Sept. 2007 Vol. X, No. 2

These past several months have been busy indeed with respect to tax and ERISA law changes affecting most types of tax-qualified, executive compensation and welfare benefit arrangements.  This Newsletter highlights the salient issues of which you should be aware, including the new 403(b) regulations, pension plan amendment requirements, legal actions required in 2007 for non-qualified deferred compensation arrangements, Massachusetts health care law, as well as developments affecting Internal Revenue Code Section 125 or “cafeteria” plans.  

Since our last Newsletter, The Wagner Law Group continues to grow.  We are pleased to welcome to our legal team Charles G. Humphrey, a nationally-recognized expert in ERISA/employee benefits law, as a partner.

We proudly announce that The Wagner Law Group has received the extraordinary honor of being named in the 2007 Bar Register of Preeminent Lawyers , in which Martindale-Hubbell lists only the most distinguished law practices, achieving its coveted AV rating; the “A” signifies the highest level of legal ability, while the “V” denotes very high adherence to professional standards of conduct, ethics, reliability and diligence.

We are truly pleased and proud to announce that: (i) Debra Dyleski-Najjar has been inducted into the American Bar Association’s College of Labor and Employment Lawyers, a truly stellar accomplishment and honor; and (ii) Alvin D. Lurie has received the first award by the American Bar Association’s Employee Benefits Committee for lifetime achievement.

Marcia S. Wagner continues to work and lecture extensively, and has the signal honor of having been appointed to the IRS Advisory Committee on Tax Exempt and Government Entities.  Barry M. Newman and Marcia Wagner have published several articles for the Compensation Planning Journal and the NYU Employee Benefits and Executive Compensation Review .

Marcia S. Wagner, and John R. Keegan have been named as New England Super Lawyers of 2007; Marcia, John were selected for this high honor as being among the top 5% of all New England attorneys, after an extensive peer review and evaluation process. 

In the event you desire legal advice or consultation, please feel free to contact any member of The Wagner Law Group.


A.        Plan Document Updates 
B.        IRS Clarifies Its Position Regarding Partial Terminations
C.        Final Regulations Under Section 403(b) of the Internal Revenue Code 
D.        Internal Revenue Code Section 415 Issues 


A.        Massachusetts Health Care Reform Act – What Do You Have To Do Next 
B.        New Regulations under Internal Revenue Code Section 125 Affecting Cafeteria Plans 
C.        IRS Issues New Dependent Care Tax Credit Regulations 

 Please note footnotes appear in [ ] at the end of the newsletter.


A. Plan Document Updates

As discussed in our January newsletter, the Pension Protection Act of 2006 made significant changes to the law governing tax-qualified retirement plans.  Only a few of these changes require an amendment to your plan document (i.e., mandatory amendments).  Some of the changes are not mandatory; if you wish to take advantage of any of these changes, your plan document must be amended to provide for them (i.e., discretionary amendments).  

The Pension Funding Equity Act of 2004 made a change to the law that would have required amending defined benefit pension plan documents by the end of the 2006 plan year.  However, the Pension Protection Act modified the change in the law and also extended the deadline until 2008 to adopt a mandatory amendment to make the change to plan documents. 

The mandatory amendments you must adopt and the discretionary amendments you might consider adopting during the 2007 plan year (i.e., the plan year beginning in 2007) are described below.  You may find that your plan administrator is operating your plan as if it will be amended to comply with, or to take advantage of, the changes in law.  If that is the case, your plan document must be amended to reflect its actual operation.

For the mandatory amendments, and any discretionary amendments that you would like to implement, the deadline for adopting the plan amendments for the 2007 plan year is the last day of the plan year (i.e., December 31, 2007, for a calendar year plan).  Failure to timely adopt an amendment could result in penalties plus the cost of correcting the untimely amendment. 

If you adopt an amendment for the 2007 plan year, you will not need to submit the amendment to the IRS until it opens the determination letter cycle for your plan.  A plan’s determination letter cycle is based on the sponsor’s EIN.  The current cycle, which ends January 31, 2008, is for EINs that end with the digit 2 or 7; for other EINs, the next cycle will not start until February 1, 2008.  As stated above, however, the deadline for adopting a plan amendment for the changes described in this letter that are to be implemented for the 2007 plan year remains the last day of the 2007 plan year, unless otherwise noted.

Comment : Please feel free to contact our office to discuss how to implement these changes.

Comment : If the Wagner Law Group maintains your plan documents, we will contact you regarding applicable and relevant mandatory plan deadlines.

Mandatory Amendments

Vesting .  Defined contribution plans that provide for employer contributions, such as profit sharing and employer matching contributions, must have a vesting schedule that, at a minimum, will either fully vest participants upon the completion of three years of service (three-year cliff) or vest at least 20% per year for each year of service beginning with the participant’s second year of service, which means a participant will fully vest after six years of service (a six-year graded schedule).  These new vesting schedules can be applied to all employer contributions or only to employer contributions made for the 2007 plan year and thereafter.  If your plan currently provides a more favorable vesting schedule, it does not need to be changed.  Also, a delayed effective date is available for certain collectively bargained plans and ESOPs. 

Comment : For those plan documents The Wagner Law Group maintains, we have already notified sponsors if their defined contribution plans’ vesting schedules will have to be changed.  If you were not contacted and have a vesting schedule that does not provide vesting as rapidly as described above, and need our assistance or more information, please contact us as soon as possible.

75% Joint and Survivor Annuity .  All qualified retirement plans that offer annuities (e.g., 50% joint and survivor annuity) must also offer a 75% joint and survivor annuity.  Although this change is not required until the 2008 plan year, we recommend adopting an amendment in 2007 to implement this requirement effective for 2008, particularly if you wish to adopt the other changes described in this letter.

Applicable Interest Rate .  Defined benefit pension plans must be amended to comply with changes to the interest rate used to determine optional forms of benefit no later than the last day of the 2008 plan year.  For plan years beginning in 2004 and 2005, the “applicable interest rate” under the plan was fixed at 5.5%, and for plan years beginning after 2005, the interest rate is the greatest of 5.5%, the rate specified in the plan, or a third rate that falls within certain specified guidelines.  Although this change is not required until the 2008 plan year, we recommend adopting an amendment in 2007 to implement this requirement effective for 2008, particularly if you wish to adopt other changes described in this letter.

Discretionary Amendments

Distribution Explanations .  All plans must provide an explanation of distribution options available under the plan no less than 30 days or more than 90 days before the distribution is to be made.  Beginning with the 2007 plan year, this explanation may be provided up to 180 days before the distribution is to be made.  We recommend that you adopt an amendment to implement this change because it provides the plan administrator with more flexibility in delivering explanations and timing distributions.

In-Service Distributions at Age 62 .  A pension plan (i.e., defined benefit or money purchase) was not permitted under prior law to make in-service distributions to participants before the plan’s normal retirement age.  Beginning with the 2007 plan year, a pension plan can allow in-service distributions at age 62 even if this is earlier than the plan’s normal retirement age.  You should consider adopting an amendment to allow in-service distributions at age 62 if you would like to allow phased-retirement for older workers.   

Hardship Distributions .  Profit sharing and 401(k) plans, are allowed (but not required) to make hardship distributions to a participant for reasons (e.g., medical expenses) relating not only to the participant but also his or her spouse or dependents.  Now, hardship distributions are also allowed for the participant’s other named beneficiaries under the plan.  If your plan administrator has adopted this change in operation, or if you want to implement this change for the 2007 plan year, the appropriate amendment needs to be adopted by the end of the 2007 plan year.

Nonspouse Rollovers .  Under prior law, only the spouse of a deceased plan participant could roll over a death benefit into another plan or individual retirement account.  Beginning with the 2007 plan year, a plan may now allow a nonspouse beneficiary to roll over the death benefit.  Some plan sponsors may find the potential estate planning opportunities of this change desirable.

Rollover to Roth IRA .  Beginning with the 2008 plan year, a qualified plan distribution may be rolled over into a Roth IRA, subject to the same rules that apply to rollovers from a traditional IRA. Thus, for example, the rollover would be taxable (except to the extent the rollover includes after-tax contributions).  However, please note that as the law is currently written, a participant whose adjusted gross income is $100,000 or more could not take advantage of the new rollover provision for 2008 or 2009. 

Roth 401(k) Accounts .  401(k) plans have been allowed (but not required) to offer a Roth 401(k) account to participants, beginning with the 2006 plan year.  With a Roth 401(k) feature, a participant may specify that all or a portion of his or her salary deferrals and catch up contributions will be made as after-tax “designated Roth contributions.”  A distribution from a Roth 401(k) account will not be subject to income taxes when distributed if the distribution occurs at least five years after the year the participant first makes a designated Roth 401(k) contribution and the distribution is made after attainment of age 59½ or on account of disability or death. 

Automatic Enrollment Safe Harbor .  Defined contribution plans that are required to perform nondiscrimination testing of pre-tax and matching contributions may avoid such testing by adopting a new automatic enrollment safe harbor design.  The new safe harbor, which is in addition to existing safe harbors, requires compliance with minimum contribution standards.  For example, employees would be automatically enrolled for pre-tax salary reductions equal to 3% of compensation initially, which would increase annually in 1% increments to 6% of compensation.  The employer must match 100% of the first 1% of compensation contributed by the employee, plus 50% of the next 5% of compensation (i.e., 3.5% would be the maximum required match).  Other requirements also apply.  If you currently have difficulty passing nondiscrimination testing, you might consider adopting the new automatic enrollment safe harbor, and we would be happy to discuss with you other alternative safe harbor designs. 

