TECHNICAL EXPLANATION OF THE

REVENUE PROVISIONS OF H.R. 3762,

THE “PENSION SECURITY ACT OF 2002”

Prepared by

the Staff of the

JOINT COMMITTEE ON TAXATION

April 11, 2002

JCX-24-02
i

CONTENTS

Page

INTRODUCTION .......................................................................................................................... 1

TITLE I: IMPROVEMENTS IN PENSION PLAN SECURITY ................................................. 2

A. Provide Investment Education Notices to Participants in Certain Plans (sec. 101(b)

of the bill and new secs. 414(w) and 6652(m) of the Code)............................................... 2

B. Excise Tax on Failure to Provide Notice to Participants of Transaction Restriction

Periods (sec. 102(b) of the bill and new sec. 4980H of the Code)..................................... 4

C. Diversification Requirements for Defined Contribution Plans that Hold Employer

Securities (sec. 104(b) of the bill and new sec. 401(a)(35) of the Code)............................ 7

D. Prohibited Transaction Exemption for the Provision of Investment Advice 

(sec. 105(b) of the bill and sec. 4975 of the Code)........................................................... 11

E. Employer-Provided Qualified Retirement Planning Services (sec. 107 of the bill

and sec. 132 of the Code).................................................................................................. 14

F. Effective Date for Collectively Bargained Plans and Plan Amendments (sec. 109 of

the bill).............................................................................................................................. 16

TITLE II: OTHER TAX PROVISIONS RELATING TO PENSIONS ...................................... 17

A. Amendments to Retirement Protection Act of 1994 (sec. 201 of the bill and sec. 412

of the Code)....................................................................................................................... 17

B. Pension Plan Reporting Simplification (sec. 202 of the bill)............................................ 19

C. Improvement of Employee Plans Compliance Resolution System (sec. 203

of the bill).......................................................................................................................... 21

D. Flexibility in Nondiscrimination, Coverage, and Line of Business Rules (sec. 204 of

the bill and secs. 401(a)(4), 410(b) and 414(r) of the Code) ............................................ 23

E. Extension to all Governmental Plans of Moratorium on Application of Certain 

Nondiscrimination Rules Applicable to State and Local Government Plans

(sec. 205 of the bill, sec. 1505 of the Taxpayer Relief Act of 1997, and secs. 401(a)

and 401(k) of the Code).................................................................................................... 25

F. Notice and Consent Period Regarding Distributions (sec. 206 of the bill and sec. 417

of the Code)....................................................................................................................... 26

G. Reduced PBGC Premiums for Small and New Plans (secs. 210-211 of the bill and

sec. 4006 of ERISA) ......................................................................................................... 28

H. Authorization for PBGC to Pay Interest on Premium Overpayment Refunds

(sec. 212 of the bill and sec. 4007(b) of ERISA).............................................................. 30

I. Rules for Substantial Owner Benefits in Terminated Plans (sec. 213 of the bill and

secs. 4021, 4022, 4043 and 4044 of ERISA).................................................................... 31

J. Studies (sec. 215 of the bill).............................................................................................. 32

K. Interest Rate Range for Additional Funding Requirements (sec. 216 of the bill and

sec. 412(l) of the Code)..................................................................................................... 33

L. Provisions Relating to Plan Amendments (sec. 217 of the bill)....................................... 37
ii

TITLE III: STOCK OPTIONS .................................................................................................... 39

A. Exclusion of Incentive Stock Options and Employee Stock Purchase Plan Stock

Options from Wages (sec. 301 of the bill and secs. 421(b), 423(c), 3121(a), 3231,

and 3306(b) of the Code).................................................................................................. 39

TITLE IV: SOCIAL SECURITY HELD HARMLESS .............................................................. 41

A. No Impact on Social Security and Medicare Trust Funds (sec. 401 of the bill)............... 41
1

INTRODUCTION

This document, 1 prepared by the staff of the Joint Committee on Taxation, provides a 

technical explanation of the revenue provisions of H.R. 3762, the “Pension Security Act of 

2002” (an amendment in the nature of a substitute for the reported bill), which is scheduled for 

consideration by the House of Representatives on April 11, 2002.

 

1

 This document may be cited as follows: Joint Committee on Taxation, Technical 

Explanation of the Revenue Provisions of H.R. 3762, the “Pension Security Act of 2002”

(JCX-24-02), April 11, 2002.
2

TITLE I: IMPROVEMENTS IN PENSION PLAN SECURITY

A. Provide Investment Education Notices to Participants in Certain Plans

(sec. 101(b) of the bill and new secs. 414(w) and 6652(m) of the Code)

Present Law

Present law does not require that participants be given specific information relating to 

investment education. 

Explanation of Provision

The provision requires the plan administrator of certain plans to provide investment 

education notices to applicable individuals. The requirement applies to qualified retirement 

plans (sec. 401(a)), qualified annuity plans (sec. 403(a)), tax-sheltered annuities (sec. 403(b)), 

and governmental eligible deferred compensation plans (sec. 457) that (1) permit a participant to 

direct the investment of his or her account or under which a participant’s accrued benefit 

depends on hypothetical investments directed by the participant (including a defined benefit 

plan) and (2) are not subject to section 105 of the Employee Retirement Income Security Act of 

1974 (“ERISA”). 

The investment education notice must be provided on enrollment in the plan and at least 

annually thereafter.2 Applicable individuals are plan participants, alternate payees under a 

qualified domestic relations order, and beneficiaries of a deceased participant or alternate payee. 

The notice requirement does not apply to one-person plans.3

The investment education notice is required to contain an explanation, for the long-term 

retirement security of participants and beneficiaries, of generally accepted investment principles, 

including risk management and diversification, and a discussion of the risk of holding substantial 

portions of a portfolio in securities of any one entity, such as employer securities. 

 

2

 The right to direct investments includes the right of an applicable individual in an 

employee stock ownership plan to direct the investment of a portion of his or her account under 

present law and the right of an applicable individual to direct the plan to divest the individual's 

account of employer securities as provided under another provision of the bill.

3

 A one-person plan is a plan that (1) on the first day of the plan year, covers only the 

employer (and the employer’s spouse) and the employer owns the entire business (whether or not 

incorporated) or covers only one or more partners (and their spouses) in a business partnership, 

(2) meets the minimum coverage requirements without being combined with any other plan that 

covers employees of the business, (3) does not provide benefits to anyone except the employer 

(and the employer’s spouse) or the partners (and their spouses), (4) does not cover a business that 

is a member of an affiliated service group, a controlled group of corporations, or a group of 

corporations under common control, and (5) does not cover a business that leases employees.
3

The notice must be written in a manner calculated to be understood by the average plan 

participant and provide sufficient information (as determined under Treasury guidance) to allow 

recipients to understand the notice. The notice is required to be in writing and may be provided 

in electronic or other form (or electronically posted on the plan’s website) to the extent that such 

form is reasonably accessible to the applicable individual. 

A penalty is imposed on a plan administrator that fails to provide the required investment 

education notice. The penalty is $100 per failure per applicable individual; the maximum 

amount of penalty that can be imposed on the plan administrator for all failures during a calendar 

year is $50,000. No penalty is imposed if the failure is due to reasonable cause and not to willful 

neglect.

Effective Date

The provision is generally effective for plan years beginning on or after January 1, 2003, 

with a delayed effective date for plans maintained pursuant to a collective bargaining agreement 

under section 109 of the bill.
4

B. Excise Tax on Failure to Provide Notice to Participants

 of Transaction Restriction Periods 

(sec. 102(b) of the bill and new sec. 4980H of the Code)

Present Law

Present law does not require that participants be given advance notice of temporary 

periods during which the ability to direct investments or to obtain loans or distributions from the 

plan is restricted.

Explanation of Provision

In general

Under the provision, a qualified retirement plan or annuity, a tax-sheltered annuity plan, 

or an eligible deferred compensation plan of a governmental employer is required to provide 

advance notice of a transaction restriction period to applicable individuals to whom the 

transaction restriction period applies. The notice must be provided to such individuals at least 30 

days before the beginning of the transaction restriction period. Applicable individuals include 

plan participants, alternate payees under a qualified domestic relations order, and beneficiaries of 

a deceased participant or alternate payee.

The notice requirement applies to a plan that maintains accounts for participants or a plan 

(including a defined benefit plan) under which a participant’s accrued benefit depends in whole 

or in part on hypothetical investments directed by the participant. The notice requirement does 

not apply to one-person plans.4

Definition of transaction restriction period

A transaction restriction period means a period during which certain rights are 

substantially reduced (other than because of the application of securities laws or other 

circumstances specified in regulations) if the rights are not restored by the third day after the 

rights are reduced. A transaction restriction period may occur with respect to the right under the 

plan of one or more applicable individuals to direct investments, or obtain loans or distributions 

from the plan. For this purpose, rights are treated as substantially reduced with respect to 

directing investments out of employer securities if rights are significantly restricted for at least 

three consecutive business days. In the case of a publicly-traded security, “business day” means 

any day on which the security may be traded on its principal market, and, in the case of a 

security that is not publicly traded, “business day” means any calendar day.

