Source: https://www.thetaxadviser.com/issues/2008/dec/currentdevelopmentsinemployeebenefitsandpensions-partii.html
Timestamp: 2019-04-19 10:14:21+00:00

Document:
By Deborah Walker, CPA; Stephen LaGarde, J.D.; and Mark Neilio, J.D.
Rev. Proc. 2008-50 updated the rules for the Employee Plans Compliance Resolution System (EPCRS), under which qualified plan sponsors correct plan qualification failures and avoid plan disqualification.
The IRS issued proposed regulations dealing with automatic enrollment arrangements, employer stock diversification, and cash balance and other hybrid plans.
In Notice 2008-30, the IRS provided guidance on changes, including ones made by the Pension Protection Act of 2006, affecting qualified plan distributions.
This two-part article provides an overview of current developments in employee benefits, including executive compensation, welfare benefits, and qualified plans. Part I, in the November issue, focused on executive compensation and benefits. Part II focuses on new guidance regarding qualified retirement plans.
The IRS published the first update to the Employee Plans Compliance Resolution System (EPCRS) in over two years on September 2, 2008. EPCRS allows plan sponsors to correct plan qualification failures without suffering the severe consequences of plan disqualification. Rev. Proc. 2008-5044 retains the basic structure and operation of EPCRS but adds several new correction methods for common plan qualification failures and makes numerous, mostly liberalizing, technical and procedural changes. These changes are effective January 1, 2009, but may be relied upon voluntarily beginning September 2, 2008.
Appendix A and Appendix B 45 in Rev. Proc. 2008-50 specify that, where an employee makes a 401(k) elective deferral and that election is not honored, the missed deferral is based on the deferral percentage that the employee attempted to elect, rather than on the average for his or her group.
Another new method of correction provided in Appendix A involves a failure to provide catch-up contributions. To the extent an employee is improperly excluded from making a catch-up contribution, the correction is a qualified nonelective contribution (QNEC) equal to 50% of the missed deferral, but for this purpose the missed deferral is defined as one-half of the catch-up contribution limit in effect for the year of failure.
To illustrate, if an employee is excluded from the ability to make catchup contributions during 2007 (when the catch-up contribution limit was $5,000), the missed deferral is equal to $2,500 and the missed deferral opportunity (and therefore the required QNEC) is $1,250. The QNEC must be adjusted for earnings through the date of correction.
Rev. Proc. 2006-27, 46 the last update of EPCRS, specifically stated that the method for correcting the failure to include an otherwise eligible employee in a 401(k) plan did not apply to a plan that allowed participants to make designated Roth contributions. Rev. Proc. 2008-50 now allows the same correction method to be used regardless of whether Roth contributions are available. The corrective QNEC, however, does not enjoy the benefits of a Roth contribution. Instead, it is excluded from income, and distributions are taxable.
Rev. Proc. 2008-50 retains the principle that an actual deferral percentage (ADP) test failure must be corrected before the correction of improper exclusions, but it clarifies that the ADP test is performed without considering the improperly omitted participants. The test results (reflecting any required corrections) are then used to calculate the excluded individual's missed deferrals. After that, the test is not run again. The same rule applies if the employee's deferral election was not honored.
Rev. Proc. 2008-50 allows a defaulted loan that originally had a shorter term than the maximum permitted by Sec. 72(p) (five years except in the case of a loan whose proceeds are used to acquire a principal place of residence) to be reamortized over the longest period for which it could have been taken. Hence, in the case of the typical participant loan with a maximum term of five years, the loan may be reamortized over any term that ends no later than five years from the date of original issuance.
In addition, loans made by a plan that lacks Sec. 72(p) language (or even without any provision for loans at all) may now be corrected under EPCRS, although, as Rev. Proc. 2008-50 observes, they may result in fiduciary violations or prohibited transactions that will have to be dealt with separately under the rules established by the Department of Labor (DOL). Rev. Proc. 2008-50 also states that the maximum payment amount (the basis for negotiating sanctions under the Audit Closing Agreement Program (Audit CAP)) will now include the amount of income tax that will be due under Sec. 72(p) if a loan failure is discovered upon examination and corrected through the Audit CAP process. While not stated explicitly, because Audit CAP sanctions are paid exclusively by the employer, this presumably means that the participant will be excused from the income tax consequences normally associated with loan failures.
