Source: https://www.thetaxadviser.com/issues/2010/dec/walker-dec10.html
Timestamp: 2019-04-23 12:34:59+00:00

Document:
Health care reform legislation passed in 2010 included a provision that limits the deduction for compensation paid by health insurance providers to certain executive employees.
In Notice 2010-6, the IRS provides methods for taxpayers to voluntarily correct certain types of failures to comply with the document requirements of Sec. 409A. The notice includes specific methods for correcting plan provisions and the eligibility requirements to use them.
The IRS issued final regulations (T.D. 9471) that contain a comprehensive set of rules governing stock options issued under an employee stock purchase plan. The IRS also issued final regulations (T.D. 9470) that set out return and information statement requirements for stock acquired through the exercise of an incentive stock option or an option granted under an employee stock purchase plan.
The Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act provides employers an opportunity to amortize pension funding shortfalls over a longer period.
This two-part article covers significant developments in late 2009 and 2010 in employee benefits, including executive compensation, health and welfare benefits, qualified plans, and employment taxes. Part I, in the November issue, contained updates on employment taxes and an overview of the health care reform legislation. Part II focuses on guidance released and changes to the rules for executive compensation and qualified plans.
The health care reform legislation (PPACA) 1 transforms the nation’s health care system and changes the compensation structure of corporate executives in the health care industry. As part of generating revenue to help offset the cost of health care reform, PPACA, among other revenue provisions, limited the deduction for compensation for services provided by most individuals to a covered health insurance provider to $500,000 per year. 2 Prior to 2012, a “covered health insurance provider” is any employer qualifying as a health insurance provider that receives premiums for providing health insurance coverage. After 2012, an employer is a covered health insurance provider for a year if at least 25% of the provider’s gross premium income is derived from health insurance plans that meet the minimum essential coverage requirements in the legislation. In determining a covered health insurance provider, the controlled group aggregation rules (Secs. 414(b), (c), (m), or (o)) apply, but only to parent-subsidiary controlled groups, not to brother-sister controlled groups. 3 Employers with self-insured plans are not considered covered health insurance providers.
The deduction limits apply to compensation attributable to services performed by an applicable individual. Applicable individuals include all officers, employees, directors, and other workers or service providers (such as nonemployee independent contractors) performing services for or on behalf of a covered health insurance provider. Thus, the deduction restrictions will apply to any individual providing compensated services to a covered health insurance provider, not just the top executives.
The deduction limits apply to both current and deferred compensation. The limit that applies to deferred compensation earned in a year is equal to the $500,000 limit for that year reduced by the amount of current compensation paid. Thus, if an employee receives a salary of $400,000 in 2013, the deduction for deferred compensation attributable to the same year is limited to $100,000 in the year in which the compensation is otherwise deductible. In this example, deferred compensation for that year that exceeds $100,000 will not be deductible in the year paid.
The limit is based on the year in which compensation is earned, rather than the year in which the deduction is claimed. A limit based on when compensation is earned requires determination of the period to which compensation is attributable and has the effect of limiting deductions for both current and former service providers. It will also have the effect of limiting deductions for compensation earned when the company is considered a health insurance provider, even if the company ceases to be a health insurance provider by the time the compensation is paid.
The limit applies to compensation to any individual service provider, including independent contractors as well as all employees, rather than just the chief executive officer and highest three officers, as disclosed in Securities and Exchange Commission (SEC) filings.
The deduction limitations apply to covered insurance providers, regardless of whether the provider is a publicly held corporation that is subject to SEC registration requirements.
The deduction limits apply to compensation paid by all entities within the insurer’s parent subsidiary controlled group. For this purpose, controlled group status is determined using rules similar to those for determining controlled group status for qualified plans.
Some of the exceptions for performance-based compensation and commission compensation are inapplicable.
These limits are effective for remuneration paid in tax years beginning after 2012 for services performed after 2009. Thus, the limits will apply to current compensation paid in years after 2012 but will apply to deferred compensation earned after 2009 and paid after 2012.
Although Sec. 409A was signed into law in 2004, the IRS continues to issue guidance to ease the burden of complying with the new nonqualified deferred compensation (NQDC) rules. On January 5, 2010, the IRS issued Notice 2010-6, 4 which provides methods for taxpayers to voluntarily correct certain types of failures to comply with the document requirements of Sec. 409A. The notice addresses eligibility and provides methods for correcting plan provisions that do not comply with Sec. 409A(a) plan document requirements. In some cases, plans may be corrected without service providers having to include amounts in income under Sec. 409A, while in other cases as much as 50% of the amount deferred under the plan must be included in income, subject to the 20% additional income tax rate (although not the additional premium interest tax). In addition, taxpayers taking advantage of the correction program are generally required to attach a statement to their tax returns.