Whether an individual’s right to direct investments or obtain loans or distributions from 

the plan is substantially reduced, or whether the right to direct investments out of employer 

securities is significantly restricted, is generally determined by reference to the normal rights and 

procedures provided under the plan. A variety of factors may be relevant in making this

 

4

 The term “one-person plan” is defined as under the provision of the bill relating to 

investment education notices (sec. 101 of the bill).
5

determination. For example, if, in connection with a change in plan recordkeepers, no 

investment directions, loans, or distributions can be executed over a three-day weekend (i.e., a 

Saturday, a Sunday, and a Monday that is a Federal holiday), then no transaction restriction 

period results if the participants would not, under the terms of the plan, have been able to engage 

in such transactions during that period in any event. In addition, if a plan provides that a 

participant’s ability to make investment changes, or obtain a loan or a distribution, is limited for 

a certain period in connection with a qualified domestic relations order with respect to the 

participant’s account, that limitation generally does not result in a transaction restriction period. 

Factors in addition to the time period involved may also be relevant. For example, suppose a 

plan offers a variety of investment options, including three options that have similar 

characteristics (e.g., similar risk and return characteristics). If the ability to transfer funds into 

only one of these options is restricted, this may not result in a transaction restriction period for 

purposes of the provision, because participants have the right to transfer funds into similar 

investment options.

Timing of notice

Notice of a transaction restriction period generally has to be provided at least 30 days 

before the beginning of the period. If there is the possibility of a transaction restriction period in 

connection with a major corporate disposition by a corporation maintaining the plan, the notice 

must be provided at least 30 days before the date of the disposition. Advance notice is not 

required if the plan administrator has a substantial basis to believe that no transaction restriction 

period will occur. If notice is provided at least 30 days before the disposition, no other notice is 

required if the transaction restriction period begins within 30 days after the disposition. A 

“major corporate disposition” means the disposition of substantially all of the stock of the 

corporation, or a subsidiary thereof, or the disposition of substantially all of the assets used in a 

trade or business of the corporation or subsidiary. Similar rules apply in the case of an entity that 

is not a corporation.

It is intended that participants will be given the opportunity to execute investment 

changes with respect to their accounts, or obtain loans or distributions otherwise permitted under 

the plan, before the transaction restriction period begins.

Form of notice

Notice of a transaction restriction period has to be written in a manner calculated to be 

understood by the average plan participant and provide sufficient information (as determined 

under Treasury guidance) to allow the recipients to understand the timing and effect of the 

transaction restriction period. The notice is required to be provided in writing and may be 

provided in electronic or other form to the extent that such form is reasonably accessible to the 

applicable individual.

Excise tax

In the case of a failure to comply with the notice requirement, an excise tax of $100 for 

each applicable individual with respect to whom the failure occurred is generally imposed on the 
6

employer.5 If the employer exercises reasonable diligence to meet the notice requirements, the

total excise tax imposed during a taxable year will not exceed $500,000. 

No tax is imposed with respect to a failure if the employer exercises reasonable diligence 

to comply and the failure is corrected as soon as reasonably practicable and at least one business 

day before the beginning of the transaction restriction period. No tax is imposed if, in the case of 

an unforeseeable event, it is not reasonably practicable to provide notice before the beginning of 

the transaction restriction period. In the case of a failure due to reasonable cause and not to 

willful neglect, the Secretary of the Treasury is authorized to waive the excise tax to the extent 

that the payment of the tax would be excessive or otherwise inequitable relative to the failure 

involved.

Effective Date

The provision is generally effective for plan years beginning on or after January 1, 2003, 

with a delayed effective date for plans maintained pursuant to a collective bargaining agreement 

under section 109 of the bill. The Secretary of the Treasury, in consultation with the Secretary of 

Labor, is required to issue guidance for carrying out the new notice requirements within 120 days 

after the date of enactment. Guidance concerning a reduction of rights relating to the direction of 

investments out of employer securities is required to be issued by November 1, 2002 (or within 

60 days after the date of enactment, if later).

 

5

 In the case of a multiemployer plan, the excise tax is imposed on the plan.
7

C. Diversification Requirements for Defined Contribution Plans

 that Hold Employer Securities

(sec. 104(b) of the bill and new sec. 401(a)(35) of the Code)

Present Law

In general

Whether and the extent to which present law places limits on defined contribution plan 

investment in employer securities depends on the type of plan. 

Diversification requirements applicable to employee stock ownership plans (“ESOPs”)

Under the Internal Revenue Code, ESOPs are subject to a requirement that a participant 

who has attained age 55 and who has at least 10 years of participation in the plan must be 

permitted to diversify the investment of the participant’s account in assets other than employer 

securities. The diversification requirement applies to a participant for six years, starting with the 

year in which the individual firsts meets the eligibility requirements (i.e., age 55 and 10 years of 

participation). The participant must be allowed to elect to diversify up to 25 percent of the 

participant’s account (50 percent in the sixth year), reduced by the portion of the account 

diversified in prior years.

The participant must be given 90 days after the end of each plan year in the election 

period to make the election to diversify. In the case of participants who elect to diversify, the 

plan satisfies the diversification requirement if (1) the plan distributes the applicable amount to 

the participant within 90 days after the election period, (2) the plan offers at least three 

investment options (not inconsistent with Treasury regulations) and, within 90 days of the 

election period, invests the applicable amount in accordance with the participant’s election, or 

(3) the applicable amount is transferred within 90 days of the election period to another qualified 

defined contribution plan of the employer providing investment options in accordance with (2).6

10-percent limit on the acquisition of employer securities 

ERISA prohibits money purchase pension plans (other than certain plans in existence 

before the enactment of ERISA) from acquiring employer securities if, after the acquisition, 

more than 10 percent of the assets of the plan would be invested in employer stock. 7 This 10-

percent limitation does not apply to other types of defined contribution plans. Thus, most 

defined contribution plans, such as profit-sharing plans, stock bonus plans, and ESOPs, are not 

subject to any limit on the amount of employer securities that can be invested in employer 

securities. In addition, a fiduciary generally is deemed not to violate the requirement that plan 

 

6

 Code sec. 401(a)(28); IRS Notice 88-56, 1988-1 CB 540, Q&A 16.

7

 This 10-percent limitation also applies to defined benefit plans.
8

assets be diversified with respect to the acquisition or holding of employer securities in such 

plans.8

Under ERISA, the 10-percent limitation on the acquisition of employer securities, 

described above, applies separately to the portion of a plan consisting of elective deferrals (and 

earnings thereon) if any portion of an individual’s elective deferrals (or earnings thereon) are 

required to be invested in employer securities pursuant to plan terms or the direction of a person 

other than the participant. This restriction does not apply if (1) the amount of elective deferrals 

required to be invested in employer securities does not exceed more than one percent of any 

employee’s compensation, (2) the fair market value of all defined contribution plans maintained 

by the employer is no more than 10-percent of the fair market value of all retirement plans of the 

employer, or (3) the plan is an ESOP.

Explanation of Provision

In general

Under the bill, defined contribution plans that hold employer securities are generally 

required to permit applicable individuals at least quarterly to direct that the portion of the 

individual’s account held in employer securities be invested in alternative investments. In order 

to satisfy this diversification requirement, applicable individuals must be given a choice of at 

least three investment options, other than employer securities, each of which is diversified and 

has materially different risk and return characteristics. Other investment options offered by the 

plan generally must also be available. The definition of applicable individual who must be 

permitted to diversify depends on the type of contribution involved. 

The diversification requirement does not apply to a defined contribution plan holding 

employer securities if there is no class of stock issued by the employer (or a member of the 

employer’s controlled group) that is publicly traded (i.e., readily tradable on an established 

securities market). It is intended that the Secretary will exercise general interpretive authority to 

identify exceptions to the diversification requirements in appropriate cases. For example, an

exception may be appropriate if no stock of the employer maintaining the plan (including stock 

held in the plan) is publicly traded, but a member of the employer’s controlled group has issued a 

limited amount of publicly-traded stock.

The diversification requirement does not apply to an ESOP unless the ESOP holds 

contributions (or earnings thereon) that are subject to the special nondiscrimination tests that 

apply to elective deferrals, employee after-tax contributions, and matching contributions. The 

present-law ESOP diversification rules no longer apply to an ESOP that is subject to the 

requirements of the bill (i.e., an ESOP that holds elective deferrals, employee after-tax 

contributions, matching contributions, or nonelective employer contributions used to satisfy the 

special nondiscrimination tests (or earnings thereon) and that is maintained by a publicly-traded 

company).