Gap Period Income .  Defined contribution plans making corrective distributions to highly compensated employees in order to pass the nondiscrimination tests currently must include so-called “gap period income” (i.e., investment earnings on the corrective distributions from the end of the plan year until the amount is distributed).  Starting with the 2008 plan year, a plan no longer has to include gap period income with the corrective distributions.  If your plan administrator would like to take advantage of this change, your plan can be amended in 2007, effective for the 2008 plan year, to implement the change.

Comment : We realize that you may have questions after reading these brief summaries above explaining options that are available for your plan.  Please contact our office if you wish to further discuss any of these options for your plan.

B. IRS Clarifies Its Position Regarding Partial Terminations

An issue which frequently confronts employers is how to determine whether participants in a qualified retirement plan should become fully vested in the event the employer experiences a reduction in workforce or other similar event which substantially reduces plan participation.  This can occur through a divestiture (i.e., sale of a subsidiary or division), a downsizing (e.g., due to economic conditions requiring layoffs or terminations of employment), or in the normal course of people terminating employment.  The Internal Revenue Code (“Code”) provides that a plan will not retain its qualified status unless, upon a partial termination, the affected employees’ rights to benefits become fully vested to the extent then funded [1]  In the case of defined contribution plans, the amount to be vested is the amount then credited to the affected employees’ accounts. 

Partial terminations occur as a result of plan operation rather than the employer determining to terminate the plan.  According to the Code, if a sufficient number of participants terminate employment, then, with respect to these individuals, the plan would be considered to be terminated.  In such case, affected participants’ accounts would become 100% vested.  It should be noted that the partial termination of a qualified plan can also occur for reasons unrelated to turnover, such as:  plan amendments that adversely affect the rights of employees to vest in benefits, plan amendments that exclude a group of employees previously covered by the plan, or the reduction or cessation of future benefit accruals which results in a potential reversion to the employer.

In a recently released Revenue Ruling, the IRS has clarified many of the positions which have been taken over the years regarding the determination of a partial termination whether by IRS guidance or case law. [2]   In the Revenue Ruling, Employer X operated four separate business locations.  As a result of ceasing operation in one of its four business locations, 23% of the plan’s participants who were employees of Employer X severed employment and ceased participation in the plan.  It should be noted that this 23% calculation excluded any employees who severed employment due to death, disability, or normal retirement.

Relevant regulatory guidance has set forth the general principle that a partial termination is determined by the IRS based on all relevant facts and circumstances.[3]  The new Revenue Ruling cites various IRS rulings and case law as leading guidance in this area.[4]  Previous guidance focused on such issues as whether those people who were affected by the termination were already vested prior to the event and also established a “rule of thumb” 20% threshold number in determining whether the amount of terminations are significant.  The newly-issued Revenue Ruling summarizes the prior guidance by clarifying the relevant factors to be used when making the calculation.

The guidance provides that if the turnover rate is at least 20%, there is a presumption that a partial plan termination has occurred.  The turnover rate is determined by dividing (i) the number of plan participants who are terminated due to an employer-initiated severance during the time period in question, by (ii) the sum of all participants as of the start of the applicable period and employees who become participants during that time period.  Whether the applicable period is one year or more or less depends on the facts and circumstances.  For example, if the terminations of employment are part of a series of related severances from employment, then the applicable period can extend to multiple plan years based on the applicable facts.

In calculating the applicable percentage, participants whose employment is severed at the employer’s initiative are counted, including those who were vested regardless of the termination of employment event.  “Employer-initiated severance” is severance that is not on account of death, disability, or retirement.  Employer-initiated severance from employment can result even if caused by an event which is beyond the employer’s control, such as depressed economic conditions.  The employer can use relevant information such as corporate records, personnel files and related documentation to rebut the presumption that the termination of employment was employer-initiated and was voluntary.  If participants sever employment but transfer to a different controlled group member which maintains the same plan and therefore covers the terminating participant, such termination will not be considered as a severance of employment for purposes of calculating the turnover rate. 

An interesting concept discussed in this Revenue Ruling is the “routine turnover rate” of the employer.  If an employer can show that the terminations are routine for an applicable period, these terminations would not be considered employer-initiated, and therefore, would not be factored into the above calculation.  Applicable facts and circumstances to be analyzed include turnover rates for the employer in other periods, the extent to which terminated employees are replaced, whether such new employees have the same job classification, functions, or titles, and whether they receive comparable compensation as the replaced employees.  Thus, if an employer can show that certain employee terminations and replacements are actually part of typical turnover for the employer, no partial termination, and therefore, no accelerated vesting, would be required for the affected participants.

In summary, the Revenue Ruling clarifies that a turnover rate of 20% or more establishes a presumption that a partial termination has occurred.  At that point, the employer must produce facts and circumstances that would rebut the presumption in defending the position that no partial termination has occurred.  In the case discussed in the Revenue Ruling, the severances from employment occurred as a result of the shutdown of one of the employer’s locations and were not the result of routine turnover.  Further, the presumption of a 20% or more employer-initiated turnover was not rebutted.   Thus, a partial termination of the plan had occurred, requiring full vesting of the accounts of the affected participants.

C. Final Regulations Under Section 403(b) of the Internal Revenue Code

On July 26, 2007, the Internal Revenue Service published its long-awaited final regulations under Section 403(b) of the Code.  The final regulations, which were issued in proposed form in November 2004, will replace regulations issued in 1964 that have not been comprehensively revised in more than 40 years. 

The final regulations, like the proposed rules, consolidate legislative and regulatory developments over the last four decades that have significantly eroded the differences between 403(b) plans and other salary reduction arrangements such as 401(k) and 457(b) plans.  While the new regulations generally codify existing rules, they also impose new documentary requirements; eliminate good faith compliance with the statutory nondiscrimination requirements for nonelective contributions; and generally narrow the universal availability standard for elective deferrals by requiring that each employee have an effective opportunity to make deferrals and limiting some of the categories of employees that may be excluded in applying the universal availability requirement.

In conjunction with the issuance of the IRS regulations, the Department of Labor has issued Field Assistance Bulletin 2007-2 in which it discusses the impact of the IRS’s final regulations on its safe harbor regulation under which employer programs for the purchase of annuity contracts or custodial accounts funded solely through salary reduction agreements are not treated as employee pension benefit plans for purposes of Title I of the Employee Retirement Income Security Act of 1974 (“ERISA”).

The IRS’s final regulations are generally effective January 1, 2009, although deferred effective dates apply to certain church plans and 403(b) plans maintained pursuant to a collective bargaining agreement in effect on July 26, 2007. 

Statutory Background

Section 403(b) of the Code provides an exclusion from an employee’s gross income for contributions made by an eligible employer to purchase an annuity contract for the employee’s benefit.  A 403(b) plan may be funded in one of three ways:

To qualify for the exclusion from gross income provided by Section 403(b) of the Code, contributions under the 403(b) plan must be nonforfeitable, meet certain nondiscrimination requirements and be limited in amount.

403(b) vs. 401(k)

While the effect of various amendments made to Section 403(b) of the Code in the past 40 years has been to diminish the distinctions between 403(b) plans and other tax-favored employer-provided retirement plans (such as 401(k) plans and 457(b) plans for state and local government entities), the following significant differences continue to exist:

1.      403(b) plans are limited to certain employers and employees,i.e., employees of a
public school, employees of an organization exempt from tax under Section 501(c)(3) of the Code, and certain ministers. 

Plan Document Requirement

A major change effected by the final (and proposed) regulations, and consistent with the trend toward making 403(b) plans and qualified plans uniform, is the new requirement that a 403(b) plan be maintained pursuant to a written defined contribution plan which, in both form and operation, satisfies the Section 403(b) regulations.  The plan document must contain all the material terms and conditions for eligibility, benefits, applicable limitations, and the time and form under which distributions will be made.  The plan may incorporate by reference other documents, such as the insurance policy or custodial agreement, which, as a result of the reference, become part of the plan.  In the event of any conflict between the plan and documents incorporated by reference, the plan governs.  The plan document may allocate responsibility for performing administrative functions and must identify who is responsible for complying with those Code requirements, such as loans and hardship withdrawals, that apply on an aggregated basis to all contracts issued to a participant.  The IRS has stated that it expects to publish guidance that includes model plan provisions that may be used by public school employers to satisfy the written plan requirement. 

Responding to concerns that the adoption of a written plan document would jeopardize the exclusion from ERISA coverage of salary reduction-only plans under the Department of Labor’s safe harbor for Section 403(b) programs, Field Assistance Bulletin 2007-2 addresses the interaction of ERISA and the final IRS regulations.  Specifically, the Field Assistance Bulletin provides guidance (to the Employee Benefits Security Administration’s national and regional offices) on the extent to which compliance with the IRS regulations would cause employers to exceed the limitations on employer involvement permitted under the Department of Labor’s safe harbor.

According to the Department, the following activities by an employer would not cause its tax sheltered annuity program to be excluded from the safe harbor:

The Field Assistance Bulletin confirms, however, that an employer could not remain within the safe harbor if it had responsibility to make, or in fact made, discretionary determinations in administering the program, such as authorizing plan-to-plan transfers, processing distributions, satisfying joint and survivor annuity requirements, or making determinations with respect to hardship distributions, qualified domestic relations orders or eligibility for, or enforcement of, loans.

The Field Assistance Bulletin concludes that tax exempt employers will be able to comply with the new IRS 403(b) regulations while remaining within the Department of Labor’s safe harbor, although the question of whether any particular employer has established or maintains an ERISA plan as a result of complying with the IRS’s 403(b) regulations will continue to be determined on case-by-case basis.

