 Proposed Regs make clear that a seller and buyer may agree to allocate COBRA liability to either party to the transaction. Only if the party that assumes this liability under the terms of the parties' agreement fails to perform as promised could the other party be potentially subject to liability.
C. New Cafeteria Plan Rules Regarding Change in Status
On March 23, 2000, the IRS issued final regulations to guide cafeteria plan sponsors in determining when a plan participant has experienced a "change in status" sufficient to permit a change in the participant's cafeteria plan election. The IRS also issued proposed regulations covering two areas: (i) the expansion of the change in status rules to apply to dependent care and adoption assistance benefits provided under a cafeteria plan (the final regulations apply only to health and life insurance benefits); and (ii) the expansion of the rules governing cafeteria plan election changes related to changes in the cost or coverage of the underlying benefits in the plan.
1. Change in Status. Code Section 125 permits an employee who participates in a cafeteria plan to elect, prior to the beginning of a plan year, to receive one or more of the nontaxable benefits provided under the plan. Once this election is made, it generally cannot be changed until the beginning of the next plan year. But there are a few exceptions to this rule if the employee experiences a "change in status".
The final regulations permit an employee to make a mid-year cafeteria plan election change if two criteria are met: (i) a change in status event has occurred, and (ii) the employee's requested election change is consistent with that event.
Any event that falls in one of the categories provided in the final regulations qualifies as a change in status event. The new "change in status" list is as follows:
(i) Change in employee's legal marital status including marriage, divorce, death of spouse, legal separation, and annulment.
(ii) Change in number of dependents including birth, adoption, placement for adoption, and death.
(iii) Change in employment status this is the category that now includes changes in work schedule and worksite. This category applies to any employment status change that affects benefit eligibility. Any of the following events, if it changes the employment status of the employee or his spouse or dependent, qualifies under this category: the beginning or ending of employment; a strike or lockout; the beginning of or return from an unpaid leave of absence; or a change in worksite.
Also, if a cafeteria or underlying benefit plan conditions eligibility on an individual's employment status, and that status changes, and, as a result, the individual becomes (or ceases to be) eligible under the plan, then the change qualifies as a change in employment status. For example, if a plan covers only salaried employees and an employee switches from salaried to hourly, meaning the employee is no longer eligible for the salaried plan, then that employee has incurred a change in employment status.
(iv) Change in eligibility for dependent status including any event that causes a dependent to satisfy (or stop satisfying) coverage requirements due to age, student status, marriage, or similar circumstances. An event resulting in loss of coverage eligibility (such as loss of student status) permits the employee to drop coverage for that dependent; similarly, an event resulting in new eligibility (where a dependent starts school) permits the employee to add coverage for that dependent.
(v) Change in residence including any change in the residence of an employee, spouse, or dependent, but only if the change affects the employee's eligibility for coverage (for example, an individual moves in or out of the territory of an HMO). Also, an example in the final regulations makes it clear that, if an individual loses coverage due to a change in residence, he must select substitute coverage if it's available (rather than simply dropping coverage altogether).
(vi) Adoption assistance Under this new category, added by the proposed regulations, the beginning or ending of adoption proceedings allows an election change under an adoption assistance program.
There are other events (besides "change in status" events) that permit mid-year election changes. The final regulations clarify that if, in connection with special enrollment rights under Code Section 9801(f) (i.e., HIPAA, which would, in certain cases require mid-year changes), an employee, spouse, or new dependent is entitled to enroll in a group health plan, a cafeteria plan may permit the employee to also elect to enroll pre-existing dependents in the underlying group health plan.
The final regulations also clarify that if, under the change of status rules relating to a new spouse or dependent, an employee is entitled to elect family coverage under a group health plan, then other family members can become covered under the family coverage as a result of the election change.
In addition, if there is a loss of Medicare or Medicaid entitlement by an employee (or by the employee's spouse or dependent), the final regulations clarify that a cafeteria plan may permit the employee to add health coverage under the employer's accident or health plan. Also, the plan may permit cancellation or reduction in coverage if an employee (or the employee's spouse or dependent) who is enrolled in an accident or health plan becomes entitled to Medicare or Medicaid.