 

8

 Under ERISA, plans that are not subject to the 10-percent limitation on the acquisition 

of employer securities are referred to as “eligible individual account plans.”
9

Elective deferrals and employee contributions

In the case of elective deferrals under a qualified cash or deferred arrangement and 

employee after-tax contributions, an applicable individual means (1) any plan participant, and 

(2) any beneficiary who has an account under the plan with respect to which the beneficiary is 

entitled to exercise the rights of a participant. Thus, in the case of all participants and such 

beneficiaries, the portion of the account attributable to elective deferrals and employee after-tax 

contributions held in employer securities is subject to the diversification requirements.

Other contributions

In the case of all other contributions, the diversification requirements apply in the case of 

an applicable individual with a benefit based on three years of service. For this purposes, an 

applicable individual has a benefit based on three years of service if the individual is (1) a 

participant with three years of service,9 or (2) a beneficiary with respect to a participant with 

three years of service if the beneficiary has an account under the plan with respect to which the 

beneficiary is entitled to exercise the rights of a participant.

An alternative is available for satisfying the diversification requirements with respect to 

the portion of an individual’s account attributable to contributions other than elective deferrals 

and employee after-tax contributions that is held in employer securities. Under the alternative, 

the time when an applicable individual must be permitted to diversify that portion of the account 

is based on when the employer securities were allocated to the account. Diversification must be 

permitted no later than the last day of the third plan year after the plan year in which the 

allocation occurred. For example, if employer securities are allocated to an applicable 

individual’s account in July 2008, and the plan year is the calendar year, the individual must be 

permitted no later than December 31, 2011, to make a diversification election with respect to the 

employer securities. The provision does not preclude the three-year period from being measured 

more frequently than annually. For example, the plan may provide diversification rights with 

respect to employer securities as of the end of the calendar quarter that occurs three years after 

the calendar quarter in which the securities were allocated to the account.

Transition rule

The provision includes a transition rule for the first five years for which the new 

diversification requirements apply to a plan. Under the transition rule, in the case of employer 

securities held in the plan on the first day on which the diversification requirements apply to the 

plan, diversification rights generally must be provided with respect to the applicable percentage 

as shown in the following table.

 

9

 Years of service are defined as under the rules relating to vesting (sec. 411(a)).
10

Table 1 – Applicable Percentage for Employer

Securities Held on Effective Date

Plan year for which

diversification applies: Applicable percentage:

First year ............................... Greater of amount that would be required 

under present-law ESOP diversification rule or 

20 percent

Second year........................... Greater of amount that would be required 

under present-law ESOP diversification rule or 

40 percent

Third year.............................. 60 percent

Fourth year............................ 80 percent

Fifth year or thereafter .......... 100 percent

The applicable percentage is reduced to the extent necessary to reflect any previous 

diversification of employer securities pursuant to an election under the present-law ESOP 

diversification requirements.

The applicable percentage is 100 percent with respect to employer securities attributable 

to employee after-tax contributions and elective deferrals (and earnings thereon) held in a plan 

under which the elective deferrals are treated as a separate plan for purposes of the ERISA 

10-percent limitation on the acquisition of employer securities. The determination of whether 

elective deferrals are treated as a separate plan and thus are subject to the 100 percent 

diversification rule (rather than the phase-in) is made as of the date of enactment.

Effective Date

The provision is generally effective for plan years beginning after December 31, 2002, 

with a delayed effective date for plans maintained pursuant to a collective bargaining agreement 

under section 109 of the bill, and applies with respect to employer securities allocated before, on, 

or after the date of enactment of the provision. The provision does not apply to employer 

securities held by an ESOP that are acquired before January 1, 1987 (and thus are not subject to 

the present-law diversification requirement).
11

D. Prohibited Transaction Exemption for the Provision of Investment Advice

(sec. 105(b) of the bill and sec. 4975 of the Code)

Present Law

Present law prohibits certain transactions between an employee benefit plan and a 

disqualified person. Disqualified persons include a fiduciary of the plan, a person providing 

services to the plan, and an employer with employees covered by the plan. For this purpose, a 

fiduciary includes any person who (1) exercises any authority or control respecting management 

or disposition of the plan’s assets, (2) renders investment advice for a fee or other compensation 

with respect to any plan moneys or property, or has the authority or responsibility to do so, or (3) 

has any discretionary authority or responsibility in the administration of the plan.

Prohibited transactions include (1) the sale, exchange or leasing of property, (2) the 

lending of money or other extension of credit, (3) the furnishing of goods, services or facilities, 

(4) the transfer to, or use by or for the benefit of, the income or assets of the plan, (5) in the case 

of a fiduciary, any act that deals with the plan’s income or assets for the fiduciary’s own interest 

or account, and (6) the receipt by a fiduciary of any consideration for the fiduciary’s own 

personal account from any party dealing with the plan in connection with a transaction involving 

the income or assets of the plan. However, certain transactions are exempt from prohibited 

transaction treatment, for example, certain loans to plan participants.

If a prohibited transaction occurs, the disqualified person who participates in the 

transaction is subject to a two-tier excise tax. The first level tax is 15 percent of the amount 

involved in the transaction. The second level tax is imposed if the prohibited transaction is not 

corrected within a certain period and is 100 percent of the amount involved. The prohibited 

transaction rules apply to a qualified retirement plan, a qualified retirement annuity, an 

individual retirement account or annuity, an Archer MSA, or a Coverdell education savings 

account.

Explanation of Provision

The provision adds a new category of prohibited transaction exemptions in connection 

with the provision of investment advice with respect to plan assets for a fee if (1) the investment 

of plan assets is subject to the direction of plan participants or beneficiaries, (2) the advice is 

provided to the plan or a participant or beneficiary by a fiduciary advisor in connection with a 

sale, acquisition or holding of a security or other property (an “investment transaction”) for 

purposes of investment of plan assets, and (3) certain other requirements are met. Under the 

provision, the following are exempt from prohibited transaction treatment: (1) the provision of 

investment advice to the plan, participant or beneficiary, (2) an investment transaction (including 

any lending of money or other extension of credit associated with the investment transaction) 

pursuant to the advice, and (3) the direct or indirect receipt of fees or other compensation by a 

fiduciary advisor or affiliate (or any employee, agent or registered representative of the fiduciary 

advisor or affiliate) in connection with the provision of the advice or an investment transaction 

pursuant to the advice.
12

Under the provision, certain requirements must be met in order for the exemption to 

apply. When initially providing advice about a security or other property, the fiduciary advisor 

must provide to the recipient of the advice, on a reasonably contemporaneous basis, written 

notification of specified information (discussed below) as well as any disclosure required in 

connection with the investment transaction under any applicable securities laws. In addition, the 

investment transaction must occur solely at the direction of the recipient of the advice; the 

compensation received by the advisor and affiliates in connection with the investment transaction 

must be reasonable; and the terms of the investment transaction must be at least as favorable as 

an arm’s length transaction would be.

The written notification required to be provided by the fiduciary advisor must include 

information about the following: (1) all fees or compensation to be received by the advisor or an 

affiliate (including from a third party) in connection with the advice or the investment 

transaction, (2) any material affiliation or contractual relationship of the advisor or affiliates in 

the security or other property involved in the investment transaction, (3) any limitation to be 

placed on the scope of the investment advice, (4) the types of services provided by the advisor in 

connection with the provision of investment advice, (5) the advisor’s status as a fiduciary of the 

plan in connection with the provision of the advice, and (6) the ability of the recipient of the 

advice separately to arrange for the provision of advice by another adviser that could have no 

material affiliation with and receive no fees or other compensation in connection with the 

security or other property. The written notification can be provided electronically. In addition, 

in connection with the initial advice or subsequent advice, the required information must be 

provided in currently accurate form at least annually and also when requested by the recipient of 

the advice and when there is a material change in the information. Any notification (or currently 

accurate information) must be written in a clear and conspicuous manner, calculated to be 

understood by the average plan participant, and be sufficiently accurate and comprehensive 

reasonably to apprise participants and beneficiaries of the required information.

The fiduciary advisor must maintain for at least six years any records necessary for 

determining whether the requirements for the prohibited transaction exemption were met. A 

prohibited transaction will not be considered to have occurred merely because records were lost 

or destroyed before the end of six years due to circumstances beyond the advisor’s control.