Nondiscrimination Rules

Nonelective Contributions .  For contributions other than elective deferrals, the IRS’s final regulations replace the nondiscrimination standard that previously applied under Notice 89-23 (a reasonable, good faith interpretation of the statutory nondiscrimination rules in Section 403(b)(12) of the Code) with the same rules that apply to employer contributions to qualified plans.  As a result, contributions to a 403(b) plan, other than elective deferrals and after-tax employee contributions, must satisfy the coverage and amount testing that apply to such contributions when made under a qualified plan.  Similarly, matching and after-tax employee contributions must satisfy the actual contribution percentage test that applies to qualified plans.  A failure to satisfy these nondiscrimination requirements or the universal availability requirement described below affects all contracts issued under the plan.

Elective Deferrals; Universal Availability .  Elective deferrals under a 403(b) plan are not subject to the above nondiscrimination requirements.  Instead, there is a universal availability requirement:  if any employee of the employer is eligible to make elective deferrals, all employees must be eligible.  To be considered eligible to make an elective deferral, an employee must have an effective opportunity to make or change a deferral election at least once each plan year, as well as receive a notice of the availability of the right to make an elective deferral, the period of time during which an election to defer may be made and any other conditions on deferral elections.  Eligibility to make elective deferrals may be conditioned upon deferring more than $200 each year.  Under the final regulations, the right to make elective deferrals includes the right to designate elective deferrals as Roth contributions if any employee of the employer may elect to make designated Roth contributions.

For purposes of determining whether all employees are eligible to make elective deferrals, the following categories of employees are not taken into account:

1.      Employees who are eligible to make elective deferrals under another 403(b) plan or a 457(b) eligible governmental plan of the employer;

2.      Employees who are eligible to make a cash or deferred election under a 401(k) plan of the employer;

3.      Nonresident aliens;

4.      Students performing services for a school; and

5.      Employees who normally work less than 20 hours per week (or a lower number of hours per week specified in the plan).

Collectively bargained employees, employees who make a one-time election to participate in a governmental plan instead of a 403(b) plan, visiting professors at public schools and religious order employees who have taken a vow of poverty are not excluded under the universal availability rule, even though they had been excluded under earlier IRS guidance.  While the last three categories of employees are not excluded in the final regulations, the preamble to the regulations explain that other rules may provide relief for individuals who are under a vow of poverty and certain university professors.  Moreover, there is transition relief for all four categories of employees. 

Church Plans; Governmental Plans .  Church 403(b) plans are not subject to either the nondiscrimination rules described above or the universal availability rule.  Governmental plans are subject to the universal availability requirement and to the requirement that compensation in excess of the Code Section 401(a)(17) limit may not be taken into account, but are not subject to the other nondiscrimination rules. 

Contributions; Limits on Contributions

The Section 403(b) income exclusion applies only to amounts that do not exceed the limit on elective deferrals under Section 402(g) and the overall limit on annual additions in Section 415 of the Code.  The limit on elective deferrals, including elective deferrals under all other plans, contracts or arrangements of the employer, must be stated in the annuity contract. 

Overall Limit on Contributions .  Contributions for a participant under a 403(b) plan (nonelective employer contributions, including matching contributions, elective deferrals and after-tax employee contributions) must not exceed the overall limit on contributions under Section 415 of the Code ($45,000 for 2007).  For purposes of Section 415, a 403(b) plan is treated as a plan maintained by the employee rather than the employer (even if the 403(b) plan is established and maintained by the employee’s employer and covered by Title I of ERISA), unless the employee controls either the employer maintaining the 403(b) plan or another employer.  If the employee controls any employer, then the 403(b) plan is treated as a defined contribution plan maintained by both the controlled employer and the participant and is aggregated for purposes of Section 415 with any other defined contribution plans maintained by the controlled employer.

Example :  If a doctor is employed by (but does not control) a nonprofit hospital which is tax exempt under Section 501(c)(3) of the Code and which maintains a 403(b) plan for the doctor, and the doctor also owns more than 50% of a professional corporation by which he or she is employed, any defined contribution plan maintained by the professional corporation must be aggregated with the hospital’s 403(b) plan for purposes of Section 415.  This is the case whether the 403(b) contributions are elective deferrals by the doctor or nonelective (or matching) contributions by the hospital.

Comment :  Because of this aggregation rule, it is important that any employer contributing to a 403(b) plan for an employee obtain information from participants regarding other employers controlled by the participant and plans maintained by those controlled employers in order to monitor compliance with applicable limitations and to comply with reporting and withholding obligations.  This might best be accomplished during the open enrollment period, and an explanation of the aggregation rules should also be provided in the 403(b) plan’s summary plan description.
Catch-up contributions .  Age 50 catch-up contributions (which are not subject to the Section 415 overall limit) are permitted under 403(b) plans, as is a special catch-up election under Code Section 402(g)(7) (which is subject to Section 415) for employees who have completed 15 or more years of service with an educational organization, hospital or certain other organizations described in the regulations.  The final regulations have expanded the list of organizations whose employees qualify for this catch-up provision to include adoption agencies and agencies assisting substance abusers and the disabled.  Under the special 403(b) catch-up election, employees with the requisite number of years of service with a qualifying organization may make an additional elective deferral each year of up to $3,000.  Where an employee is eligible to make both the special 403(b) catch-up election and age 50 catch-up contributions, catch-up contributions are treated first as made under the special 403(b) catch-up election and then under the age 50 catch-up provision. 

Former Employees .  For purposes of applying the contribution limits to a 403(b) plan, a former employee is deemed to have includible compensation until the end of the fifth complete taxable year of the employee beginning after termination of employment (which could be a period approaching six years, depending upon when employment terminates).  Based upon this compensation, the employer may continue to contribute to a 403(b) plan on behalf of a former employee, subject to the Section 415 limit (either the applicable dollar limit or 100% of the former employee’s includible compensation, whichever is less).  Unlike severance payments made directly to the former employee, these contributions would not be subject to FICA taxes.  They are, however, subject to the nondiscrimination requirements applicable to nonelective employer contributions.

The final regulations also permit elective deferrals to be made from the same post-employment compensation as is permitted for 401(k) plans under the final Section 415 regulations,i.e., certain compensation paid by the later of 2-1/2 months after severance from employment or the end of the limitation year in which severance from employment occurs.  This change applies for taxable years beginning on or after July 1, 2007. 

Excess Contributions .  Any contribution made to a 403(b) plan for a year on behalf of an employee that exceeds the above limits is includible in the employee’s income for that year.  If the contribution exceeds the overall limit under Section 415 of the Code, it must be held in a separate account; if it is not, the annuity contract ceases to be a 403(b) contract.  Any excess allocated to a separate account may be distributed to the employee.  Excess deferrals may be distributed by April 15 following the taxable year in which contributed (together with allocable income).  In this case, the excess deferral is included in the employee’s income for the year of deferral and the income is included in the employee’s gross income for the year of distribution.  If distributed after April 15, there would also be a 10% penalty tax for early distribution. 

Time for Contributions .  Contributions to a 403(b) plan must be transferred to the insurance company issuing the annuity contract (or to the entity holding assets of a custodial or retirement income account treated as an annuity contract) within a period that is no longer than is reasonable for the proper administration of the plan.  A plan may require the transfer of elective deferrals within a specified period after the amounts would otherwise have been paid to the participant, such as within 15 business days following the month in which the amounts would otherwise have been paid.  If the 403(b) plan is subject to Title I of ERISA, Department of Labor regulations require elective deferrals to be transferred to the annuity contract as soon as reasonably practicable but in no event later than 15 business days following the month in which the amounts would otherwise have been paid to the employee.


When distributions may be made from a 403(b) plan depends upon the type of contribution involved and the funding medium in which it is held in the 403(b) plan. 

Amounts Not Held in a Custodial Account and Not Attributable to Elective Deferrals .  These amounts may be distributed no earlier than the first to occur of the employee’s severance from employment or the occurrence of an identified event, such as the occurrence of a financial need (including the need to buy a home), the passage of a fixed number of years, the attainment of a stated age or disability.  After-tax employee contributions (and earnings) and excess deferrals are not subject to this distribution restriction.  Nor does it apply to prevent distributions on termination of a 403(b) plan.

Amounts Held in a Custodial Account that are Not Attributable to Elective Deferrals .  These amounts may not be distributed before the employee severs from employment, dies, becomes disabled or attains age 59-1/2.  Amounts transferred from a custodial account to an annuity contract or retirement income account (in the case of a church plan), including earnings, continue to be subject to this distribution restriction.

Amounts Attributable to Elective Deferrals .  These amounts are subject to the same distribution restrictions as amounts held in a custodial account, except that they may be distributed earlier on account of the employee’s hardship.  The amount that may be distributed on account of hardship, and the circumstances that constitute a hardship, are determined in the same way as under Section 401(k) of the Code and may not exceed the employee’s aggregate elective deferrals, not including earnings.  If the 403(b) plan includes both elective deferrals and other contributions, the elective deferrals must be maintained in a separate account to be distributable on account of hardship. 

Severance from Employment .  For purposes of the distribution rules, a severance from employment occurs when an employee ceases to be an employee of the eligible employer (including other entities treated, under the rules described in Controlled Group Rules for Tax Exempt Organizations, below, as the same employer as the employer maintaining the plan) that maintains the 403(b) plan.  There is therefore no severance from employment if the employee transfers from one Section 501(c)(3) organization to another such organization that is treated as the same employer under the controlled group rules.  There is, however, a severance from employment when an employee of a Section 501(c)(3) organization transfers to another entity that is treated as the same employer but is not an eligible employer (for example, to a for-profit subsidiary of a non-profit organization) or to employment that is not employment with an eligible employer (for example, when an employee performing services for a public school continues to work for the same State employer).