Correction under the notice isolates the document failure to the year of correction so that it will not taint prior years. Notice 2010-6 also modifies Notice 2008-113 5 (providing relief for certain operational failures to comply with Sec. 409A) and Notice 2008-115 6 (providing guidance on Sec. 409A reporting and withholding requirements for 2008 and subsequent years). In particular, the modifications clarify treatment of correction of distributions involving transfers of stock or other property and coordination of repayment with adjustments to withholding.
Taxpayers may rely on Notice 2010-6 for tax years beginning on or after January 1, 2009. The modifications to Notice 2008-113 are effective for service provider tax years beginning on or after January 1, 2010, but may be relied upon for service provider tax years beginning before this date.
In particular, if a plan is eligible for correction under this notice and is corrected on or before December 31, 2010, the plan may be treated as having been corrected on January 1, 2009, and any income inclusion that would otherwise be required is waived, provided that any payment made before December 31, 2010, that would not have been made under the amended provision (or any payment not made before December 31, 2010, that would have been made under the amended provision) is treated as an operational failure and fully corrected in compliance with all the requirements of Notice 2008-113 on or before December 31, 2010.
The modifications to Notice 2008-115 are generally effective for service provider tax years beginning on or after January 1, 2009, provided that the modifications to Notice 2008-115 that are due to changes to Notice 2008-113 are effective for service provider tax years beginning on or after January 1, 2010, but may be relied upon for service provider tax years beginning before that date.
In order to be eligible for relief under Notice 2010-6, the taxpayer must satisfy general eligibility requirements, requirements for a particular correction method, and information and reporting requirements of the notice. The taxpayer has the burden of demonstrating eligibility for relief and that each of the requirements of the notice has been satisfied. A taxpayer’s eligibility for relief is subject to IRS examination. In addition to the general requirements, the notice addresses issues such as coordination of multiple failures and how to measure the amount of income to be included, to the extent required.
Notice 2010-6 does not provide relief for stock rights or plans where the time and form of payment under an NQDC plan are linked to one or more other NQDC plans or one or more qualified plans. Certain relief for discounted stock rights is set forth in Notice 2008-113. The notice provides transition relief for corrections made on or before December 31, 2011, with respect to linked NQDC plans and payment schedules determined by the timing of payments received by the service recipient. Generally, if any amounts have been paid under the plans under the pre-amendment provisions since January 1, 2009, or have failed to be paid consistent with the amended provisions, these amounts must be treated as operational failures and corrected under Notice 2008-113.
Notice 2010-6 provides significant relief for potential document failures by allowing correction in one year to address failures in prior years. This notice and Notice 2008-113 give taxpayers many opportunities to address noncompliance. While the notice provides welcome relief, it does require significant income inclusion in some cases based on post-amendment events, which may affect service providers with similar issues differently for reasons outside the control of the service provider. Similarly, the notice imposes requirements on the service recipient, such as consistency in corrections, which are outside the control of the service provider.
Many taxpayers do not appreciate the required notification and thus use other approaches to resolve Sec. 409A issues. In many cases this includes prospective clarification in conjunction with carefully constructed legal arguments for determining compliance under the old document.
Final Employee Stock Purchase Plan Regs.
On November 16, 2009, Treasury issued final regulations relating to employee stock purchase plans (ESPPs) under Sec. 423. 7 The final regulations are effective on January 1, 2010.
Generally, an ESPP is a plan that allows employees to purchase stock of their employer or its related corporations through payroll deductions. An ESPP is also permitted to allow employees to purchase employer stock at a discount, based on an exercise price that is no less than the lesser of 85% of fair market value (FMV) of the stock on the date of grant or the FMV of the stock on the date of exercise.
At all times during the period beginning on the date of grant and ending on the date three months before the exercise of the option, the individual is an employee of either the corporation granting the option or its related corporations.
If an option qualifies for tax-favored treatment, there is no income at the time of exercise, and no deduction under Sec. 162 is allowed to the employer corporation for the transfer.
ESPP requirements: The regulations clarify that the plan document requirements might be satisfied by the terms of the plan document or the terms of the offering under the plan. 8 In order for a plan to be considered an ESPP, it must provide that options will be granted only to employees of the employer corporation or its related corporations. In addition, the granting corporation’s stockholders must approve the plan within 12 months before or after the date the plan is adopted.
An option cannot be transferable other than by will or laws of descent and distribution and can be exercised only by the participant during the participant’s lifetime.
If the terms of an option are inconsistent with the terms of the plan or an offering under the plan, the option will not be treated as granted under an ESPP and thus will not be eligible for tax-favored treatment. On the other hand, an option may qualify for tax-favored treatment if it is granted under an offering with terms that comply with the ESPP requirements, even if the plan terms are inconsistent.