For purposes of the provision, “fiduciary advisor” is defined as a person who is a 

fiduciary of the plan by reason of the provision of investment advice to the plan, a participant or 

beneficiary and who is also (1) registered as an investment advisor under the Investment 

Advisors Act of 1940 or under State laws, (2) a bank or similar financial institution supervised 

by the United States or a State, but only if the advice is provided through a trust department that 

is subject to periodic examination and review by Federal or State banking authorities, (3) an 

insurance company qualified to do business under State law, (4) registered as a broker or dealer 

under the Securities Exchange Act of 1934, (5) an affiliate of any of the preceding, or (6) an 

employee, agent or representative of any of the preceding who satisfies the requirements of 

applicable insurance, banking and securities laws relating to the provision of advice. “Affiliate” 

means an affiliated person as defined under section 2(a)(3) of the Investment Company Act of 

1940. “Registered representative” means a person described in section 3(a)(18) of the Securities 

Exchange Act of 1934 or a person described in section 202(a)(17) of the Investment Advisors 

Act of 1940.
13

Effective Date

The provision is effective with respect to investment advice provided on or after 

January 1, 2003.
14

E. Employer-Provided Qualified Retirement Planning Services 

(sec. 107 of the bill and sec. 132 of the Code)

Present Law

Under present law, certain employer-provided fringe benefits are excludable from gross 

income and wages for employment tax purposes.10 These excludable fringe benefits include 

qualified retirement planning services provided to an employee and his or her spouse by an 

employer maintaining a qualified employer plan. A qualified employer plan includes a qualified 

retirement plan or annuity, a tax-sheltered annuity, a simplified employee pension, a SIMPLE 

retirement account, or a governmental plan, including an eligible deferred compensation plan 

maintained by a governmental employer.

Qualified retirement planning services are retirement planning advice and information. 

The exclusion is not limited to information regarding the qualified employer plan, and, thus, for

example, applies to advice and information regarding retirement income planning for an 

individual and his or her spouse and how the employer’s plan fits into the individual’s overall 

retirement income plan. On the other hand, the exclusion does not apply to services that may be 

related to retirement planning, such as tax preparation, accounting, legal or brokerage services.

The exclusion does not apply with respect to highly compensated employees unless the 

services are available on substantially the same terms to each member of the group of employees 

normally provided education and information regarding the employer’s qualified plan.

Explanation of Provision

The provision permits employers to offer employees a choice between cash compensation 

and eligible qualified retirement planning services. The provision only applies to qualified 

retirement planning services provided by a qualified investment advisor. It is intended that 

qualified investment advisors will be certified and regulated under applicable laws and 

regulations. In addition, qualified investment advisors also include investment advisors within a 

financial institution’s trust or custody department chartered under the National Bank Act. 11 As 

under present law, the provision applies only to amounts for retirement planning advice and 

information and does not apply to services that may be related to retirement planning, such as tax 

preparation, accounting, legal or brokerage services.

Under the provision, no amount is includible in gross income or wages merely because 

the employee is offered the choice of cash in lieu of eligible qualified retirement planning 

services. Also, no amount is includible in income or wages merely because the employee is 

offered a choice among eligible qualified retirement planning services. The amount of cash 

offered is includible in income and wages only to the extent the employee elects cash. The 

exclusion does not apply to highly compensated employees unless the salary reduction option is 

 

10 Secs. 132 and 3121(a)(20).

11 12 U.S.C. 92(a).
15

available on substantially the same terms to all employees normally provided education and 

information about the plan.

Under the provision, salary reduction amounts used to provide eligible qualified 

retirement planning services are generally treated for pension plan purposes the same as other 

salary reduction contributions. Thus, such amounts are included for purposes of applying the 

limits on contributions and benefits, and an employer is able to elect whether or not to include 

such amounts in compensation for nondiscrimination testing.

Effective Date

The provision is effective for taxable years beginning after December 31, 2002.
16

F. Effective Date for Collectively Bargained Plans and Plan Amendments

(sec. 109 of the bill)

Present Law

Plan amendments to reflect amendments to the law generally must be made by the time 

prescribed by law for filing the income tax return of the employer for the employer’s taxable 

year in which the change in law occurs.

Explanation of Provision

Delayed effective date for collectively bargained plans

The provision provides a delayed effective date for collectively bargained plans. Under 

the provision, in the case of a plan maintained pursuant to one or more collective bargaining 

agreements ratified on or before the date of enactment, the amendments made by Title I of the 

bill are applied beginning with the first plan year beginning on or after the earlier of: 

(1) The later of: (a) January 1, 2004, or (b) the date on which the last of such 

collective bargaining agreements terminates (determined without regard to any 

extension thereof after the date of enactment), or

(2) January 1, 2005.

Time for making plan amendments

If the amendments made by the provisions of the bill relating to benefit statements, 

notices to participants, informational and educational support for plan fiduciaries, or 

diversification of employer securities require an amendment to the plan, such plan amendment is 

not required to be made before the first plan year beginning on or after January 1, 2005, if, 

during the period after the provisions of the proposal take effect and before such first plan year, 

the plan is operated in accordance with the provisions of the bill and the plan amendment applies 

retroactively.

Effective Date

The provision is effective on the date of enactment.
17

TITLE II: OTHER TAX PROVISIONS RELATING TO PENSIONS

A. Amendments to Retirement Protection Act of 1994

 (sec. 201 of the bill and sec. 412 of the Code)

Present Law

Under present law, defined benefit pension plans are required to meet certain minimum 

funding rules. In some cases, additional contributions are required if a defined benefit pension 

plan is underfunded. Additional contributions generally are not required in the case of a plan 

with a funded current liability percentage of at least 90 percent. A plan’s funded current liability 

percentage is the value of plan assets as a percentage of current liability. In general, a plan’s 

current liability means all liabilities to employees and their beneficiaries under the plan. 

Quarterly minimum funding contributions are required in the case of certain underfunded plans.

The Pension Benefit Guaranty Corporation (“PBGC”) insures benefits under most 

defined benefit pension plans in the event the plan is terminated with insufficient assets to pay 

for plan benefits. The PBGC is funded in part by a flat-rate premium per plan participant, and a 

variable rate premium based on plan underfunding.

Under present law, a special rule modifies the minimum funding requirements in the case 

of certain plans. The special rule applies in the case of plans that (1) were not required to pay a 

variable rate PBGC premium for the plan year beginning in 1996, (2) do not, in plan years 

beginning after 1995 and before 2009, merge with another plan (other than a plan sponsored by 

an employer that was a member of the controlled group of the employer in 1996), and (3) are 

sponsored by a company that is engaged primarily in interurban or interstate passenger bus 

service.

The special rule treats a plan to which it applies as having a funded current liability 

percentage of at least 90 percent for plan years beginning after 1996 and before 2005 if for such 

plan year the funded current liability percentage is at least 85 percent. If the funded current 

liability of the plan is less than 85 percent for any plan year beginning after 1996 and before 

2005, the relief from the minimum funding requirements applies only if certain specified 

contributions are made.

For plan years beginning after 2004 and before 2010, the funded current liability 

percentage will be deemed to be at least 90 percent if the actual funded current liability 

percentage is at least at certain specified levels. 

The relief from the minimum funding requirements applies for the plan year beginning in 

2005, 2006, 2007, and 2008 only if contributions to the plan equal at least the expected increase 

in current liability due to benefits accruing during the plan year.

Explanation of Provision

The provision modifies the special funding rule for plans sponsored by a company 

engaged primarily in interurban or interstate passenger bus service by making the rule 

permanent.
18

In addition, the provision modifies the rule by providing that (1) the funded current 

liability percentage of a plan to which the rule applies is treated as not less than 90 percent for 

purposes of the minimum funding rules applicable to underfunded plans, and (2) the funded 

current liability percentage of a plan to which the rule applies is treated as not less than 100 

percent for purposes of the quarterly contribution requirement.

Effective Date

The provision is effective with respect to plan years beginning after December 31, 2001.
19

B. Pension Plan Reporting Simplification

(sec. 202 of the bill) 

Present Law

A plan administrator of a pension, annuity, stock bonus, profit-sharing or other funded 

plan of deferred compensation generally must file with the Secretary of the Treasury an annual 

return for each plan year containing certain information with respect to the qualification, 

financial condition, and operation of the plan. Title I of ERISA also ma y require the plan 

administrator to file annual reports concerning the plan with the Department of Labor and the 

Pension Benefit Guaranty Corporation (“PBGC”). The plan administrator must use the Form 

5500 series as the format for the required annual return.12 The Form 5500 series annual 

return/report, which consists of a primary form and various schedules, includes the information 

required to be filed with all three agencies. The plan administrator satisfies the reporting 

requirement with respect to each agency by filing the Form 5500 series annual return/report with 

the Department of Labor, which forwards the form to the Internal Revenue Service and the 

PBGC.