The new proposed regulations also allow certain election changes to reflect significant cost and coverage changes for all types of qualified benefits, other than a health flexible spending arrangement ("FSA"), provided under a cafeteria plan. Thus:
(i) If a plan adds a new benefit package option (e.g., a new HMO option), the cafeteria plan may permit affected participants to elect that option and make a corresponding election change with respect to other benefit package options during a period of coverage.
(ii) Election changes are permitted if there are significant cost increases for self-insured accident or health plans, group-term life insurance, dependent care assistance, and adoption assistance coverage under a cafeteria plan. For example, if the cost of a self-insured accident or health plan increases, a plan may permit employees either to make a corresponding prospective increase in their elective contributions, or to revoke their elections and instead receive, on a prospective basis, coverage under another benefit package option providing similar coverage. Or the plan may, on a reasonable and consistent basis, automatically make a prospective increase in affected employees' elective contributions.
(iii) When one dependent care provider is replaced by another, a corresponding election change may be made.
(iv) An employee may be permitted to make an election change during a period of coverage corresponding with an open enrollment period change made by a spouse or dependent, when the plan of that individual's employer has a different period of coverage.
(v) An employee may be permitted to make an election change in the event that a spouse or dependent makes an election change under a cafeteria plan or qualified benefits plan maintained by that individual's employer, provided the spouse's or dependent's election change satisfies the election change rules. For example, if a spouse's employer's plan adds a new HMO option and the spouse elects the HMO option, a cafeteria plan may permit the employee to drop family coverage.
2. The Consistency Requirement. If a change in status event occurs, employees may make changes consistent with the event. The final regulations clarify (and limit) the election changes that will qualify under this consistency requirement. Generally, to be consistent, a requested election change must "be on account of and correspond with" a change in status event that affects the eligibility of an employee, spouse, or dependent for a qualified benefit (be it accident/health or group term life coverage, or under the proposed regulations dependent care or adoption assistance). To be consistent, a requested election change must be on account of, and correspond with, a change in status that causes the employee, spouse, or dependent to gain or lose coverage under an employer plan.
The final regulations set forth two specific consistency tests one when dependent eligibility is lost, and another when coverage eligibility is gained through another employer plan:
(i) If the change in status is the employee's divorce, annulment, or legal separation from a spouse, the death of a spouse or dependent, or a dependent's loss of dependency status, the employee may cancel accident or health insurance coverage only for the spouse or dependent (whichever applies), not anyone else.
(iii) If an employee, spouse, or dependent gains eligibility for coverage under another employer's cafeteria plan (or underlying benefit plan) due to a change in marital or employment status, the employee may elect to stop or decrease coverage for that individual under the cafeteria plan only if the individual actually becomes covered (or increases coverage) under the other employer's plan.
There is an important exception to the general consistency rule: When there is a change in the employee's marital status or in the employment status of the employee's spouse or dependents, the employee may elect to increase or to decrease group-term life insurance or disability coverage either election will be deemed to correspond with the change in status (and therefore satisfy the consistency requirement) even if the election does not track the increase or decrease in family size, or result in the gain or loss of eligibility.
D. Cafeteria Plan Audits
Cafeteria plans are subject to nondiscrimination testing and to written plan document requirements. Many employers have been lax with respect to observing the formalities of cafeteria plans and testing, in part due to the IRS's failure to finalize the regulations in this area.
The IRS has undertaken a cafeteria plan audit program. The results of these audits are that very few plans have been actually conducting nondiscrimination tests on cafeteria plans and that many plans do not have written plan documents.
Recommendation: Review your cafeteria plans for compliance with recent law changes and ensure applicable nondiscrimination tests have been satisfied.