Other Notable Changes in the Final Regs.
Multiple offerings: More than one offering may be made under a plan, and the offerings may be consecutive or overlapping. 10 Although offerings must satisfy the ESPP requirements, offerings are not required to have identical terms.
Employees or citizens of a foreign country (without regard to whether they are also U.S. citizens or green card holders) if the grant of options to such individuals is prohibited by the laws of the foreign country or if compliance with the laws of the foreign country would cause the plan to violate the requirements of Sec. 423.
Whether the terms of a plan and offering satisfy this rule is determined on an offering-by-offering basis. As a result, the terms of each offering may provide for different exclusions of employees, but these exclusions must be applied in an identical manner to all employees of every corporation who are granted options under that particular offering.
Rights and privileges: The terms of the ESPP must provide that all the employees who are granted options have the same rights and privileges. 12 The final regulations provide an exception to this rule if, in order to comply with the laws of a foreign country, options granted to citizens or residents of a foreign country (without regard to whether they are also U.S. citizens or green card holders) are less favorable than the terms of options granted under the same plan or offering to employees who are U.S. residents. 13 This exception will not be satisfied if foreign citizens or residents are provided more favorable options. In addition, the offering-by-offering concept in the regulations applies to determine whether the equal rights and privileges requirements have been satisfied.
Maximum number of shares that may be purchased: For purposes of an ESPP, the date of grant is significant in order to determine whether the holding period to obtain tax-favored treatment under Sec. 421 has been satisfied and to determine the FMV for purposes of calculating the $25,000 limitation. The regulations provide rules for determining the date of grant based on whether the terms of the plan or offering designate the maximum number of shares that may be purchased by each employee during the offering or apply a formula on the first day of the offering to determine the maximum number of shares that may be purchased by each employee. 14 In response to comments, the regulations do not require that there be a specified number of shares to satisfy this requirement or to establish the first day of the offering period as the date of grant for an option.
Annual $25,000 limit: The terms of an ESPP must provide that no employee may be permitted to accrue the right to purchase stock under all ESPPs sponsored by the employer corporation and its related corporations at a rate that exceeds $25,000 in the FMV of the stock (determined on the date of grant) for each calendar year in which such option is outstanding at any time.15 The regulations do not impose this limit only in the year the options are first exercisable but instead provide that the ESPP limit increases by $25,000 for each calendar year during which the option is outstanding.16 If the option gives the holder the right to purchase stock in excess of the $25,000 limit, no portion of the option will be treated as granted under an ESPP, and the option will not be eligible for tax-favorable treatment. This limit applies only to options granted under an ESPP and does not limit the amount of stock an employee may purchase under other option plans.
Shareholder approval: Shareholders of the granting corporation must approve an ESPP within 12 months before or after the date the plan is adopted. 17 Generally, shareholders are not required to reapprove a plan unless there is a need to offer additional shares under the plan or there is a change in the granting corporation. Such changes will be considered the adoption of a new plan. Only the shareholders of the specific corporation adopting the plan are required to approve the plan.
On November 16, 2009, Treasury issued final regulations 18 relating to the return and information statement requirements under Sec. 6039, which, as amended, imposes return and information statement reporting requirements on any corporation that transfers stock pursuant to an individual’s exercise of an ISO or an option under an ESPP. These returns and statements are due by January 31 of the calendar year following the calendar year in which the transfer occurred. The primary objective of the final regulations is to require corporations to give employees sufficient information to enable them to calculate their tax obligations upon dispositions of shares acquired under an ESPP or under the exercise of an ISO.
The proposed regulations, issued in July 2008, waived the return requirement for 2007 and 2008. 19 The final regulations waive the return requirement for 2009. 20 Although the return requirement has been waived for these years, corporations must still give employees information statements.
The final regulations apply as of January 1, 2007. For information statements related to transfers that occurred in 2007 or 2008, taxpayers may rely on Regs. Sec. 1.6039-1 of the 2004 final regulations or Regs. Sec. 1.6039-2 of the 2008 proposed regulations. With respect to information statements related to transfers in 2009, taxpayers may rely on Regs. Sec. 1.6039-1 of the 2004 final regulations, Regs. Sec. 1.6039-2 of the 2008 proposed regulations, or these final regulations.
In addition, if the exercise price is not fixed and determinable on the date of grant, the return and information statement must also include the exercise price per share determined as if the option were exercised on the date the option was granted. 23 Note that this has been modified by the final regulations. One of the features of an ESPP is that options can be granted at up to a 15% discount. This modification takes into account options that are granted with exercise prices that are less than 100% of the FMV and where the exercise price is not fixed or determinable on the date of grant. For example, an exercise price may not be fixed or determinable when options are granted with exercise prices that are determined based on a percentage of the value on the date of exercise (for example, an exercise price equal to 85% of the FMV on the date of exercise).