The Form 5500 series consists of 2 different forms: Form 5500 and Form 5500-EZ. 

Form 5500 is the more comprehensive of the forms and requires the most detailed financial 

information. A plan administrator generally may file Form 5500-EZ, which consists of only one 

page, if (1) the only participants in the plan are the sole owner of a business that maintains the 

plan (and such owner’s spouse), or partners in a partnership that maintains the plan (and such 

partners’ spouses), (2) the plan is not aggregated with another plan in order to satisfy the 

minimum coverage requirements of section 410(b), (3) the employer is not a member of a related 

group of employers, and (4) the employer does not receive the services of leased employees. If 

the plan satisfies the eligibility requirements for Form 5500-EZ and the total value of the plan 

assets as of the end of the plan year and all prior plan years beginning on or after January 1, 

1994, does not exceed $100,000, the plan administrator is not required to file a return.

With respect to a plan that does not satisfy the eligibility requirements for Form 5500-EZ, 

the characteristics and the size of the plan determine the amount of detailed financial information 

that the plan administrator must provide on Form 5500. If the plan has more than 100 

participants at the beginning of the plan year, the plan administrator generally must provide more 

information.

Explanation of Provision

The Secretary of the Treasury and the Secretary of Labor are directed to modify the 

annual return filing requirements with respect to plans that satisfy the eligibility requirements for 

Form 5500-EZ (referred to as a “one-participant plan”) to provide that if the total value of the 

plan assets of such a plan as of the end of the plan year does not exceed $250,000, the plan 

administrator is not required to file a return. In addition, the provision directs the Secretary of 

 

12 Treas. Reg. sec. 301.6058-1(a).
20

the Treasury and the Secretary of Labor to provide simplified reporting requirements for plan 

years beginning after December 31, 2003, for certain plans with fewer than 25 employees.

Effective Date

The provision relating to one-participant plans is effective for plans beginning on or after 

January 1, 2002. The provision relating to simplified reporting for plans with fewer than 25 

employees is effective on the date of enactment.
21

C. Improvement of Employee Plans Compliance Resolution System

(sec. 203 of the bill)

Present Law

A retirement plan that is intended to be a tax-qualified plan provides retirement benefits 

on a tax-favored basis if the plan satisfies all of the requirements of section 401(a). Similarly, an 

annuity that is intended to be a tax-sheltered annuity provides retirement benefits on a taxfavored basis if the program satisfies all of the requirements of section 403(b). Failure to satisfy 

all of the applicable requirements of section 401(a) or section 403(b) may disqualify a plan or 

annuity for the intended tax-favored treatment.

The Internal Revenue Service (“IRS”) has established the Employee Plans Compliance 

Resolution System (“EPCRS”), which is a comprehensive system of correction programs for 

sponsors of retirement plans and annuities that are intended, but have failed, to satisfy the 

requirements of section 401(a), section 403(a), or section 403(b), as applicable.13 EPCRS 

permits employers to correct compliance failures and continue to provide their employees with 

retirement benefits on a tax-favored basis.

The IRS has designed EPCRS to (1) encourage operational and formal compliance, 

(2) promote voluntary and timely correction of compliance failures, (3) provide sanctions for 

compliance failures identified on audit that are reasonable in light of the nature, extent, and 

severity of the violation, (4) provide consistent and uniform administration of the correction 

programs, and (5) permit employers to rely on the availability of EPCRS in taking corrective 

actions to maintain the tax-favored status of their retirement plans and annuities.

The basic elements of the programs that comprise EPCRS are self-correction, voluntary 

correction with IRS approval, and correction on audit. The Self-Correction Program (“SCP”) 

generally permits a plan sponsor that has established compliance practices to correct certain 

insignificant failures at any time (including during an audit), and certain significant failures 

within a 2-year period, without payment of any fee or sanction. The Voluntary Correction 

Program (“VCP”) program permits an employer, at any time before an audit, to pay a limited fee 

and receive IRS approval of a correction. For a failure that is discovered on audit and corrected, 

the Audit Closing Agreement Program (“Audit CAP”) provides for a sanction that bears a 

reasonable relationship to the nature, extent, and severity of the failure and that takes into 

account the extent to which correction occurred before audit.

The IRS has expressed its intent that EPCRS will be updated and improved periodically 

in light of experience and comments from those who use it.

Explanation of Provision

The Secretary of the Treasury is directed to continue to update and improve EPCRS, 

giving special attention to (1) increasing the awareness and knowledge of small employers 

concerning the availability and use of EPCRS, (2) taking into account special concerns and 

 

13 Rev. Proc. 2001-17, 2001-7 I.R.B. 589.
22

circumstances that small employers face with respect to compliance and correction of 

compliance failures, (3) extending the duration of the self-correction period under SCP for 

significant compliance failures, (4) expanding the availability to correct insignificant compliance 

failures under SCP during audit, and (5) assuring that any tax, penalty, or sanction that is 

imposed by reason of a compliance failure is not excessive and bears a reasonable relationship to 

the nature, extent, and severity of the failure.

The provision clarifies that the Secretary has the full authority to effectuate the foregoing 

with respect to EPCRS (or similar program or policies), including the authority to waive income, 

excise or other taxes to ensure that any tax, penalty or sanction is not excessive and bears a 

reasonable relationship to the nature, extent and severity of the failure.

Effective Date

The provision is effective on the date of enactment.
23

D. Flexibility in Nondiscrimination, Coverage, and Line of Business Rules

(sec. 204 of the bill and secs. 401(a)(4), 410(b) and 414(r) of the Code)

Present Law

A plan is not a qualified retirement plan if the contributions or benefits provided under 

the plan discriminate in favor of highly compensated employees (sec. 401(a)(4)). The applicable 

Treasury regulations set forth the exclusive rules for determining whether a plan satisfies the 

nondiscrimination requirement. These regulations state that the form of the plan and the effect of 

the plan in operation determine whether the plan is nondiscriminatory and that intent is 

irrelevant.

Similarly, a plan is not a qualified retirement plan if the plan does not benefit a minimum 

number of employees (sec. 410(b)). A plan satisfies this minimum coverage requirement if and 

only if it satisfies one of the tests specified in the applicable Treasury regulations. If an 

employer is treated as operating separate lines of business, the employer may apply the minimum 

coverage requirements to a plan separately with respect to the employees in each separate line of 

business (sec. 414(r)). Under a so-called “gateway” requirement, however, the plan must benefit 

a classification of employees that does not discriminate in favor of highly compensated 

employees in order for the employer to apply the minimum coverage requirements separately for 

the employees in each separate line of business. A plan satisfies this gateway requirement only 

if it satisfies one of the tests specified in the applicable Treasury regulations.

Explanation of Provision

The Secretary of the Treasury is directed to modify, on or before December 31, 2003, the 

existing regulations issued under section 414(r) in order to expand (to the extent that the 

Secretary may determine to be appropriate) the ability of a plan to demonstrate compliance with 

the line of business requirements based upon the facts and circumstances surrounding the design 

and operation of the plan, even though the plan is unable to satisfy the mechanical tests currently 

used to determine compliance.

The Secretary of the Treasury is directed to provide by regulation applicable to years 

beginning after December 31, 2003, that a plan is deemed to satisfy the nondiscrimination 

requirements of section 401(a)(4) if the plan satisfied the pre-1994 facts and circumstances test, 

satisfied the conditions prescribed by the Secretary to appropriately limit the availability of such 

test, and is submitted to the Secretary for a determination of whether it satisfies such test (to the 

extent provided by the Secretary).

Similarly, a plan will comply with the minimum coverage requirement of section 410(b) 

if the plan satisfied the pre-1989 coverage rules, is submitted to the Secretary for a determination 

of whether it satisfied the pre-1989 coverage rules (to the extent provided by the Secretary), and 

satisfies conditions prescribed by the Secretary by regulation that appropriately limit the 

availability of the pre-1989 coverage rules.
24

Effective Date

The provision relating to the line of business requirements under section 414(r) is 

effective on the date of enactment. The provision relating to the nondiscrimination requirements 

under section 401(a)(4) is effective on the date of enactment, except that any condition of 

availability prescribed by the Secretary will not be effective before the first year beginning not 

less than 120 days after the date on which such condition is prescribed. The provision relating to 

the minimum coverage requirements under section 410(b) is effective for years beginning after 

December 31, 2003, except that any condition of availability prescribed by the Secretary by 

regulation will not apply before the first year beginning not less than 120 days after the date on 

which such condition is prescribed.
25

E. Extension to all Governmental Plans of Moratorium on Application of Certain 

Nondiscrimination Rules Applicable to State and Local Government Plans

(sec. 205 of the bill, sec. 1505 of the Taxpayer Relief Act of 1997, 

and secs. 401(a) and 401(k) of the Code) 

Present Law

A qualified retirement plan maintained by a State or local government is exempt from the 

rules concerning nondiscrimination (sec. 401(a)(4)) and minimum participation (sec. 401(a)(26)). 