E. Qualified State Tuition Programs
The Code has been amended to provide two types of qualified state tuition programs ("QSTP") or Code Section 529 plans: (i) prepaid tuition programs; and (ii) tax-deferred savings plans. The prepaid tuition programs enable a contributor to purchase future tuition credits at current tuition prices. The tax-deferred savings plans enable the contributor to make contributions to an account to pay for future education. A contributor may contribute $100,000 or more to these plans annually, with no contributor income limitations or adjusted gross income phase-out limitations. However, contributions are subject to the $10,000 per donee annual gift tax exclusion. Nonetheless, the contributor may aggregate 5 years of the allowable $10,000 per year gift tax exclusion into 1 year, thereby enabling contributions in 1 year of $50,000 (or $100,000 for a married couple) without being subject to gift tax.
1. Prepaid Tuition Plan. The prepaid tuition enables an individual to purchase future tuition at current prices. Thus, if a parent purchases half of his child's tuition at the current tuition price, it is guaranteed to be worth half of the tuition when the child reaches college age, irrespective of tuition inflation.
There are numerous limitations on the prepaid tuition plans: very often these plans are applicable for only a limited number of schools; if the child attends a school outside of the applicable list of schools (most schools within these types of plans are in-state schools), the contributor will only recover the initial deposit plus the consumer price index; many plans are limited to state residents (although the Massachusetts U. Plan does not have a residency requirement); many prohibit the transfer of monies from one account to another. For example, if one child does not use the entire account, a transfer to another child might not be permissible. The monies in the account may often only be used for tuition and not room and board. The rate of college inflation has been slowing down, whereas the stock market has been rising steadily; and although not technically in the student's name, a ruling from the Department of Education sets forth the treatment of QSTP plans with regard to financial aid, detailing that pre-tuition plans (unlike tax-deferred savings plans) will be considered assets of the child, thereby potentially negatively affecting the child's financial aid eligibility status.
2. Tax-Deferred Savings Plan. The tax-deferred savings plans enable people to set aside monies in an account for the benefit of a child. Contributions to the tax-deferred savings plan are not tax-deductible, but the earnings grow tax-free until they are withdrawn for "qualified higher education expenses" (i.e., tuition, fees, books, supplies and equipment, as well as room and board, if the student is enrolled at least half-time) required for the enrollment or attendance of the student at virtually all accredited public, non-profit and proprietary post-secondary institutions. The withdrawn amounts are taxed at the child's rate. With many of these plans, the child can matriculate anywhere. Many programs are open to non-residents, enabling the contributor to "forum shop" for the best program. However, with some programs, there may be adverse tax consequences by moving monies out of state.
Ownership of the tax-deferred savings plan account remains with the contributor, but is still excluded from the contributor's estate in the case of death. If, for example, the grandparent is the contributor, the grandchild does not have the tax-deferred savings plan account in his possession for financial aid purposes. Additionally, the grandparent does not have to worry about the grandchild using the monies earmarked for college for other purposes.
If a child decides not to attend college, the monies may be transferred to another child in the family or withdrawn with a 10% penalty tax on the investment gains which are taxed at the contributor's rate.
The monies are invested in a variety of mutual funds at the discretion of the state and investment firm administering the fund. The contributor has no discretionary control over the investments; usually the monies are invested depending upon the date the child will enter into college (i.e., aggressively early on and as the child gets closer to graduating from high school, conservatively).
The disadvantages of these plans are: the returns are not as high as they might otherwise be as the investment portfolio is often not very aggressive; the expenses of the program add a layer of cost to the mutual funds, bonds or other underlying investment vehicles; and although the account is owned by the contributor, if the contributor is a parent, the child may have to divulge the parental asset information on his financial aid application.
With these plans, the beneficiary is not required to withdraw the monies by a specific year. Thus, the child may travel or work prior to attending college or may elect to use other funds prior to withdrawing monies from the plan.
Contributions may not be made to a QSTP after the designated beneficiary or account holder reaches age 18. Any balance in a QSTP account must be distributed within 30 days after the earlier of: the date that the beneficiary or account holder reaches age 30 (or dies); or the date that the beneficiary or account holder completes the equivalent of the first four years of post-secondary education at one or more eligible institutions. Any undistributed funds may then be rolled over to the account of a new beneficiary. Otherwise, earnings on such funds are taxable income to the contributor and are subject to an additional 10% tax.