If the plan contains a rule under which the excess can be reallocated to other participants' accounts, it must be reallocated.
To the extent the excess is solely attributable to elective deferrals or employee after-tax contributions, it must be returned to the participants, with attributable earnings. If the plan provides for both types of contribution, after-tax contributions are returned first.
If the plan provides for matching contributions, unmatched after-tax contributions and elective deferrals are returned first. If returning unmatched after-tax contributions and deferrals is insufficient to correct the violation, the remaining excess must be apportioned between the deferrals or after-tax contributions and the match (based on the match formula). The deferrals and after-tax contributions are returned, and the attributable match is forfeited and used to reduce future employer contributions.
Rev. Proc. 2008-50 revises the definitions of the key terms "excess amount" and "overpayment" and coins a new term, "excess allocation."
An excess amount includes any allocation in a defined contribution plan that exceeds either (1) a specific statutory limit or (2) the amount that can be allocated to a participant's account under the terms of the plan. The revised definition specifically excludes defined benefit plans (except for allocations of after-tax contributions to a separate account under such a plan) and, unlike the prior definition, does not include overpayments.
An excess allocation is an excess amount for which the Code and regulations do not provide a specific correction mechanism. For example, an allocation to a participant that exceeds the amount permitted under the plan's terms is both an excess amount and an excess allocation, but elective deferrals in excess of the limits under Sec. 402(g) would only be an excess amount (because the Code permits these deferrals to be corrected by distributing them to the participant).
If there is an excess allocation to a participant's account under a plan, it is to be corrected in the same manner as a Sec. 415 violation, as described above.
An overpayment is any distribution that exceeds the amount payable to a participant or beneficiary under the terms of the plan or that exceeds a statutory limit. Thus, a distribution from a defined contribution plan that includes an excess amount, or from a defined benefit plan that is greater than the recipient is entitled to under the terms of the plan, is an overpayment. An improper in-service distribution (such as a purported hardship distribution that does not meet the conditions of Sec. 401(k)(2)) is also an overpayment, although this conclusion is not stated clearly and must be inferred from the discussion of correction methods.
To correct an overpayment, the employer must take reasonable steps to recover it from the participant and must notify him or her that the overpayment is not eligible for favorable tax treatment. If the participant does not repay, the employer is required to reimburse the plan for the unrecovered amount, which is then allocated to other participants or applied to reduce future employer contributions. Presumably, no reimbursement is necessary if the overpayment results from a premature inservice distribution because the plan suffers no loss in that case. Rev. Proc. 2008- 50 does not, however, address that point.
In the case of an overpayment resulting from an improper in-service distribution, the plan sponsor shows good cause why relief should be granted.
The IRS may waive the 10% additional income tax on premature distributions under Sec. 72(t) if the participant repays the plan, although it may require the plan sponsor to pay an additional VCP fee equal to part or all of the forgone tax. This relief is available only for improper in-service distributions.
Under Rev. Proc. 2008-50, corrective distributions need not be made to participants who are entitled to no more than $75 (increased from $50). Overpayments and excess amounts of $100 or less may be left uncorrected (same threshold as before, but now available for self-correction as well as VCP and Audit CAP).
Rev. Proc. 2008-50 allows employers to use the Department of Labor's online Voluntary Fiduciary Correction Program (VFCP) calculator 48 as a proxy for a reasonable interest rate, but only where the plan sponsor cannot conveniently avail itself of the other methods for calculating earnings.
Schedule 1: Failure to timely adopt an interim or a discretionary amendment.
Schedule 2: Failure to timely adopt amendments with respect to legislative or regulatory changes.
Schedule 3: For a SEP or SARSEP, certain failures resulting from eligibility, ADP, contributions, excluded amounts, and excess amounts. This schedule also includes the necessary language to request a waiver of excise tax.
Schedule 4: For a SIMPLE IRA, certain failures resulting from eligibility, contributions, excluded amounts, and excess amounts. This schedule also includes the necessary language to request a waiver of excise tax.