All other governmental plans are not exempt from the nondiscrimination and minimum 

participation rules.

Explanation of Provision

The provision exempts all governmental plans (as defined in sec. 414(d)) from the 

nondiscrimination and minimum participation rules.

Effective Date

The provision is effective for plan years beginning after December 31, 2002.
26

F. Notice and Consent Period Regarding Distributions

(sec. 206 of the bill and sec. 417 of the Code)

Present Law

Notice and consent requirements apply to certain distributions from qualified retirement 

plans. These requirements relate to the content and timing of information that a plan must 

provide to a participant prior to a distribution, and to whether the plan must obtain the 

participant’s consent to the distribution. The nature and extent of the notice and consent 

requirements applicable to a distribution depend upon the value of the participant’s vested 

accrued benefit and whether the joint and survivor annuity requirements (sec. 417) apply to the

participant. 

If the present value of the participant’s vested accrued benefit exceeds $5,000, the plan 

may not distribute the participant’s benefit without the written consent of the participant. The 

participant’s consent to a distribution is not valid unless the participant has received from the 

plan a notice that contains a written explanation of (1) the material features and the relative 

values of the optional forms of benefit available under the plan, (2) the participant’s right, if any, 

to have the distribution directly transferred to another retirement plan or IRA, and (3) the rules 

concerning the taxation of a distribution. If the joint and survivor annuity requirements apply to 

the participant, this notice also must contain a written explanation of (1) the terms and conditions 

of the qualified joint and survivor annuity (“QJSA”), (2) the participant’s right to make, and the 

effect of, an election to waive the QJSA, (3) the rights of the participant’s spouse with respect to 

a participant’s waiver of the QJSA, and (4) the right to make, and the effect of, a revocation of a 

waiver of the QJSA. The plan generally must provide this notice to the participant no less than 

30 and no more than 90 days before the date distribution commences.

If the participant’s vested accrued benefit does not exceed $5,000, the terms of the plan 

may provide for distribution without the participant’s consent. The plan generally is required, 

however, to provide to the participant a notice that contains a written explanation of (1) the 

participant’s right, if any, to have the distribution directly transferred to another retirement plan 

or IRA, and (2) the rules concerning the taxation of a distribution. The plan generally must 

provide this notice to the participant no less than 30 and no more than 90 days before the date 

distribution commences.

Explanation of Provision

Under the provision, a qualified retirement plan is required to provide the applicable 

distribution notice no less than 30 days and no more than 180 days before the date distribution 

commences. The Secretary of the Treasury is directed to modify the applicable regulations to 

reflect the extension of the notice period to 180 days and to provide that the description of a 

participant’s right, if any, to defer receipt of a distribution shall also describe the consequences 

of failing to defer such receipt. In the case of a description of such consequences that is made 

before the date 90 days after the date on which the Secretary of the Treasury issues a safe harbor 

description, the plan administrator will be required to make a reasonable attempt to comply with 

the requirements of the provision. 
27

Effective Date

The provision is effective for years beginning after December 31, 2002.
28

G. Reduced PBGC Premiums for Small and New Plans

(secs. 210-211 of the bill and sec. 4006 of ERISA)

Present Law

Under present law, the Pension Benefit Guaranty Corporation (“PBGC”) provides 

insurance protection for participants and beneficiaries under certain defined benefit pension 

plans by guaranteeing certain basic benefits under the plan in the event the plan is terminated 

with insufficient assets to pay benefits promised under the plan. The guaranteed benefits are 

funded in part by premium payments from employers who sponsor defined benefit plans. The 

amount of the required annual PBGC premium for a single-employer plan is generally a flat rate 

premium of $19 per participant and an additional variable-rate premium based on a charge of $9 

per $1,000 of unfunded vested benefits. Unfunded vested benefits under a plan generally means 

(1) the unfunded current liability for vested benefits under the plan, over (2) the value of the 

plan’s assets, reduced by any credit balance in the funding standard account. No variable-rate 

premium is imposed for a year if contributions to the plan were at least equal to the full funding 

limit.

The PBGC guarantee is phased in ratably in the case of plans that have been in effect for 

less than five years, and with respect to benefit increases from a plan amendment that was in 

effect for less than five years before termination of the plan.

Explanation of Provision

Reduced flat-rate premiums for new plans of small employers

Under the provision, for the first five plan years of a new single-employer plan of a small 

employer, the flat-rate PBGC premium is $5 per plan participant. 

A small employer would be a contributing sponsor that, on the first day of the plan year, 

has 100 or fewer employees. For this purpose, all employees of the members of the controlled 

group of the contributing sponsor are to be taken into account. In the case of a plan to which 

more than one unrelated contributing sponsor contributes, employees of all contributing sponsors 

(and their controlled group members) are to be taken into account in determining whether the

plan was a plan of a small employer.

A new plan means a defined benefit plan maintained by a contributing sponsor if, during 

the 36-month period ending on the date of adoption of the plan, such contributing sponsor (or 

controlled group member or a predecessor of either) has not established or maintained a plan 

subject to PBGC coverage with respect to which benefits were accrued for substantially the same 

employees as in the new plan.

Reduced variable-rate PBGC premium for new plans

The provision provides that the variable-rate premium is phased in for new defined 

benefit plans over a six-year period starting with the plan’s first plan year. The amount of the 

variable-rate premium is a percentage of the variable premium otherwise due, as follows: zero 

percent of the otherwise applicable variable-rate premium in the first plan year; 20 percent in the 
29

second plan year; 40 percent in the third plan year; 60 percent in the fourth plan year; 80 percent 

in the fifth plan year; and 100 percent in the sixth plan year (and thereafter). 

A new defined benefit plan is defined as described above under the flat-rate premium 

provision of the provision relating to new small employer plans.

Reduced variable-rate PBGC premium for small plans

In the case of a plan of a small employer, the variable-rate premium is no more than $5 

multiplied by the number of plan participants in the plan at the end of the preceding plan year. 

For purposes of the provision, a small employer is a contributing sponsor that, on the first day of 

the plan year, has 25 or fewer employees. For this purpose, all employees of the members of the 

controlled group of the contributing sponsor are to be taken into account. In the case of a plan to 

which more than one unrelated contributing sponsor contributed, employees of all contributing 

sponsors (and their controlled group members) are to be taken into account in determining 

whether the plan was a plan of a small employer.

Effective Date

The reduction of the flat-rate premium for new plans of small employers and the 

reduction of the variable-rate premium for new plans is effective with respect to plans first 

effective after December 31, 2001. The reduction of the variable-rate premium for small plans is 

effective with respect to plan years beginning after December 31, 2002.
30

H. Authorization for PBGC to Pay Interest on Premium Overpayment Refunds

(sec. 212 of the bill and sec. 4007(b) of ERISA)

Present Law

The PBGC charges interest on underpayments of premiums, but is not authorized to pay 

interest on overpayments.

Explanation of Provision

The provision allows the PBGC to pay interest on overpayments made by premium payors. 

Interest paid on overpayments is to be calculated at the same rate and in the same manner as 

interest charged on premium underpayments.

Effective Date

The provision is effective with respect to interest accruing for periods beginning not 

earlier than the date of enactment.
31

I. Rules for Substantial Owner Benefits in Terminated Plans

(sec. 213 of the bill and secs. 4021, 4022, 4043 and 4044 of ERISA) 

Present Law

Under present law, the Pension Benefit Guaranty Corporation (“PBGC”) provides 

participants and beneficiaries in a defined benefit pension plan with certain minimal guarantees 

as to the receipt of benefits under the plan in case of plan termination. The employer sponsoring 

the defined benefit pension plan is required to pay premiums to the PBGC to provide insurance 

for the guaranteed benefits. In general, the PBGC will guarantee all basic benefits which are 

payable in periodic installments for the life (or lives) of the participant and his or her 

beneficiaries and are non-forfeitable at the time of plan termination. The amount of the 

guaranteed benefit is subject to certain limitations. One limitation is that the plan (or an 

amendment to the plan which increases benefits) must be in effect for 60 months before 

termination for the PBGC to guarantee the full amount of basic benefits for a plan participant, 

other than a substantial owner. In the case of a substantial owner, the guaranteed basic benefit is 

phased in over 30 years beginning with participation in the plan. A substantial owner is one who 

owns, directly or indirectly, more than 10 percent of the voting stock of a corporation or all the 

stock of a corporation. Special rules restricting the amount of benefit guaranteed and the 

allocation of assets also apply to substantial owners.