Minimum Distribution .  403(b) plans are subject to the same minimum distribution rules as qualified plans, with some minor modifications.  For this purpose, they are treated as IRAs under the minimum distribution rules of Code Section 401(a)(9), except that a surviving spouse may not elect to treat a 403(b) contract as his or her own contract.

Loans .  Loans are permitted under 403(b) plans.  Whether the availability of a loan, the making of a loan or a failure to repay a loan is to be treated as a distribution depends on the facts and circumstances.

Termination of 403(b) Plan .  The final regulations permit a 403(b) plan to be terminated or amended to eliminate future contributions for existing participants or to limit participation to existing participants and employees (subject to the nondiscrimination requirements discussed above, including the universal availability rule).  On plan termination, accumulated benefits must be distributed as soon as possible, and this may be accomplished by the delivery of a fully paid individual annuity contract.  If the distribution restrictions on elective deferrals and custodial accounts described above apply to the 403(b) plan, the plan may be terminated (and accumulated benefits distributed) only if the employer (including all entities that are treated as the same employer under the controlled group rules) does not contribute to any other 403(b) plan during the period beginning on the date of plan termination and ending 12 months after the distribution of all assets from the terminated plan.  An exception applies if fewer than 2% of the employees under the terminated plan are eligible under the alternative 403(b) plan.

Qualified Domestic Relations Orders .  A distribution from a 403(b) plan pursuant to a qualified domestic relations order is permitted even if the employee from whose contract distribution is made has not had a severance from employment or other event permitting a distribution. 

Transfers .  The final regulations permit three types of transfers from annuity contracts that are not treated as distributions: 

Contract exchanges within the same plan are permitted if the 403(b) plan provides for the exchange; the employee’s accumulated benefit is not reduced by the exchange; the new contract is subject to the same (or more stringent) distribution restrictions as the exchanged contract; and the employer enters into an agreement with the issuer of the new contract under which the employer and the issuer will provide each other with certain information.

A plan-to-plan transfer is permitted if the participant or beneficiary for whom or with respect to whom the transfer is made is an employee or former employee of the employer for the receiving plan; both the transferor and transferee plan provide for transfers; the participant’s or beneficiary’s accumulated benefit is not reduced by the transfer; and the transferee plan imposes the same (or more stringent) distribution restrictions on the transferred amount and treats the amount transferred as a continuation of the participant’s or beneficiary’s interest in the transferor plan. 
Except in the case of permissive service credit, a transfer (not to be confused with a rollover, discussed immediately below) may not be made from a 403(b) plan to a qualified plan or to a 457(b) eligible governmental plan.

The changes to the rules governing contract exchanges do not apply to a contract received in an exchange that occurs before September 25, 2007, provided the exchange satisfied the IRS guidance in effect at the time of the exchange.

Rollovers .  Amounts distributed from a 403(b) plan may be rolled over, either by means of a direct rollover or within 60 days of the distribution, to an eligible retirement plan.  An eligible retirement plan includes a qualified plan, a 403(a) annuity plan, a 457(b) eligible governmental plan, an individual retirement account or annuity, and another 403(b) plan.  Amounts that are not taxable upon distribution may only be rolled over by means of a direct rollover, except where the rollover is to an IRA.   

The 403(b) plan must permit direct rollovers of eligible rollover distributions and the payor must provide the distributee with a notice of rollover rights under Section 402(f) of the Code.  The 20% income tax withholding on eligible rollover distributions that are not directly rolled over applies to distributions from a 403(b) plan, as does the automatic rollover requirement of Code Section 401(a)(31) for mandatory distributions where the distributee does not affirmatively elect a direct rollover or a distribution. 

Effect of Failure to Satisfy Section 403(b)

The effect of failing to satisfy the requirements of the regulations varies with the type of failure.  If there is a failure that relates to the annuity contract of one individual only (for example, an excess contribution), since all annuity contacts purchased for an individual by an employer are treated as a single contract, any other contract purchased for that individual by that employer will also be treated as failing to satisfy Section 403(b) of the Code.  Other individuals covered by the 403(b) plan are not affected.

A failure to operate in accordance with the terms of the 403(b) plan affects all of the contracts issued to the employee or employees with respect to whom the operational failure occurs.  It does not affect other individuals covered by the 403(b) plan unless the operational failure involves noncompliance with the discrimination requirements or the employer is not an employer eligible to maintain a 403(b) plan.  If the nondiscrimination requirements are not met, the employer is not an eligible employer or there is no written plan, all contracts issued under the plan fail to be Section 403(b) annuity contracts, and all contributions and earnings would be taxable to employees.

Controlled Group Rules for Tax Exempt Organizations

The employer for a plan maintained by a tax exempt organization includes the organization whose employees participate in the plan and other organizations with which it is under common control.  The common control rules must be considered when applying the nondiscrimination requirements, the overall limit on benefits and contributions under Section 415 of the Code and the minimum distribution rules under Section 401(a)(9) of the Code.  While the controlled group rules generally do not apply to church entities or governmental entities (such as public schools), they apply for purposes beyond Section 403(b) of the Code including for purposes of the qualification rules relating to Section 401(a) plans.

Common control generally exists between two exempt organizations if at least 80% of the directors or trustees of one organization are representatives of, or directly or indirectly controlled by, the other organization.  A trustee or director is a representative of another organization if he or she is a trustee, director, agent or employee of the other organization.  A trustee or director is controlled by another organization if that other organization has the general power to remove the trustee or director and designate a new trustee or director.

In addition to mandatory aggregation of exempt organizations, the regulations permit exempt organizations that maintain a single plan covering one or more employees of each organization to treat themselves as under common control if each organization regularly coordinates its day-to-day activities with the other.  As an example, emergency relief organizations operating within different geographic regions may treat themselves as under common control if they have a single plan covering employees of both entities and regularly coordinate their day-to-day exempt activities.  Similarly, an exempt hospital and another exempt organization with which it coordinates the delivery of medical services or medical research may treat themselves as under common control in an appropriate case.  The final regulations authorize the IRS to issue further rules or rulings permitting permissive aggregation of tax exempt entities.  Permissive disaggregation is permitted between churches and entities that are not churches that jointly contribute to a church plan.  Finally, the regulations authorize the IRS to treat an entity (including a taxable entity) as being under common control with an exempt organization if the entities are structured to avoid or evade the common control rules or other requirements under Sections 401(a), 403(b) or 457(b) of the Code. 

Effective Dates

The final regulations are generally applicable for taxable years beginning after December 31, 2008.

Collective Bargaining Agreements .  If a 403(b) plan is maintained under one or more collective bargaining agreements in effect on July 26, 2007, the regulations do not apply before the earlier of the date on which the last collective bargaining agreement terminates or July 26, 2010. 

Church-Related Organizations .  If authority to amend a 403(b) plan is held by a church convention, the regulations do not apply until the first plan year beginning after December 31, 2009.

Transition Rules .  The universal availability rule does not apply to plans that exclude certain categories of employees on July 26, 2007, until the first taxable year beginning after December 31, 2009.  The excluded categories of employees are those who make a one-time election to participate in a governmental plan, certain visiting professors and religious order employees who have taken a vow of poverty.  Where collectively bargained employees are excluded from eligibility to make elective deferrals, the universal availability rule does not apply until the first taxable year beginning after December 31, 2008, or, if later, the first to occur of the date on which the collective bargaining agreement terminates or July 26, 2010.

Governmental Plans .  Governmental plans that exclude the categories of employees mentioned above have until January 1, 2011, or the earlier close of the first post-2008 legislative session of the body with authority to amend the plan. 

In-Service Distributions .  The prohibition on in-service distributions of nonelective contributions from annuity contracts does not apply to contracts issued before January 1, 2009, and any amendment to a 403(b) plan to eliminate in-service distributions is not subject to the anti-cutback rules if adopted before January 1, 2009. 

Designated Roth Contributions .  The provisions of the regulations addressing Roth contributions are effective for taxable years beginning after 2006.

Special Rules for Certain Contracts .  The final regulations limit the types of contracts that qualify as an annuity contract.  For example, life insurance, endowment and health or accident insurance contracts do not qualify.  This new rule does not apply to a contract issued before September 24, 2007.

D. Internal Revenue Code Section 415 Issues

IRS Issues Final Regulations on Maximum Retirement Plan Contributions and Benefits Following last year’s proposals, the IRS has issued final regulations under Internal Revenue Code Section 415.  This Code section limits contributions to 401(k) and other defined contribution (“DC”) plans to the lesser of 100% of compensation or a prescribed dollar amount ( e.g. , $45,000 is the DC dollar limit for 2007).  It also limits pension benefits from defined benefit (“DB”) plans to the lesser of 100% of average compensation for a participant’s high three years or a dollar amount ( e.g. , $180,000 is the DB dollar limit in 2007).  In this Newsletter, we focus on several of the more significant provisions in the Section 415 regulations. 

Severance Pay .  Compensation received by a DC plan participant after employment termination is generally not considered compensation for Section 415 purposes. This general rule effectively prevents contributions to DC plans on behalf of plan participants who are no longer employed.  In the past, Congress created narrow exceptions to the general rule for participants who were disabled or serving in the military.  The final Section 415 regulations provide two broader exceptions.  A DC plan can now recognize as compensation for Section 415 purposes:


Interaction with Compensation Limit .  Unlike the old Section 415 regulations, the new regulations apply the Section 401(a)(17) compensation limit.  Thus, for 2007, compensation in excess of $225,000 (the Section 401(a)(17) limit) would be disregarded.  This change does not apply retroactively.  In addition, the final Section 415 regulations include a grandfather provision that allows a DB plan to provide that compensation in excess of the Section 401(a)(17) compensation limit can be used for benefits accrued or payable as of the limitation year that ends prior to April 5, 2007.  To allay concerns of DC plan administrators, the preamble to the final Section 415 regulations states that a plan is not required to determine a participant’s compensation using the earliest payments during a year.  Thus, a highly compensated employee who earned more than the Section 401(a)(17) limit early in the year, but did not make contributions, can still make contributions later in the year on compensation up to the Section 401(a)(17) limit.