Schedule 5: Plan loan failures resulting from noncompliance with Sec. 72(p)(2).
Schedule 6: For 401(k) and 403(b) plans, an employer eligibility failure.
Schedule 7: Failure to distribute Sec. 402(g) excess deferrals.
Schedule 8: Failure to pay Sec. 409(a) required minimum distributions.
Schedule 9: Various failures (disregard of Sec. 401(a)(17) compensation limitations, hardship distributions or plan loans that do not comply with plan documents, or premature inclusion of employees in the plan) that are corrected by a plan amendment conforming the plan to its administrative practices.
If a determination letter request is made as part of a VCP application or an Audit CAP settlement, Rev. Proc. 2008- 50 clarifies that the plan will be reviewed based on the current cumulative list and must therefore be updated to reflect the requirements on the list. Rev. Proc. 2008- 50 also provides that a failure to adopt an interim amendment must be corrected before the submission of a VCP application (that is, the VCP application must contain an executed interim amendment). This is an exception to the normal rule that allows corrections to be implemented after receiving IRS approval.
Rev. Proc. 2008-50 clarifies that although only a limited number of failures may be self-corrected under the Self-Correction Program (SCP) by adopting a retroactive plan amendment that conforms the plan's terms to actual operation, a plan sponsor otherwise eligible for self-correction will not be precluded from using the SCP merely because it must adopt such an amendment to allow a correction to be implemented. A common example is an amendment to authorize QNECs, which can then be contributed to correct an ADP failure.
The employer contribution requirement can be satisfied in either of two ways. One way is for the employer to make a 3% nonelective contribution on behalf of each nonhighly compensated employee who is eligible to participate in the automatic enrollment feature. The other way is for the employer to make matching contributions to eligible nonhighly compensated employees on a dollar-for-dollar basis up to 1% of compensation, and then on a 50-cent-per-dollar basis up to 6% of compensation.
The rate of matching contribution for any rate of elective deferral by a highly compensated employee may be no greater than the rate of matching contribution for the same rate of elective deferral by a nonhighly compensated employee.
One concern some plan sponsors had with automatic enrollment was that automatic enrollees would opt out after a short period of time, leaving the plan with many small accounts to administer. As a result, the PPA created a special rule permitting plans to distribute "erroneous automatic contributions" within 90 days of an automatic enrollee's first elective contribution (see Sec. 414(w)). These corrective distributions are treated as compensation rather than as plan distributions. As a result, otherwise applicable withdrawal restrictions and the 10% penalty tax on early withdrawals do not apply. In addition, these "erroneous automatic contributions" do not count for nondiscrimination testing purposes.
The uniformity requirement for EACAs is like the uniformity requirement for QACAs. As a result, the proposed regulations would allow the same differences in contribution rates for EACAs as are permitted for QACAs. The notice requirement for EACAs also is similar to the notice requirement for QACAs. Thus, the proposed regulations would apply the same timing rules to the EACA notice that are applied to the QACA notice.
Effective date: The QACA and EACA rules are effective for plan years beginning on or after January 1, 2008. Likewise, the IRS's regulations are proposed to be effective for plan years beginning on or after January 1, 2008. Until the IRS issues final regulations, plans may rely on the proposed regulations.
On November 15, 2007, the IRS issued a sample participant notice that 401(k) plans can use to satisfy the notice requirements for QACAs, EACAs, and QDIAs. The sample notice is available on the IRS's website at www.irs.gov/pub/irs-tege/sample_notice.pdf.
The IRS published final regulations under Sec. 403(b) in July 2007.62 These regulations reflected numerous amendments made to Sec. 403(b) over the past several decades and provided comprehensive guidance under Sec. 403(b), including the requirement that Sec. 403(b) contracts must be maintained under a written plan.
Subsequently, the IRS issued model plan language for use by public schools adopting a written plan, or amending an existing plan, to comply with the final regulations under Sec. 403(b).63 The adoption by a public school employer of the model language on a word-for-word basis, or the use of language that is substantially similar in all material respects, will be treated as meeting the requirements of Sec. 403(b).