Explanation of Provision

The provision provides that the 60-month phase-in of guaranteed benefits applies to a 

substantial owner with less than 50 percent ownership interest. For a substantial owner with a 50 

percent or more ownership interest (“majority owner”), the phase-in occurs over a 10-year period 

and depends on the number of years the plan has been in effect. The majority owner’s 

guaranteed benefit is limited so that it cannot be more than the amount phased in over 60 months 

for other participants. The rules regarding allocation of assets applies to substantial owners, 

other than majority owners, in the same manner as other participants.

Effective Date

The provision is effective for plan terminations with respect to which notices of intent to 

terminate are provided, or for which proceedings for termination are instituted by the PBGC, 

after December 31, 2002.
32

J. Studies (sec. 215 of the bill)

Present Law

No provision.

Explanation of Provision

Study on small employer group plans 

The provision directs the Secretary of Labor, in consultation with the Secretary of the 

Treasury, to conduct a study to determine (1) the most appropriate form(s) of pension plans that 

would be simple to create and easy to maintain by multiple small employers, while providing 

ready portability of benefits for all participants and beneficiaries, (2) how such arrangements 

could be established by employer or employee associations, (3) how such arrangements could 

provide for employees to contribute independent of employer sponsorship, and (4) appropriate 

methods and strategies for making such pension plan coverage more widely available to 

American workers.

The Secretary of Labor is required to consider the adequacy and availability of existing 

pension plans and the extent to which existing models may be modified to be more accessible to 

both employees and employers. The Secretary of Labor is required to issue a report within 18 

months, including recommendations for one or more model plans or arrangements as described 

above which may serve as the basis for appropriate administrative or legislative action. 

Study on effect of legislation 

The provision also directs the Secretary of Labor to report to the Committee on Education 

and the Workforce of the House of Representatives and the Committee on Health, Education, 

Labor and Pensions of the Senate regarding the effect of the bill and title VI of the Economic 

Growth and Tax Relief Reconciliation Act of 2001 (“the 2001 Act”) on pension coverage, 

including any change in the extent of pension plan coverage for low and middle-income workers, 

the levels of pension plan benefits generally, the quality of pension plan coverage generally, 

workers’ access to and participation in pension plans, and retirement security. This report is 

required to be submitted no later than five years after the date of enactment. 

Effective Date

The provision is effective on the date of enactment.
33

K. Interest Rate Range for Additional Funding Requirements 

(sec. 216 of the bill and sec. 412(l) of the Code)

Present Law

In general

ERISA and the Code impose both minimum and maximum14 funding requirements with 

respect to defined benefit pension plans. The minimum funding requirements are designed to 

provide at least a certain level of benefit security by requiring the employer to make certain 

minimum contributions to the plan. The amount of contributions required for a plan year is 

generally the amount needed to fund benefits earned during that year plus that year’s portion of 

other liabilities that are amortized over a period of years, such as benefits resulting from a grant 

of past service credit.

Additional contributions for underfunded plans

Additional contributions are required under a special funding rule if a single-employer 

defined benefit pension plan is underfunded.15 Under the special rule, a plan is considered 

underfunded for a plan year if the value of the plan assets is less than 90 percent of the plan’s 

current liability. 16 The value of plan assets as a percentage of current liability is the plan’s 

“funded current liability percentage.”

If a plan is underfunded, the amount of additional required contributions is based on 

certain elements, including whether the plan has an unfunded liability related to benefits accrued 

before 1988 or 1995 or to changes in the mortality table used to determine contributions, and 

whether the plan provides for unpredictable contingent event benefits (that is, benefits that 

depend on contingencies that are not reliably and reasonably predictable, such as facility 

shutdowns or reductions in workforce). However, the amount of additional contributions cannot 

exceed the amount needed to increase the plan’s funded current liability percentage to 

100 percent.

 

14 The maximum funding requirement for a defined benefit plan is referred to as the full 

funding limitation. Additional contributions are not required if a plan has reached the full 

funding limitation.

15 Plans with no more than 100 participants on any day in the preceding plan year are not 

subject to the special funding rule. Plans with more than 100 but not more than 150 participants 

are generally subject to lower contribution requirements under the special funding rule.

16 Under an alternative test, a plan is not considered underfunded if (1) the value of the 

plan assets is at least 80 percent of current liability and (2) the value of the plan assets was at 

least 90 percent of current liability for each of the two immediately preceding years or each of 

the second and third immediately preceding years.
34

Required interest rate

In general, a plan’s current liability means all liabilities to employees and their 

beneficiaries under the plan. The interest rate used to determine a plan’s current liability must be 

within a permissible range of the weighted average of the interest rates on 30-year Treasury 

securities for the four-year period ending on the last day before the plan year begins.17 The 

permissible range is from 90 percent to 105 percent. As a result of debt reduction, the 

Department of the Treasury does not currently issue 30-year Treasury securities.

Timing of plan contributions

In general, plan contributions required to satisfy the funding rules must be made within 

81⁄2 months after the end of the plan year. If the contribution is made by such due date, the 

contribution is treated as if it were made on the last day of the plan year.

In the case of a plan with a funded current liability percentage of less than 100 percent for 

the preceding plan year, estimated contributions for the current plan year must be made in 

quarterly installments during the current plan year. The amount of each required installment is 

25 percent of the lesser of (1) 90 percent of the amount required to be contributed for the current 

plan year or (2) 100 percent of the amount required to be contributed for the preceding plan 

year.18

PBGC premiums

Because benefits under a defined benefit pension plan may be funded over a period of 

years, plan assets may not be sufficient to provide the benefits owed under the plan to employees 

and their beneficiaries if the plan terminates before all benefits are paid. In order to protect 

employees and their beneficiaries, the Pension Benefit Guaranty Corporation (“PBGC”) 

generally insures the benefits owed under defined benefit pension plans. Employers pay 

premiums to the PBGC for this insurance coverage.

In the case of an underfunded plan, additional PBGC premiums are required based on the 

amount of unfunded vested benefits. These premiums are referred to as “variable rate

premiums.” In determining the amount of unfunded vested benefits, the interest rate used is 

85 percent of the interest rate on 30-year Treasury securities for the month preceding the month 

in which the plan year begins.

 

17 The interest rate used under the plan must be consistent with the assumptions which 

reflect the purchase rates which would be used by insurance companies to satisfy the liabilities 

under the plan (section 412(b)(5)(B)(iii)(II)).

18 No additional quarterly contributions are due once the plan’s funded current liability 

percentage for the plan year reaches 100 percent.
35

Special interest rate for 2002 and 2003

Section 405 of the Job Creation and Worker Assistance Act of 2002,19 enacted March 9, 

2002, provides a special interest rate rule applicable in determining the amount of additional 

contributions for plan years beginning after December 31, 2001, and before January 1, 2004 (the 

“applicable plan years”).20

The special rule expands the permissible range of the statutory interest rate used in 

calculating a plan’s current liability for purposes of applying the additional contribution 

requirements for the applicable plan years. The permissible range is from 90 percent to 

120 percent for these years. Use of a higher interest rate under the expanded range will affect the 

plan’s current liability, which may in turn affect the need to make additional contributions and 

the amount of any additional contributions.

Because the quarterly contributions requirements are based on current liability for the 

preceding plan year, a special rule is provided for applying these requirements for plan years 

beginning in 2002 (when the expanded range first applies) and 2004 (when the expanded range 

no longer applies). In each of those years (“present year”), current liability for the preceding 

year is redetermined, using the permissible range applicable to the present year. This 

redetermined current liability will be used for purposes of the plan’s funded current liability 

percentage for the preceding year, which may affect the need to make quarterly contributions and 

for purposes of determining the amount of any quarterly contributions in the present year, which 

is based in part on the preceding year. 

Explanation of Provision

Under the provision, the special interest rate rule for 2002 and 2003 applies also in 

determining the amount of additional contributions for the 2001 plan year that must be 

contributed to the plan within 81⁄2 months after the end of the plan year (e.g., by September 15, 

2002). The provision does not affect quarterly contributions required to be made for the 2001 

plan year.21

 

19 Pub. L. No. 107-147.

20 Under a related special rule, the interest rate used in determining the amount of 

unfunded vested benefits for PBGC variable rate premium purposes is increased to 100 percent 

of the interest rate on 30-year Treasury securities for the month preceding the month in which the 

applicable plan year begins.

21 The provision also makes conforming changes to the special rule for PBGC variable 

rate premiums so that (1) the special rule applies for purposes of notices and reporting required 

with respect to underfunded plans and (2) a similar special rule will apply in the case of the 

issuance of a new mortality table by the Department of Treasury.
36

Effective Date

The provision is effective as if included in section 405 of the Job Creation and Worker 

Assistance Act of 2002.
37

L. Provisions Relating to Plan Amendments

(sec. 217 of the bill)

Present Law

Plan amendments to reflect amendments to the law generally must be made by the time 

prescribed by law for filing the income tax return of the employer for the employer’s taxable 

year in which the change in law occurs.