Foreign Compensation .  The final Section 415 regulations clarify that compensation paid to a nonresident alien with no U.S.-source income is still compensation for Section 415 purposes.  For employers whose DC plans cover nonresident aliens without U.S.-source income, the clarification means contributions can be made to DC plans for foreign workers based on their foreign compensation.

Restorative Payments .  To compensate a plan for losses resulting from errors or omissions creating a reasonable risk of liability for a breach of fiduciary duty under ERISA, restorative payments can be made without regard to the Section 415 limits.  The final Section 415 regulations emphasize that this treatment applies only if the restorative payments are made to all similarly-situated participants adversely affected by the error or omission. 

Effective Date .  The final Section 415 regulations generally apply to limitation years beginning on or after July 1, 2007.  For employers whose plans use the calendar year for both the plan year and the limitation year, the regulations will generally apply beginning January 1, 2008. 


After more than two years of interim guidance and transition rules, IRS has finally set December 31, 2008, as the firm and final deadline for employers to amend their nonqualified deferred compensation plans to comply with Internal Revenue Code Section 409A.  Well before then, however, employers will need to make decisions affecting the design and administration of their 409A plans.  In addition, employers must designate in writing in 2007 a time and form of payment that complies with Section 409A for unpaid pre-2008 deferrals as well as 2008 deferrals.

Also in 2007, deferred compensation payment decisions need to be made under favorable transition rules in the recently issued final Section 409A regulations.  In this summary, we explain the background to Section 409A, provide an overview of the final regulations, and identify action steps that should be taken before the end of 2007.


Qualified Plans v 409A Plans .  A 409A plan includes any arrangement that enables an employee to defer receiving compensation to be earned until a subsequent year and thus delay taxation on the deferred compensation.  Although Section 409A covers a broad array of arrangements, it does not apply to tax-qualified retirement plans ( e.g ., 401(k) plans), 403(b) plans, 457(b) plans, or similar tax-favored plans, even though these plans also delay taxation on the compensation deferred thereunder.  The key differences between tax-favored plans and typical 409A plans include:

Tax-Favored Plans

409A Plans

  • Qualification rules prohibit discrimination in favor of the highly compensated and limit tax advantages even if the plan does not discriminate.


  • Nondiscrimination rules and most other limits do not apply.
  • ERISA minimum standards for eligibility, participation, vesting, funding, etc. apply.


  • ERISA minimum standards do not apply.


  • Plans must be funded (except non-governmental 457(b) plans).


  • Plan must be unfunded.
  • For-profit employer is allowed a tax deduction when contributions are made to the plan.
  • Employer tax deduction delayed until employee is taxed on deferred compensation.


  • Employee’s deferred compensation is not taxed until payment.
  • Employee’s deferred compensation is not taxed until payment or “constructive receipt.”[5]
Pre-Section 409A Plan Design Practices .  Before Section 409A was enacted, tax practitioners had developed several techniques to soften the harder edges of the deferred compensation taxation rules.  After their initial compensation deferral elections, employees could subsequently delay taxation again by making a subsequent payment deferral election before their deferred compensation was otherwise payable.  Employees could easily accelerate receiving their deferred compensation without concerns about “constructive receipt,” if the nonqualified deferred compensation plan imposed a “haircut” ( i.e. , the employee forfeited a small portion of the deferred compensation upon accessing it).  Employees with unfunded deferred compensation could reduce the risk of losing their deferred compensation upon their employer’s bankruptcy if the plan included financial triggers that caused the deferred compensation to be paid as the employer approached bankruptcy.   

Key Concepts in Section 409A Rules .  The American Jobs Protection Act of 2004 added Section 409A to the Internal Revenue Code to regulate compensation deferral and payment elections.  The new Section 409A rules essentially bar employees from accelerating the payment of deferred compensation.  They also restrict the timing of initial compensation deferral elections and subsequent payment deferral elections.  The penalties for not complying with these rules are severe.  Noncompliance will cause an employee’s deferred compensation (and related investment earnings) to become taxable and subject to a 20% additional tax penalty with a possible assessment of interest.   

2007 Action Steps

On September 10, 2007, the IRS issued Notice 2007-78 to extend until the end of 2008 the deadline to make certain amendments to nonqualified deferred compensation plans in order to bring them into compliance with Code Section 409A.  However, the extension is subject to two major limitations.  First, 409A plans still must be amended before the end of 2007 if they do not include at least one time and form of payment provision that complies with Section 409A.  Second, in a departure from its previous practice when extending the documentary deadline, IRS has not extended the current good-faith reliance period or transition rules.  In the Notice, IRS also announced its intention to establish a voluntary compliance program that will enable employers to correct unintentional failures to comply with Section 409A in operation.

Effective Date .  The final Section 409A regulations are effective January 1, 2008.  Plans must operate in “good faith compliance” with Section 409A and interim guidance from January 1, 2005, through December 31, 2007.  As noted above, IRS has not extended the current good-faith reliance period.  That means plans must be operated in accordance with the final regulations starting in 2008.

2008 Plan Amendment Deadline .  Plan documents must be amended to comply with Section 409A on or before December 31, 2008.  Amendments must be made retroactively effective as of January 1, 2008. Written plan documents, at a minimum, must include:

The minimum content need not be included in one document. For example, compensation deferral election and payment deferral election forms may be separate from the plan design document. 

2007 Written Designation Requirement .  Even though plans need not be amended before the end of 2008, they must designate in writing in 2007 a time and form of payment that complies with Section 409A for unpaid pre-2008 deferrals as well as 2008 deferrals.  Plans and participant elections should be reviewed to determine whether at least one of the payment events specified in the plan adequately complies with Section 409A.  Because the plan amendment deadline has generally been extended until the end of 2008, employers can adopt a separate written document in 2007 to satisfy the interim written designation requirement.        

Transition Payment Elections .  A 409A plan may allow employees to revise elections as to the time or form of payment of previously deferred compensation, if the revised elections:

IRS has not extended this transition rule.  Employees who fail to change their time and form of payment elections in 2007 will generally be able to do so in 2008 or later only if they comply with the re-deferral rules in the final regulations.  An employer need not amend its plan retroactively to reflect actions taken during the transition period ( i.e. , January 1, 2005 to December 31, 2007), or amend or adopt a written plan document with regard to deferred compensation already paid.

Grandfathered Plans .  Compensation earned and vested under a nonqualified deferred compensation plan in effect on October 3, 2004, need not comply with Section 409A.  However, if these grandfathered plans are materially modified after October 3, 2004, they become subject to Section 409A.

Voluntary Correction Program .  To avoid adverse tax consequences under Section 409A, the voluntary compliance program would permit unintentional operational failures to be corrected, but only in the year in which they occur.  Later correction would result in limited amounts becoming includible in income and subject to additional taxes under Section 409A.

Section 409A Overview

Compensation Deferral Elections .  An employee generally must make a compensation deferral election prior to the year in which the compensation is earned.  For example, deferral elections for compensation to be earned in 2008 must be made by December 31, 2007.  However, there are many exceptions to the general rule, including the key exceptions described below.

Newly Eligible Participants .  Employees newly eligible to participate in a 409A plan can make their initial compensation deferral elections within 30 days of becoming eligible.  However, the deferral election will apply only to compensation earned after the election.

Performance-Based Compensation .  Deferral elections for performance-based compensation can be made as late as six months before the end of the performance period.  However, the performance period must be at least 12 months.  The amount or payment of the compensation must be contingent upon the satisfaction of the performance-based objectives ( e.g. , bonus tied to achieving sales targets for a year) established at the beginning of the performance period.  Also, whether the objectives would be achieved must be substantially uncertain when they are established.   
Ad Hoc Bonuses .  An employee may elect to defer an ad hoc bonus if:


Excess Plans .  Excess plans typically provide benefits based on a formula in a qualified plan that produces benefits that exceed the plan qualification limits designed to restrict benefits for the highly compensated employees.  Accruing benefits under excess plans is usually automatic.  The design of an excess plan may or may not allow an employee to chose the time and form of payment.     

The final regulations allow an excess plan to permit employees accruing a benefit to elect the time and form of payment within the first 30 days of the plan year following the year during which they first accrue a benefit.  The election applies to benefits that were accrued in the prior plan year as well as those that accrue after the payment election.  For purposes of this rule, however, all excess benefit plans are aggregated.  Thus, if an employee participates in an excess 401(k) plan, the employee cannot rely on the 30-day special election rule if the employee later accrues a benefit under another excess pension plan.  When an employee first accrues a benefit under any excess plan, the employee should make payment elections for all excess plans under which the employee may accrue a benefit. 


Payment Elections .  When employees make compensation deferral elections under a 409A plan, they must also elect the time and form of payment.  Alternatively, the plan must specify the time and form of payment.  A 409A plan may allow for payment no earlier than one of the following events:

In certain circumstances, different forms of payment can be elected for different types of payment events.  For example, a participant can elect to receive a lump sum payment at disability and installment payments at separation from service.