Plans must be amended to comply with the final regulations no later than the first day of the first tax year beginning after December 31, 2008. For calendar tax years, the deadline would be January 1, 2009. To maintain Sec. 403(b) status, the plan must be operated in accordance with the plan language from the effective date of the language, and the plan must continue to satisfy all other requirements of Sec. 403(b).
Any public school employer may comply with the written plan requirements of the 2007 regulations by adopting the IRS model provisions. A public school employer's plan will be treated as meeting the requirements of Sec. 403(b) to the extent the model language is adopted. The adoption of all the model language by a public school has the same status as a private letter ruling stating that the plan satisfies Sec. 403(b). To obtain this reliance, the employer must adopt the model language word for word or use language that is substantially similar in all material respects.
Other employers may use the IRS model language to comply with Sec. 403(b), but adoption by such employers does not carry the same level of reliance because additional or revised provisions may be necessary to comply with the final regulations.
The DOL has posted an online penalty calculator for Form 5500, Annual Return/Report of Employee Benefit Plan, filings under the Delinquent Filer Voluntary Compliance Program (DFVCP). The DFVCP provides eligible late Form 5500 filers the opportunity to avoid DOLassessed civil penalties by voluntarily correcting the delinquent filing and paying a reduced penalty.
In order for those items to constitute eligible indirect compensation, however, the plan administrator must have received written notice that disclosed the existence and the amount of the compensation, or the formula used to determine the amount, and the identity of the parties paying and receiving the compensation.
Persons who receive compensation other than or in addition to eligible indirect compensation are subject to more detailed disclosure, which requires that the amounts of direct and indirect compensation (excluding the eligible indirect compensation) be separately identified and reported.
The IRS has issued proposed regulations relating to new Secs. 411(a)(13) and (b)(5), which were added by PPA to enable cash balance and other hybrid plans to satisfy age discrimination and certain other qualification requirements.72 The regulations incorporate the transitional guidance provided in Notice 2007-6, 73 adopt new terminology to take into account situations in which more than one benefit formula is used by a plan, and provide additional guidance, taking into account public comments.
The regulations are proposed to be effective for plan years beginning on or after January 1, 2009 (or, if later, the effective date that applies to collectively bargained plans under PPA). However, prior to that time, plans are permitted to rely on the regulations to demonstrate compliance with Secs. 411(a)(13) and (b)(5) after the statutory effective date.
The DOL is concerned about financial institutions attempting to limit their ERISA obligations by drafting trust agreements to provide that they have no obligation to monitor or collect contributions. As a result, the DOL issued guidance outlining the interrelationship among ERISA §§402–405 and setting forth a step-bystep analysis by which fiduciaries can more clearly identify their duties to collect delinquent contributions.76 This guidance clearly states that the duties long imposed under ERISA's fiduciary framework are not abrogated by those attempts.
Toward that end, all trustees (even directed trustees) are fiduciaries who are obligated to satisfy the prudence and exclusive purpose requirements of ERISA §404(a), and a fiduciary is liable for the breach of a co-fiduciary under ERISA §405(a) if it knows of a breach by that fiduciary but fails to take action to remedy it. The DOL also observed that the obligation to collect delinquent contributions must rest with either a discretionary trustee, a directed trustee subject to the proper direction of a named fiduciary, or an investment manager and that the failure to properly assign the responsibility may cause the fiduciary responsible for the appointment to be liable for plan losses resulting from the failure to collect.
90 days from the participant contribution date for welfare plans.
Under the proposed safe harbor, participant contributions to a plan with fewer than 100 participants at the beginning of the plan year would be treated as made in compliance with the general rule (i.e., on the earliest date on which they can reasonably be segregated from the employer's general assets) if they are deposited no later than the seventh business day after the participant contribution date. As under current rules, the contributions only need to be deposited to an account of the plan and need not be allocated to specific participants or investments by that date. The proposed regulations clarify that the general rule also applies to loan repayments and that the sevenbusiness- day safe harbor will be available for loan repayments made to plans with fewer than 100 participants.
The proposal is not clear on how the number of participants will be determined, although presumably it will be by reference to the Form 5500. Likewise, the proposal is not clear on whether the number will be limited to active or will also include separated participants.
Although the regulations are not yet effective, employers are entitled to rely on them.