Explanation of Provision

The provision permits certain plan amendments made pursuant to the changes made by 

title II of the bill or by title VI of the Economic Growth and Tax Relief Reconciliation Act of 

2001 (or regulations issued thereunder) to be retroactively effective. If the plan amendment 

meets the requirements of the bill, then the plan will be treated as being operated in accordance 

with its terms and the amendment will not violate the prohibition of reductions of accrued 

benefits for purposes of the Internal Revenue Code. In order for this treatment to apply, the plan 

amendment is required to be made on or before the last day of the first plan year beginning on or 

after January 1, 2005 (January 1, 2007, in the case of a governmental plan). If the amendment is 

required to be made to retain qualified status as a result of the changes in the law (or 

regulations), the amendment is required to be made retroactively effective as of the date on 

which the change became effective with respect to the plan and the plan is required to be 

operated in compliance until the amendment is made. Amendments that are not required to 

retain qualified status but that are made pursuant to the changes made by the bill or the 2001 Act 

(or applicable regulations) could be made retroactive as of the first day the plan is operated in 

accordance with the amendment. 

A plan amendment will not be considered to be pursuant to the bill or the 2001 Act (or 

applicable regulations) if it has an effective date before the effective date of the provision of the 

bill or Act (or regulations) to which it related. Similarly, the provision does not provide relief 

from section 411(d)(6) for periods prior to the effective date of the relevant provision (or 

regulations) or the plan amendment.

The Secretary is authorized to provide exceptions to the relief from the prohibition on 

reductions in accrued benefits. It is intended that the Secretary will not permit inappropriate 

reductions in contributions or benefits that are not directly related to the provisions of the bill or 

the 2001 Act. For example, it is intended that a plan that incorporates the section 415 limits by

reference can be retroactively amended to impose the section 415 limits in effect before the 2001 

Act.22 On the other hand, suppose a plan incorporates the section 401(a)(17) limit on 

compensation by reference and provides for an employer contribution of three percent of 

 

22 See also, section 411(j)(3) of the Job Creation and Worker Assistance Act of 2002, 

which provides a special rule for plan amendments adopted on or before June 30, 2002, in 

connection with the Economic Growth and Tax Relief Reconciliation Act of 2001 (the “2001 

Act”), in the case of a plan that incorporated the section 415 limits by reference on June 7, 2001, 

the date of enactment of the 2001 Act.
38

compensation. It is expected that the Secretary will provide that the plan cannot be amended 

retroactively to reduce the contribution percentage for those participants not affected by the 

section 401(a)(17) limit, even though the reduction will result in the same dollar level of 

contributions for some participants because of the increase in compensation taken into account 

under the plan as a result of the increase in the section 401(a)(17) limit under the 2001 Act. As 

another example, suppose that under present law a plan is top-heavy and therefore a minimum 

benefit is required under the plan, and that under the provisions of the 2001 Act, the plan is not 

be considered to be top-heavy. It is expected that the Secretary will generally permit plans to be 

retroactively amended to reflect the new top-heavy provisions of the 2001 Act.

Effective Date

The provision is effective on the date of enactment.
39

TITLE III: STOCK OPTIONS

A. Exclusion of Incentive Stock Options and Employee Stock Purchase Plan 

Stock Options from Wages (sec. 301 of the bill and secs. 421(b), 423(c), 

3121(a), 3231, and 3306(b) of the Code)

Present Law

Generally, when an employee exercises a compensatory option on employer stock, the 

difference between the option price and the fair market value of the stock (i.e., the “spread”) is 

includible in income as compensation. In the case of an incentive stock option or an option to 

purchase stock under an employee stock purchase plan (collectively referred to as “statutory 

stock options”), the spread is not included in income at the time of exercise.23 

If the statutory holding period requirements are satisfied with respect to stock acquired 

through the exercise of a statutory stock option, the spread, and any additional appreciation, will 

be taxed as capital gain upon disposition of such stock. Compensation income is recognized, 

however, if there is a disqualifying disposition (i.e., if the statutory holding period is not 

satisfied) of stock acquired pursuant to the exercise of a statutory stock option. Compensation 

income is also recognized in the case of a qualifying disposition of employee stock purchase plan 

stock if the option price reflected a discount. 24 Even though compensation income is recognized 

upon such dispositions, employers are generally not required to withhold income taxes.

Federal Insurance Contribution Act (“FICA”) and Federal Unemployment Tax Act 

(“FUTA”) taxes (collectively referred to as “employment taxes”) are generally imposed in an 

amount equal to a percentage of wages paid by the employer with respect to employment. 25 The 

applicable Code provisions26 do not provide a specific exception from FICA and FUTA taxes for 

wages paid to an employee arising from the exercise of a statutory stock option, i.e., for the 

excess of the fair market value of the stock at the time of exercise over the amount paid for the 

stock by the individual.

In 1971, the Internal Revenue Service issued a revenue ruling addressing the withholding 

obligations of a company upon the exercise of a qualified stock option (the predecessor to 

incentive stock options).27 The ruling concluded that there is no payment of wages for purposes 

 

23 Sec. 421.

24 The amount that must be included in income is the lesser of (1) the excess of the fair 

market value of the stock at the time of disposition over the amount paid for the stock, or (2) the 

excess of the fair market value of the stock at the time the option was granted over the option 

price.

25 Secs. 3101, 3111 and 3301.

26 Secs. 3121 and 3306.

27 Rev. Rul. 71-52, 1971-1 C.B. 278.
40

of FICA, FUTA, or income tax withholding at the time of exercise. There has been uncertainty 

as to the extent to which a similar result applies on exercise of an incentive stock option or 

employee stock purchase plan.

In January 2001, the Internal Revenue Service issued notice of its intent to clarify, 

through future guidance, the application of FICA, FUTA, and Federal income tax withholding to 

statutory stock options.28 The notice provided that in the case of a statutory stock option 

exercised before January 1, 2003, the IRS would not assess FICA or FUTA taxes upon the 

exercise of the option and would not treat the disposition of stock acquired pursuant to the 

exercise of a statutory stock option as subject to Federal income tax withholding. The notice 

also provided that the Internal Revenue Service would honor claims for refunds of FICA and 

FUTA taxes paid. The notice also concluded that Revenue Ruling 71-52 is obsolete and that its 

holding does not apply to the exercise of statutory stock options. 

Proposed Treasury regulations issued in November 2001 provide that the payment of 

FICA and FUTA taxes upon the exercise of statutory stock options will apply to the exercise of 

statutory stock options on or after January 1, 2003. Federal income tax withholding is not 

required under the proposed regulations. Consistent with Notice 2001-14, the Internal Revenue 

Service will not assess FICA or FUTA taxes upon the exercise of a statutory stock option before 

2003.

Explanation of Provision

The provision provides specific exclusions from FICA and FUTA wages for 

remuneration on account of the transfer of stock pursuant to the exercise of an incentive stock 

option or under an employee stock purchase plan, or any disposition of such stock. Thus, under 

the provision, FICA and FUTA taxes do not apply upon the exercise of a statutory stock option. 29 

The provision also provides that such remuneration is not taken into account for purposes of 

determining Social Security benefits.

Additionally, the provision provides that Federal income tax withholding is not required 

on a disqualifying disposition, nor when compensation is recognized in connection with an 

employee stock purchase plan discount. Present law reporting requirements continue to apply.

Effective Date

The provision applies to stock acquired pursuant to statutory stock options exercised after 

the date of enactment. It is expected that Treasury and the Internal Revenue Service will not 

attempt to collect FICA or FUTA taxes attributable to exercises of statutory stock options before 

the effective date. 

 

28 Notice 2001-14, 2001-6 I.R.B. 516.

29 The provision also provides a similar exclusion for wages under the Railroad 

Retirement Tax Act. 
41

TITLE IV: SOCIAL SECURITY HELD HARMLESS

A. No Impact on Social Security and Medicare Trust Funds

(sec. 401 of the bill)

Present Law

Present law provides for the transfer of employment taxes and self-employment taxes to 

the Social Security and Medicare trust funds. In addition, the income tax collected with respect 

to a portion of Social Security benefits included in gross income is transferred to the Social 

Security and Medicare trust funds.

Explanation of Provision

Under the bill, the amounts transferred to the Social Security and Medicare trust funds 

are determined as if the bill is not enacted. Thus, there will be no reduction in transfers to these 

funds as a result of the bill. 

Effective Date

The provision is effective on the date of enactment.