Anti-Acceleration Rule .  Once an employee or the 409A plan has specified when the deferred compensation will be paid, the payment of the deferred compensation payment cannot be accelerated.[8]  For example, the Section 409A regulations would treat the payment of a bonus simultaneously with the employee’s relinquishment of an equivalent amount of deferred compensation under the 409A plan as a prohibited acceleration.  Similarly, granting a loan to an employee that is secured by an offset under the 409A plan would also violate the anti-acceleration rule. 

Beneficiary Payment Elections .  The time and form of payment election for death or survivor benefits payable to a beneficiary must generally be made at the same time as the employee's payment election ( e.g ., whether the employee’s beneficiary will receive a lump sum or an annuity).  However, the Section 409A regulations allow an employee to subsequently change beneficiaries so long as the change does not affect the time or form of payment. 

Payment Deferral Elections .  Changes in payment options must be made at least 12 months prior to the first payment and postpone the first payment a minimum of five years.  For example, suppose an employee initially elects to receive deferred compensation in a lump sum at age 65 but now wants to change to installment payments.  The employee must make the payment deferral election by age 64 and cannot receive the first installment payment until age 70.

A change in the form of a payment from one type of life annuity to another life annuity with the same date for the first annuity payment is not considered a change in the time and form of payment if the annuities are actuarially equivalent. Generally, certain features ( e.g ., cash refund) are disregarded in determining whether the annuity is a life annuity but not in determining actuarial equivalence.  However, the value of a joint and survivor annuity subsidy may be disregarded in determining actuarial equivalence if the amount of annuity, both before and after the first death, does not exceed the amount that would be paid under a single life annuity. 

409A Plan Coordination with Qualified Plans .   409A plans are frequently linked to qualified plans.  The final regulations continue to allow some coordination but restrict current practices, particularly in the area of the time and form of payment under the 409A plan. 

Payment Linkage .  Until December 31, 2007, a 409A plan can continue to piggyback on the time and form of payment elections that an employee has made under a qualified plan. As of January 1, 2008, however, direct linkage of the time and form of payments between a qualified plan and a 409A plan is no longer permitted. 

Amount Linkage .  An employee can increase or decrease elective deferrals (and other employee pre-tax contributions) under qualified plans up to the 401(k) salary reduction limit ($15,500 for 2007, plus where applicable the catch-up limit) without regard to the Section 409A rules.  However, elective deferrals (or other pre-tax contributions) made under a qualified plan that cause decreases or increases in the amount of deferred compensation under a 409A plan in excess of the salary reduction limit must conform to the Section 409A compensation deferral and anti-acceleration rules.

Funding Restrictions .  An employer maintaining a 409A plan cannot fund the 409A plan for the top five officers (or certain other key employees) while any qualified defined benefit plan is in “at-risk” status because it is poorly funded or while the employer is in bankruptcy.  The funding restriction also applies six months before or after an underfunded qualified defined benefit plan is terminated.  The 409A plan funding restriction applies even to amounts set aside in a so-called “rabbi trust” whose assets remain subject to the employer’s creditors in bankruptcy.

Plan Terminations .  Employers can terminate a 409A plan without adverse tax consequences under Section 409A if:

Split Dollar Illustration .  An equity split-dollar arrangement is subject to Section 409A if the employee earns a right to cash value that is payable in a later year.  However, the Section 409A compensation deferral election rules are usually not relevant because employers typically make nonelective premium payments to the insurer.  On the other hand, the Section 409A anti-acceleration rule and the restrictions on changing the time and form of payment could come into play.  For example, the anti-acceleration rule could be problematic if an employee could borrow the cash value from the insurance policy before employment termination.

Section 409A Exceptions

As suggested by the split dollar illustration, the Section 409A definition of nonqualified deferred compensation is broad and captures many arrangements that, until recently, were not considered to constitute nonqualified deferred compensation.  To provide relief, Section 409A regulations create exceptions for many arrangements, although the exceptions are frequently packaged with their own restrictions.  Several of the more noteworthy exceptions are described below.

Short-Term Deferral Exception .  The Section 409A regulations carve out an exception for deferred compensation that is paid within 2 ½ months after the employee’s or employer’s tax year in which the deferred compensation is earned or, if later, becomes vested.  This is known as the “short-term deferral exception.”     

Severance Pay .  Section 409A does not apply to severance pay (called “separation pay” in the Section 409A regulations) if certain conditions are satisfied, including:

Restricted Stock .  An employee who receives restricted property ( e.g. , employer stock) in connection with the performance of services is not subject to Section 409A, even if taxation is deferred under Section 83.  Generally, the value of restricted stock is not included in an employee’s gross income under Section 83 so long as the restrictions make the stock subject to a substantial risk of forfeiture. 

Stock Options .  Section 409A does not apply to options granted under an employee stock purchase plan or incentive stock options ( i.e. , statutory stock options).  Nonstatutory stock options and stock appreciation rights also are not subject to Section 409A if they are granted or are awarded at fair market value and if there is no additional tax deferral feature after employees exercise them.  However, extending the exercise period for terminated employees will not be treated as an additional deferral feature if the extension does not exceed the original exercise period or, if less, 10 years from the date of grant.  For publicly-traded companies, fair market value must generally be based on market prices in actual transactions.  For non-publicly traded companies, a valuation expert must determine the fair market value taking into account all available relevant information, including the present value of anticipated future cash flows, recent arm’s length transactions in the stock, control premiums, and discounts for lack of marketability. 


A. Massachusetts Health Care Reform Act – What Do You Have To Do Next

The major provisions of the Massachusetts Health Care Reform Act (the “Act”) went into effect on July 1, 2007.  By that time, the state agencies had issued regulations and other forms of guidance for the many of the Act’s major provisions.  However, because much of this guidance contains transitional rules and delayed deadlines of various duration, employers should currently be assessing whether they are meeting the current compliance requirements as well as determining how they will comply with those requirements that will take effect in the near future.

Premium Conversion Plans

Under the Act, employers doing business in Massachusetts with 11 or more full-time equivalent employees had to adopt a cafeteria (a/k/a, Section 125 or premium conversion) plan or plans, by July 1, 2007, that allows employees to pay their share of health care premiums with pre-tax dollars.  The cafeteria plan must meet the federal requirements of the Internal Revenue Code and IRS proposed regulations as well as those rules established by the state agency called the Commonwealth Health Insurance Connector Authority (the “Connector”).  If an employer fails to meet the premium conversion plan requirement, it will be subject to the Free Rider Surcharge if five or more of its employees or their dependents use state-funded health care during a year or if one of its employees, or his or her dependent uses state-funded health care more than three times in a year.

The Act requires all cafeteria plans to be submitted to the Commonwealth.  However, the Connector has issued an Administrative Information Bulletin which provides that employers will not be required to submit cafeteria plan documents under the Massachusetts Health Care Reform Act unless specifically requested to do so by the Connector.  When such a request is made, the employer will have seven business days in which to submit the document.  The Connector had previously stated that all cafeteria plans had to be filed by October 1.

The Connector has interpreted its own regulations to say that each employee (other than those who can be excluded under the Connector’s regulations, such as employees who work less than 64 hours per month) must be offered access to the employer’s group health plan, or some other health care coverage option, using pre-tax contributions paid through a cafeteria plan.  For most employees, the primary option would be pre-tax contributions to the employer’s regular group health plan.  However, for employees who are not eligible for the employer’s plan, the option could be a health care program selected by the employee from the Connector’s Commonwealth Choice programs.

Although the alternative coverage to the employer’s own health care plan would not have to be the Connector’s programs, there are, as the Connector notes, “several advantages in doing so”.  These include:

The Connector has released the “Commonwealth Choice Voluntary Plan Employer Guide” (the “Guide”) which describes the steps that must be taken by employers and employees to allow employees to make pre-tax contributions to the Commonwealth Choice Program.  The Guide may be accessed through:
menuitem.26c01aac2120f4ce505da95c0ce08041/ .  According to the Guide, the employer must (i) establish a cafeteria plan; (ii) set up an account with the Connector by providing company information, signing a Terms and Conditions Agreement and submitting a census of employees who are eligible to participate in the Commonwealth Choice Program; and (iii) describe the cafeteria plan to eligible employees and give employees the Employer ID number assigned by the Connector.  Each eligible employee can then: (i) shop for Commonwealth Choice coverage during the cafeteria plan’s enrollment period; (ii) use the Employer ID number to enroll in the coverage of his or her choice; and (iii) sign and submit an Employee Terms and Conditions Agreement.

An employer should not set up an account with the Connector until it has at least one employee eligible for coverage under the Commonwealth Choice Program and therefore entitled to pay premiums through the employer’s cafeteria plan.  For example, if all employees of an employer are eligible for coverage under the employer’s regular group health care plan, that employer should not establish an account with the Connector.

The employer will receive monthly invoices from the Connector based on employee elections.  The Guide notes, however, that coverage generally will not be effective until the first day of the second month following the date of the first invoice on which the employee’s name appears.  For example, an employee who enrolls by October 10 and appears on an employer’s October 15 invoice will typically not be covered until December 1.  Prior to that time employees will have the option of purchasing coverage directly from the Connector on an after-tax basis.

On August 6, 2007, the IRS issued a new set of proposed regulations for cafeteria plans.  The new proposed regulations, which may be relied upon immediately, specifically permit a cafeteria plan (but not a health care FSA) to pay or reimburse individual health insurance premiums and provide that these reimbursements are excluded from the employees’ gross income.  Because the Commonwealth Choice program offers individual health insurance, salary deduction contributions used to pay for insurance offered through the Commonwealth Choice program are now exempt from both federal and state income tax.