The IRS issued Notice 2008-3079 to provide guidance on various PPA and other changes affecting qualified plan distributions.
Direct or indirect rollover permitted: A rollover to a Roth IRA can be accomplished either by a direct rollover or by a plan distribution that is followed by a rollover within 60 days.
Taxable income: For a rollover to a Roth IRA, the individual must include in gross income the amount that would be includible if the rollover did not occur.
Early distribution tax does not apply: Even though amounts are included in gross income, the 10% early distribution tax under Sec. 72(t) does not apply to the rollover. It will apply, however, if the taxable amount rolled into the Roth IRA is distributed within five years.
$100,000 adjusted gross income limit: For 2008 and 2009, a taxpayer cannot roll over a distribution from an eligible retirement plan (other than a Roth IRA) to a Roth IRA if the taxpayer has modified adjusted gross income over $100,000 or is married and files a separate return. The taxpayer could, however, elect a rollover to a traditional IRA and, when permitted in 2010, convert the traditional IRA to a Roth IRA.
Direct rollover election required: A qualified plan must permit any distributee to elect a direct rollover to a Roth IRA (subject to existing exceptions for small amounts and multiple distributions).
Administrator not responsible for determining eligibility: The plan administrator is not responsible for determining whether the distributee is eligible to make a rollover to a Roth IRA. If the distributee is mistaken and turns out to be ineligible to make a rollover, it can be corrected by transferring it to a traditional IRA or other appropriate eligible retirement plan before the due date of the individual's income tax return.
Withholding not required in direct rollover: Direct rollovers to Roth IRAs, like other direct rollovers, are not subject to the 20% mandatory tax withholding requirements, even though the rollover results in taxable income to the distributee. Voluntary withholding is permissible.
Existing optional joint and survivor annuity may be sufficient: A plan that already provides a compliant optional joint and spouse survivor annuity, with the survivor percentage required for the QOSA, and that is at least actuarially equivalent to the single life annuity payable under the plan will satisfy the requirement. In this case, the plan need not be amended (nor its administrative procedures modified) to designate the optional form as a QOSA.
The QOSA need not be actuarially equivalent to the QJSA: The QOSA must be at least actuarially equivalent to the single life annuity payable at the same time and need not be actuarially equivalent to a more valuable QJSA.
Spousal consent may or may not be required: Where the QOSA is actuarially equivalent to the QJSA, no spousal consent is required for the participant to elect it; however, where the QJSA is more valuable, spousal consent is required.
Existing written explanation requirements apply: The QOSA is an optional form of benefit, and the written explanation requirements of Regs. Sec. 1.417(a)(3)-1 apply. The written explanation need not identify the QOSA by that name.
There is no requirement to provide QPSA based on the QOSA: There is no requirement that an alternative to the qualified preretirement survivor annuity (QPSA) be offered based on the QOSA.
2009 PPA deadline applies for amendments but there is no Sec. 411(d)(6) relief: Amendments implementing the QOSA need not be adopted until the end of the PPA amendment period (generally, the last day of the plan year beginning on or after January 1, 2009) and will be retroactively effective as of the PPA effective date as long as the plan is operated in accordance during the interim period. However, the anti-cutback provision of Sec. 411(d)(6) still applies, so the elimination of a distribution form or subsidy in connection with the implementation of a QOSA would need to satisfy Sec. 411(d)(6) and could not be adopted retroactively.
A formula using the more favorable of pre- and post-PPA present value will comply: The requirement that a plan's QJSA be "at least as valuable" as any other form of benefit will not be violated if the amount payable under a form of benefit subject to Sec. 417(e) is calculated as the "more favorable of" that determined using pre-PPA interest and mortality assumptions and that determined using post-PPA interest and mortality assumptions. This special treatment expires at the end of the amendment period specified under PPA §1107(b)(2)(A) (generally the last day of the 2009 plan year or, if earlier, the date the amendment is adopted).
A second plan amendment may qualify for PPA amendment period: Although PPA §1107 provides a general deadline of the last day of the 2009 plan year for the adoption of amendments to comply with PPA, the deadline expires on the date the amendment is adopted, if earlier. Subsequent amendments for the particular PPA provision are not treated as adopted under PPA §1107 (and are subject to the deadlines otherwise applicable to the adoption amendments and the limitations of Sec. 411(d)(6)).