Comment: Given the high cost of college, parents and grandparents might want to consider either one or both of these tax-advantaged programs.
F. Group Term Life Insurance Table Revised
Code Section 79 permits an employee to exclude the cost of $50,000 of group-term life insurance coverage from gross income. The remaining cost of the employer-provided group-term life insurance is included in the employee's gross income. The IRS has issued final regulations under Code Section 79, revising the uniform premium table used to calculate the cost of group-term life insurance coverage provided to an employee by an employer. The rules provide guidance to employers who must use the uniform premium table to calculate the cost of group-term insurance includible in their employees' gross incomes. The revised table reflects improvements in mortality and includes a new under-25 age bracket. Thus, the proposed table would result in a reduction in the rates used to compute the cost of group-term life insurance provided to employees and would result in lower imputed income and lower taxes for employees.
G. Final FICA/FUTA Withholding for Nonqualified Deferred Compensation Plans
The IRS has issued final regulations under Code Sections 3121(v) and 3306(r), which provide guidance on the application of FICA and FUTA taxes, respectively, to amounts deferred under or paid from certain nonqualified deferred compensation plans.
1. Background. Under the so-called "special timing rule", an amount deferred under a nonqualified deferred compensation plan must be considered wages for employment tax purposes as of the later of the date the services are performed, or when there is no substantial risk of forfeiture of the rights to such amount even if that amount is not subject to income taxes at that time. Absent this special timing rule, the general timing rule would subject deferred compensation to employment taxes when it is actually or constructively paid. There is also a nonduplication rule which generally provides that once an amount deferred is taken into account for employment tax purposes, neither that amount nor income attributed to it will be treated as FICA/FUTA wages in the future.
2. Nonqualified Deferred Compensation Plans. The final regulations define a nonqualified deferred compensation plan as any plan or arrangement that is established by an employer to provide for the deferral of compensation. An employee does not need to make an election to have compensation deferred in order for a plan to be considered a nonqualified deferred compensation plan or arrangement. According to the final regulations, amounts will be treated as deferred compensation under a nonqualified deferred compensation if: (i) the compensation has not been actually or constructively received, and (ii) the compensation is payable in a later year.
3. Stock Option Plans. Stock options, stock appreciation rights and certain other stock-related rights generally are not deferred compensation subject to the special timing rule for payment of FICA/FUTA taxes and thus are subject to FICA/FUTA taxation under the general timing rule. This rule requires the payment of taxes upon exercise.
4. Death and Disability Benefits. According to the regulations, any benefits that a nonqualified deferred compensation plan pays, in the event of death or disability, are not nonqualified deferred compensation to the extent the benefits payable have a value in excess of the lifetime benefits that would have been paid to the employee under the plan.
5. Other Benefits. The regulations describe other types of benefits that are not nonqualified deferred compensation (e.g., vacation benefits, severance pay).
6. Termination Benefits. In general, according to the final regulations, benefits provided in connection with impending termination of employment are considered termination pay and not deferred compensation. These types of nonqualified benefits include early retirement window benefits, retirement-type subsidies, Social Security supplements or other forms of benefit made available by the employer for a limited period (no greater than one year) to employees who terminate during that period.
7. Determination of the Amount Deferred. The amount deferred under a nonqualified deferred compensation plan is the amount that should be taken into account under the special timing rule.
The final regulations retain the distinction in the proposed regulations between the methods of calculating the amount deferred (and income thereon) for "account plans" and "nonaccount plans." Different rules for determining the timing and the amount of deferred compensation that should be taken into account apply to each type of plan.
(i) Account Plans an account plan is one in which principal amounts are credited to an individual account for an employee; the income attributable to the principal amounts is credited (or debited) to the individual account; and the benefits payable to the employee are based solely on the balance credited to the individual account. An account plan is substantially similar to a defined contribution plan. Under an account plan, the amount to be taken into account as wages is the principal amount (if vested) that is credited to the employee's account, increased by (or decreased by) income (or loss) attributable to that amount through the date the amount is required to be taken into account as FICA/FUTA wages.