There are a number of other issues employers must address.  Specifically, employers should be aware of the two most significant issues which are described below:  

1. Eligibility .  The rules regarding eligibility for the Connector programs are complicated and, in many respects, unclear.  The Connector’s website states that all residents of Massachusetts and those employed by Massachusetts employers and who are 19 or older are eligible for the Connector programs.  However, the Act restricts eligibility to those individuals who are residents of Massachusetts if the individual is not offered subsidized health insurance by an employer with more than 50 employees.  In light of this discrepancy, we recommend that employers do not respond to any questions regarding eligibility for the Connector programs.  Rather, we recommend, that the employer suggest that the employee contact the Connector directly at 1-877-MA-ENROLL (1-877-623-6765) or at hichomepage& L=1& L0=Home& sid=Qhic.

2. Mid-year Elections .  Under the federal cafeteria plan rules, employees cannot make mid-year changes to cafeteria plan salary reduction elections unless there has been a “status change event” such as the birth of a child, a spouse’s open enrollment, or a curtailment of health care coverage.  Under these rules, an employee who terminates employment but returns within 30 days must have his old election reinstated.  Therefore, an employee who elected not to make pre-tax contributions and who left the job for fewer than 30 days would be bound by his election under federal law.  However, under the Connector’s rules, this individual would be required to be given the opportunity to elect pre-tax contributions. 

Therefore, because of these discrepancies, employers should follow the Connector’s rules in a stand-alone Connector payroll deduction plan but make no changes to the operation of their regular cafeteria plan for employees covered by their group health plan.

Fair Share Contribution Test

Massachusetts employers with 11 or more employees that fail to make a “fair and reasonable” contribution toward the cost of health coverage must pay an annual “Fair Share Contribution” not to exceed $295 per employee.  To be exempt from the requirement to pay a Fair Share Contribution, the employer must pass one of the following two tests:

The Fair Share rules were effective October 1, 2006, and the initial reporting obligation is for the determination period ending on September 30, 2007.  In accordance with the final regulations, each employer will have to file or make available information that will enable the Division of Unemployment Assistance (“DUA”) to calculate the Fair Share Contribution.

Employers will have to demonstrate that they have met the Fair Share Contribution tests by filing a report with the DUA by November 15 of each year.  The DUA is developing a web-based, on-line application for the employer to file the report and will not employ a paper filing method.  Some employers who use payroll services may wish to obtain payroll information from their payroll services, such as the number of payroll hours for particular employees during the 12-month determination period.

Health Insurance Responsibility Disclosure (“HIRD”) Information

In addition to the cafeteria plan and Fair Share Contribution requirements imposed on employers under the Act, employers with 11 or more full time employee equivalents, doing business in Massachusetts must file information about the health coverage they provide to their employees with the DUA.

The Massachusetts Division of Health Care Finance & Policy (the “Division”) has issued regulations on the requirements for Employer and Employee Health Insurance Responsibility Disclosure (“HIRD”).  The DUA will be receiving the Employer HIRD information as well as information demonstrating that an employer is meeting the Fair Share Contribution requirement.  Therefore, DUA has announced it will combine the HIRD filing requirement with the Fair Share Contribution filing requirement, making it possible for employers to satisfy the two required reports in one on-line filing.  As noted above, DUA is developing a web-based, on-line form for employers to use and will notify employers about the method of submitting the Employer HIRD information at a later date.

Employer HIRD

The Division has issued a list of information that must be submitted to satisfy the Employer HIRD requirement, which is to reflect the employer’s situation as of July 1.  At this
time, employers should ascertain the administrative procedures that will be required to obtain this information.  The list includes:

- the contribution percentage for each employee category if the percentage varies by category
- the total monthly premium cost for the lowest priced health insurance offered for an individual and for a family, and
- the total monthly premium cost for the highest priced health insurance offered for an individual and for a family.

Employee HIRD

Each Massachusetts employer required to file Employer HIRD information also must collect signed Employee HIRD Forms from each employee who is employed at a Massachusetts location and who declines :

Under the regulations, employers must obtain signed Employee HIRD Forms within 30 days after the close of the open enrollment period for the employer’s health insurance and/or its premium conversion plan, or if earlier, September 30 of the year to which the open enrollment election applies.  For new hires, the Employee HIRD Form must be signed within 30 days of their open enrollment period.  If an employee terminates participation under the employer’s plan, the employee must sign the HIRD Form within 30 days of the date of participation termination.  However, under a transitional rule, if an employer’s open enrollment period for 2007-2008 ended prior to July 1, 2007, and an employee has signed an employer form acknowledging he or she was offered, and declined, employer sponsored coverage, that employee is not required to sign an Employee HIRD form until after the next applicable open enrollment period occurring after June 30, 2007.

The regulations contain a model Employee HIRD Form at  However an employer may collect the required information and acknowledgements “in any form or manner, including any electronic or other media that it deems necessary or appropriate.”

If an employee fails to return the signed form, the employer must document its diligent efforts to obtain the signed Employee HIRD Form and maintain the documentation for three years.  The Employee HIRD Forms must be made available to the Division upon request. 

Again, employers should, at this time, determine what administrative procedures will be required to meet the Employee HIRD requirements.

The regulations require the following:

- Employee name;
- Employer name;
- Whether the employee was informed about the employer's premium conversion plan;
- Whether the employee declined to use the employer's premium conversion plan to pay for health insurance;
- Whether the employee was offered employer subsidized health insurance;
- Whether the employee declined to enroll in employer subsidized health insurance;
- If the employee declined employer-subsidized health insurance, the dollar amount of employee’s portion of the monthly premium cost of the least expensive individual health plan offered by the employer to the employee;
- Whether the employee has alternative insurance coverage; and
- The date the employee completes and signs the HIRD form.

- that he or she has declined to enroll in employer-sponsored insurance, and/or has declined to use the employer's premium conversion plan to pay for health insurance;
- that if he or she declines an employer offer of subsidized health insurance, he or she may be liable for his or her health care costs;
- that he or she is aware of the individual health insurance mandate and the penalties for failure to comply with the individual mandate; and
- that he or she is required to maintain a copy of the signed HIRD Form and that the HIRD Form contains information that must be reported in the employee's Massachusetts tax return. 


Under the Act, effective July 1, 2007, a group health insurance policy or contract (including HMOs, but excluding stand-alone dental plan arrangements) cannot be issued or delivered in Massachusetts unless the employer offers the insurance to all full-time employees who live in the Commonwealth.  In addition, the employer cannot contribute a smaller percentage of the insurance premium for one employee than it does for another employee who receives an equal or greater salary.  The Massachusetts Division of Insurance has issued a Bulletin providing guidance on this provision of the law.  These provisions do not apply to self-insured group health plans or policies entered into before July 1, 2007.

The guidance defines full-time employees to mean employees who work at least 35 hours per week and who are expected to work more than 12 consecutive weeks.  It also states that the non-discrimination requirement is met if the employer contributes either a fixed percentage or a fixed dollar amount for all full-time employees.  However, the employer may contribute different amounts for different plan options ( e.g ., if the employer has an indemnity and HMO options or offers individual and family coverage).  The rules also say an employer can have different contribution levels based on length of service or for employees who participate in wellness programs.

Finally, the guidance notes that an insurer is not obligated to actively monitor “whether employers’ practices change during a contract period”.

Employers should, at this time, assess the effect, if any, that these new non-discrimination rules will have on their group health plan’s eligibility and enrollment rules.

Dependent Coverage

Under the Act, a dependent must be covered under a group health insurance contract for two years after the “loss of dependent status” or until age 26, whichever comes first.  This requirement does not apply to self-insured group health plans.

The Division of Insurance has issued a Bulletin which clarifies that the “loss of dependent status” occurs on January 1 of the first year for which the individual can no longer be claimed as a dependent on the employee’s (or in some cases employee’s spouse’s) federal tax return for that year. For example, a dependent who permanently leaves home on November 1, 2006, can still be claimed as a dependent on the employee’s Form 1040 for 2006 but not for 2007.  Therefore, for purposes of the Act, the loss of dependent status would begin on January 1, 2007.

The Bulletin also discusses the relationship between the extended coverage under the Act and both state and federal COBRA.  (The state law applies to employers with 2 to 19 employees, COBRA to those with 20 or more.)  Surprisingly, the Bulletin says that for both federal and state law “the qualifying event will be the earlier of the 26th birthday or the date two years after the loss of continuation dependent status.”  This means that, according to the state, some people will be entitled to five years of continuation coverage (two years under Act’s dependent coverage provision and 36 months under federal or state COBRA).  However, while this part of the Notice may apply to state law, the state has no jurisdiction to rule on the application of federal COBRA.  Only the IRS is authorized to make such a determination.

There does not appear to be any requirement that the employer continue to make contributions for these former dependents.  Thus, if a plan so provides, the former dependent child may have to pay the entire cost of coverage.  However, if an employer does provide a contribution for individuals who are no longer dependents as defined under the Internal Revenue Code, the amount of the contribution will be considered imputed income for the employee under both federal and state income tax law.

The IRS has never ruled on how these subsidies should be valued.  However, in instances such as this, the IRS will generally accept any reasonable method of valuation.  For example, if an employer has domestic partners in its plan, it may want to use the same method for valuing subsidized health care coverage as is used for them.  If not, an employer could use the COBRA rates, but many employers are hesitant to do so because they think the rates are too high for imputed income.  Often, employers simply ask their insurer or HMO for an appropriate value.  While all these methods of valuing the former dependent’s health care coverage may be acceptable, none have official IRS approval.

Therefore, at this time, employers should determine whether they will continue to make contributions on behalf of children who remain covered under the group health plan but no longer qualify as dependents under income tax law.  If an employer decides to continue contributions on behalf of these children, the employer must also determine the method it will use to calculate imputed income to the employee.