An amendment that provides for using the more favorable of the pre-PPA and post-PPA interest and mortality assumptions would constitute a PPA amendment for this purpose, thereby ending the PPA amendment period for that change. To avoid problems, the IRS established the rule that, in order to determine whether an amendment that implements the PPA applicable interest rate and applicable mortality table is the first amendment, amendments adopted on or before June 30, 2008, will be disregarded.
Therefore, if the plan is amended to provide the "greater of" formula on or before June 30, 2008, and is later amended to provide only the PPA formula, the latter amendment will qualify for the PPA amendment period and related Sec. 411(d)(6) relief provided under PPA §1107. The same relief applies to plan amendments that replace a plan reference to a pre-PPA interest or mortality assumptions with the PPA interest or mortality assumption, regardless of whether PPA requires such an amendment.
Cycle B and C plans must include gap earnings provisions: Plans submitted in remedial amendment Cycle B (February 1, 2007–January 31, 2008) or Cycle C (February 1, 2008–January 31, 2009) are required to provide for the distribution of gap earnings. A sponsor of a plan submitted prior to March 24, 2008, that does not provide for gap earnings will be asked to amend the plan to so provide.
Interim amendment not required: An interim amendment to provide for gap earnings is not required to be adopted until the last day of the first plan year beginning on or after January 1, 2009; however, the plan must be in operational compliance and distribute gap earnings with excess deferrals effective for excess deferrals attributable to tax years beginning on or after January 1, 2007.
This article does not constitute tax, legal, or other advice from Deloitte Tax LLP, which assumes no responsibility with respect to assessing or advising the reader as to tax, legal, or other consequences arising from the reader's particular situation. Copyright © 2008 Deloitte Development LLC. All rights reserved.
Deborah Walker is a tax partner at Deloitte Tax LLP in Washington, DC. Stephen LaGarde and Mark Neilio are tax managers at Deloitte Tax LLP in Washington, DC. For more information about this article, contact Ms. Walker at debwalker@deloitte.com, Mr. LaGarde at slagarde@deloitte.com, or Mr. Neilio at mneilio@deloitte.com.
44 Rev. Proc. 2008-50, 2008-35 I.R.B. 464.
45 Appendix A and Appendix B of Rev. Proc. 2008-50 contain guidance on methods of correction that are deemed acceptable under EPCRS for certain specified failures.
46 Rev. Proc. 2006-27, 2006-22 I.R.B. 945.
47 See prior Regs. Sec. 1.415-6(b)(6).
49 Pension Protection Act of 2006, P.L. 109-280.
54 Prop. Regs. Sec. 1.401(k)-3(j)(2)(iii).
58 Prop. Regs. Sec. 1.414(w)-1(b).
59 Prop. Regs. Sec. 1.414(w)-1(c).
60 Prop. Regs. Sec. 1.414(w)-1(d)(1).
61 Prop. Regs. Sec. 1.414(w)-1(d)(2).
63 Rev. Proc. 2007-71, 2007-51 I.R.B. 1184.
65 Regs. Secs. 1.401(a)(35)-1(b), (c).
70 RIN 1210-AB06, 72 Fed. Reg. 64710 (11/16/07).
73 Notice 2007-6, 2007-3 I.R.B. 272.
75 Rev. Rul. 2008-7, 2008-7 I.R.B. 419.
76 Field Assistance Bulletin No. 2008-01 (2/1/08).
77 RIN 1210-AB02, 73 Fed. Reg. 11072 (2/29/08).
78 DOL Regs. Sec. 2510.3-102(a).
79 Notice 2008-30, 2008-12 I.R.B. 638.
80 Sec. 408A(e), as amended by PPA §824.
81 Sec. 417(a)(1)(A), as amended by PPA §1004.
82 Sec. 417(e)(3), as amended by PPA §302.
83 Regs. Sec. 1.401(a)-20, Q&A-16.

References: §404
 §405
 §1107
 §1107
 §1107
 §1107
 §824
 §1004
 §302