(ii) Nonaccount Plans a nonaccount plan (e.g., a defined benefit-type plan) is a plan that does not meet the requirements to be an account plan. For a nonaccount plan, the amount taken into account for a period is the present value of the future payments to which the employee has obtained a legally binding right.
The income attributable to the amount taken into account is defined as the increase, due solely to the passage of time, in the present value of any future payments to which the employee has a legally binding right. Importantly, the regulations allow employers to use any reasonable actuarial assumptions and methods in determining present value.
The final regulations provide that no amount need be taken into account under nonaccount plans, even if vested, unless the value is "reasonably ascertainable." According to the final regulations, an amount is reasonably ascertainable when there are no actuarial or other assumptions needed to determine the amount deferred other than interest, mortality, or cost-of-living assumptions. Thus, for example, if assumptions as to qualified plan offsets, future pay or the time or form of benefit payment are necessary to determine an amount at the time services were performed, then the amount would not be reasonably ascertainable.
An employer may choose to take into account an amount earned in a year under a nonaccount plan before it is reasonably ascertainable (i.e., an early inclusion date), and perform a final calculation when the amount becomes reasonably ascertainable. However, if the amount taken into account (plus related earnings) is less than the amount determined when it becomes reasonably ascertainable (e.g., at termination of employment), then the employer must "true up" and pay the employment taxes on the true-up amount at that time.
H. New Annual Report for Multiple Employer Welfare Arrangements
In February 2000, the Department of Labor published a new form called Form M-1, to be filed by multiple employer welfare arrangements ("MEWAs") that provide health benefits. The Form M-1 acts both as a registration for MEWAs , checks compliance with HIPAA, as well as the Mental Health Parity Act of 1996, the Newborns' and Mothers' Health Protection Act of 1996, and the Women's Health and Cancer Rights Act of 1998. The PWBA has published two sets of Questions and Answers ("Q& A's") explaining the Form M-1, which are both available on the internet at www.dol.gov/dol/pwba and by calling 1-800-998-7542.
The Form M-1 is due on a calendar year basis, regardless of the MEWA's fiscal year. However, fiscal year data may be used in certain cases. The initial report was due May 1, 2000. The DOL has stated that, if a MEWA files this report in good faith in 2000, it will not assess penalties even if late. The DOL is still accepting requests for extensions of the filing deadlines, so a request for an extension (or the completed Form itself) should be filed as soon as possible.
A. Social Security Penalty Repealed for Working 65 69 Year Olds
Recently passed legislation repeals the current earnings limit for Social Security recipients aged 65 to 69. The new seniors' unlimited earnings law eliminates a long-standing government policy that reduces Social Security benefits by $1 for every $3 a recipient aged 65 through 69 makes in wages over a certain threshold ($17,000 in 2000).
The measure will not repeal the existing penalty for workers aged 62 to 64, who lose $1 in benefits for every $2 they earn beyond $10,080 a year. Workers aged 70 or older have long been exempt from any earnings limit.
It is estimated that the legislation will affect 800,000 Americans with reduced benefits because they work or are dependents of workers. Another 100,000 people will receive retirement benefits from Social Security for the first time because they never filed claims for benefits because of the earnings tests. These people will receive Social Security payments under the new law when they file claims for benefits. Unchanged is the taxation of Social Security benefits for many middle and upper income taxpayers. As much as 85% of Social Security benefits is taxable, depending on overall income.
B. Congressional Estate Tax Legislation
The House of Representatives has passed H.R. 8, The Death
Tax Elimination Act of 2000, which would repeal the estate, gift
and generation-skipping transfer taxes for gifts made or individuals
dying after January 1, 2010. Before January 1, 2010, the top
estate and gift tax rates would be significantly reduced. The
President has indicated that he will veto the legislation if
passed. The Democrats have offered an alternative that reduces
estate and gift taxes, increases the unified credit amounts and
increases exclusions for farms and closely held businesses. The
future of these legislative endeavors is uncertain. However,
if you are contemplating estate tax planning that will involve
irrevocable transfers or other major changes, you should be mindful
of this legislation in the event that it becomes law in some