In order to make a smooth transition into full compliance with the Massachusetts Health Care Reform Act, employers should anticipate their future need to access the information that will be required under the Act and to develop procedures that will enable them to gather and process this information with a minimum of administrative effort.  Employers must also assess how they will respond to the new mandates for insured benefits and determine whether they will follow these rules for their own self-funded coverage.

The Act was written in an effort to extend health coverage to the majority of Massachusetts residents.  However, the Act is quite extensive and there are many questions that still remain to be answered and compliance decisions that must be made.  Naturally, The Wagner Law Group will be glad to help you in your efforts to understand, and comply, with the various aspects of this very complicated new law.

B. New Regulations under Internal Revenue Code Section 125 Affecting Cafeteria Plans

New Cafeteria Plan Regulations Issued by IRS

IRS has withdrawn all prior proposed regulations on cafeteria plans (some going back as far as 1984) and introduced new, comprehensive proposed regulations on most aspects of cafeteria plan compliance other than mid-year election changes (which were covered by final regulations several years ago).  The proposed regulations are to be effective for plan years beginning on or after January 1, 2009, but may be relied upon effective immediately. 

The new proposed regulations incorporate much of the older proposals and subsequent guidance from IRS, but also contain some new and significant items.

To begin with, the new proposal states that a cafeteria plan is the only method of electing between taxable benefits and qualified nontaxable benefits without incurring adverse tax consequences.  Under the proposal, a cafeteria plan is a written plan which must include:

Comment :  Plans drafted by The Wagner Law Group already comply with the requirements described above for a written plan document.

Proposed regulations clearly state that plan amendments may be adopted at any time during the plan year, but an amendment may only be effective for periods after the later of the adoption date or the effective date of the amendment ( i.e. , they must be effective prospectively).  As a result, employers will need to take greater care when they make changes to their welfare benefit plans that affect their cafeteria plans.

Comment :  Please note that plans drafted by The Wagner Law Group allow employers to change contracts listed in the plan document without a plan amendment, and this practice may continue under the proposed regulations.  However, amending the list of contracts is advisable for recordkeeping purposes. 

The proposal defines both permitted taxable and qualified nontaxable benefits. Along with the benefits that were previously permitted in a cafeteria plan such as health, group term life, dependent care and disability, the proposed regulations clarify that qualified nontaxable benefits include certain COBRA premiums, accidental death and dismemberment coverage, contributions to health savings accounts, and adoption assistance programs.  Furthermore, the new proposed regulations specifically permit a cafeteria plan (but not a health care FSA) to use employees’ pre-tax contributions to pay for individual health insurance premiums.  For employers subject to the Massachusetts Health Care Reform Act, pre-tax contributions to a cafeteria plan which are used to pay for insurance offered through the Commonwealth Care or Commonwealth Choice programs are now exempt from both federal and state income tax, because these programs offer individual health insurance.

Ominously, the proposal states that if the required provisions are not included in the written plan document, if the plan does not follow the rules for permitted benefits, or if the cafeteria plan violates any of several other rules such as a failure to limit mid-year election changes as prescribed in the earlier regulations, the plan will not be considered to be a cafeteria plan and all participants will be taxed as if they had selected the benefits with the greatest taxable value, regardless of the actual selections made.

The new proposed regulations also provide additional guidance with respect to the annual nondiscrimination tests that plans must satisfy including definitions of key terms, guidance on the eligibility test and the contributions and benefits test.  The eligibility test incorporates a number of rules under Code Section 410(b) for qualified retirement plans dealing with reasonable classification, and the safe harbor percentage tests and the unsafe harbor percentage components of the facts and circumstances test.  This is a design-based test and employers should examine their plan designs for compliance.

With respect to the contributions and benefits test, the proposed regulations include an objective test to determine when the actual election of benefits is discriminatory.  Specifically, a cafeteria plan must give each similarly-situated participant a uniform opportunity to elect qualified benefits and highly compensated participants must not disproportionately elect those benefits.  Qualified benefits are disproportionately utilized if the aggregate qualified benefits elected by highly compensated participants, measured as a percentage of aggregate compensation for highly compensated participants, exceeds the aggregate qualified benefits elected by nonhighly compensated participants, measured as a percentage of aggregate compensation for nonhighly compensated participants.  While this test is based on the last day of the plan year, employers should consider mid-year testing to assess compliance with the nondiscrimination rules.

The proposal also has safe harbor tests for health care benefits and for premium-only plans (but not for health care FSAs).  On the simplest level, if a health care plan coverage is available to all employees through cafeteria plan contributions and the employees contribute the same amount for coverage, the plan will pass both safe harbor tests.

Comment : Although the new cafeteria plan regulations are only in the proposed stage, and are subject to change before becoming finalized, they represent the latest interpretation of the cafeteria plan rules by the Internal Revenue Service.  Therefore, employers should, at this time, examine their own cafeteria plans to ascertain if they are, generally speaking, in compliance with the new proposed rules and what steps they would need to take in the future if the regulations are finalized.  Therefore, employers should carefully review their plan documents and operational practices (including compliance with the nondiscrimination rules).

C. IRS Issues New Dependent Care Tax Credit Regulations

IRS has issued new final regulations updating its previous dependent care tax credit rules to reflect recent legislative changes as well as other guidance issued since the original regulations were promulgated.

These regulations are important because employers rely on them to define qualifying expenses under their Section 129 dependent care assistance programs (“DCAPs”).

The Internal Revenue Code contains a tax credit for expenses paid for household and dependent care services provided to a qualifying individual ( i.e. , a child under 13 or a disabled dependent or spouse) that enables that individual to work or look for work. The credit is equal to a percentage (ranging from 20% to 35%, depending on the taxpayer’s income) of these employment- related, qualifying expenses paid during the year.  The amount of expenses that may be used for the tax credit is limited to $3,000 if there is one dependent and $6,000 for two or more.  The expenses generally cannot exceed the income of the spouse earning the lesser amount.  However, if the spouse is a full time student or disabled, the spouse is deemed to have earned $250 per month if there is one dependent and $500 per month if there are two or more.  Also, any benefits paid from a DCAP must be used to offset the maximum expense limit on the tax credit.

The regulations incorporate prior guidance that qualifying dependent care expenses include expenses for programs below the kindergarten level (but not kindergarten or above).  Also, while the cost of overnight camps is not a qualifying expense, day camp expenses for specialized camps ( e.g. , soccer or computers) would be treated the same as ordinary day camps and therefore qualify for the dependent care credit (or DCAP reimbursement).

The former rules provided that a dependent’s transportation expenses to an offsite location where care is provided were not employment-related.  However, the new regulations clarify that these costs now qualify if the dependent care provider furnishes the transportation.

Taxpayers who work part-time are required to allocate their dependent care expenses between periods worked and not worked.  Therefore, the general rule is that dependent care expenses for periods during which the taxpayer is absent from work are not employment-related and are not subject to the tax credit or reimbursable through a DCAP.  However, the new regulations provide that dependent care expenses paid during short, temporary absences, such as for a minor illness or vacation, will be included for purposes of determining the tax credit (or for DCAP reimbursement).  Any absence of two weeks or less would be considered temporary.  Longer absences would be subject to a facts and circumstances test. 

Finally, under the Code, payments to a taxpayer’s dependent, or child under age 19, do not qualify as dependent care expenses.  The regulations further explain that payments to either the taxpayer’s spouse or to a non-spousal parent are not qualifying expenses.  However, payments to any other relative, even the qualifying dependent’s grandmother, will qualify for the credit or DCAP reimbursement.

Comment :  The new regulations will help employers because they have more specific rules on what constitutes dependent care expenses.  This will make it easier for employers to determine which expenses should be reimbursed from a DCAP.


[1] Code Section 411(d)(3).
[2] Rev. Rul. 2007-43.
[3] Reg. Sec. 1.411(d)-2(b)(1).
[4] See Rev. Rul. 73-284, 1973-2 C.B. 139, Rev. Rul. 81-27, 1981-1 C.B. 228, Weil v. Terson Co. Retirement Plan Administrative Committee , 933 F.2d 106 (2d Cir. 1991), and Matz v. Household International Tax Reduction Investment Plan , 388 F.3d 570 (7th Cir. 2004).
[5] “Constructive receipt” means that IRS treats an employee as receiving compensation when the employee has the right to currently access the compensation, even if the employee has not exercised the right to actually receive the compensation.  
[6] Payment upon separation from service must be delayed at least six months for “specified employees.”  These are key employees as defined in the so-called “top-heavy” rules for qualified plans if their employer’s stock is publicly traded.
[7] The definition of disability is strict.  The employee must be unable to engage in any substantial gainful activity by reason of an impairment that can be expected to last for a continuous period of not less than 12 months or to result in death.  Alternatively, the employee must be receiving disability benefits replacing lost wages for a period of not less than 3 months under the employer’s accident and health plan.
[8] Payments made on separation from service, disability, death, change of control, etc. would not violate the anti-acceleration rule if the 409A plan provided for payments upon the occurrence of these events.
[9] A “good reason” includes a material diminution in the employee’s (or his or her supervisor’s) base compensation, duties, or budget, according to the safe harbor definition in the Section 409A regulations.  It also includes a material change in the employee’s geographic location or material breach of the employment agreement.  In addition, the employee must provide the employer with notice of the good reason condition within 90 days of its initial existence, and the employer must have at least 30 days to remedy the good reason condition. The severance pay must be paid within two years following the initial existence of the good reason condition.  The amount, time and form of payment for a voluntary good reason separation must be identical to the amount, time and form of payment for an involuntary separation.  Finally, these good reason requirements must be incorporated into the severance plan.