The return and information statement related to a transfer under an exercise of an ISO must be furnished using a Form 3921, Exercise of a Qualified Incentive Stock Option Under Sec. 442(b) (or its designated successor); for a transfer under an exercise of an ESPP option, the required form is Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Sec. 423(c) (or its designated successor). 24 If a corporation fails to file a return or furnish an information statement, it may be subject to penalties under Secs. 6721 or 6722, respectively.
The IRS expects to release Forms 3921 and 3922 in the near future. In the interim, taxpayers may satisfy the return and information statement requirements by submitting substitute Forms 3921 and 3922 in accordance with IRS Publication 1179, General Rules and Specifications for Substitute Forms 1096, 1098, 1099, 5498, W-2G, and 1042-S (2008) (or its designated successor).
The regulations provide that when shares acquired under an ESPP are directly deposited to a brokerage account established on behalf of the employee, the first transfer of legal title occurs when the shares are transferred to the broker or financial institution immediately following the exercise of the option. 25 As a result, a corporation’s reporting obligations are triggered when the shares are deposited to the brokerage account. Under these circumstances, the date the option is exercised and the date legal title is first transferred will be the same.
If, however, a corporation issues stock directly to the employee or registers the shares in the employee’s name on its record books, and the employer or its transfer agent holds the shares for the employee in book-entry form, then this arrangement is not considered the first transfer of legal title, and the employer’s Sec. 6039 filing obligations would not be triggered. The employer would not be required to report the transfer until the first transfer of legal title, such as when the employee sells the stock or transfers it to the employee’s brokerage account. In this case, the date the option is exercised and the date legal title is first transferred will not be the same.
The regulations provide an exception to the return requirements for certain nonresident aliens. A corporation is not required to file a return for transfers pursuant to ISOs and ESPP options held by nonresident aliens. This exception applies for a nonresident alien to whom the corporation is not required to provide a Form W-2 for any calendar year during the period beginning with the first day of the calendar year in which the option was granted and ending on either the last day of the calendar year in which the ISO is exercised or, for ESPPs, the last day of the calendar year in which the employee first transferred legal title of the acquired shares. A corporation includes, but is not limited to, the corporation issuing the stock, a related corporation, any agent of the corporation, any party distributing the shares of stock or other payments in connection with the plan (for example, a brokerage firm), and any party in control of the payment of remuneration for employment to the employee. The corporation would remain obligated to provide an information statement to the nonresident alien.
The overarching purpose of the new SEC rule is to enhance information being provided to shareholders. The greater disclosure is expected to increase accountability and otherwise benefit investors. The key new requirements are as follows.
Risk arising from compensation policies and practices: Discussion is now required (separate from the compensation discussion and analysis) if the company’s compensation practices and policies for employees—not just executive officers—are “reasonably likely” to have a “material adverse effect” on the company. Smaller reporting companies are exempt from the new requirement. A company that determines that the risks are not reasonably likely to have a material adverse effect is not required to make an affirmative statement to that effect.
Aggregate grant date fair value of stock and option awards: The summary compensation table and the director compensation table must now report the aggregate grant date fair value of stock awards and option awards in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 718, Compensation—Stock Compensation. Special rules apply to awards subject to performance conditions.
Experience and qualifications: The particular experience, qualifications, attributes, or skills that led the board to conclude that the director or nominee should serve as a director.
Prior directorships: The directorships at public companies and registered investment companies that the director or nominee held at any time during the prior five years.
Legal proceedings: For each of the executive officers, directors, and nominees, disclosure must be made of the legal proceedings against the person, such as SEC securities fraud enforcement actions and other proceedings under a newly expanded list, going back ten years instead of the current five.
Diversity of directors: Disclosure must be made of whether, and if so how, a nominating committee considers diversity in identifying nominees for director. If there is a policy, how the policy is implemented and how the nominating committee or board assesses its effectiveness must be disclosed.
Board leadership structure: New disclosure is required regarding the board’s leadership structure (e.g., whether the company has combined or separated the CEO and chairman positions, why the company believes its structure is the most appropriate for it, etc.) and the board’s role in risk oversight. The company must also disclose in certain circumstances whether and why it has a lead independent director, and the role of such a director.
Fees to compensation consultants: Disclosure is required of the fees that are paid to compensation consultants and their affiliates. However, exceptions are provided for circumstances that are not likely to raise potential conflicts of interest.
Reporting shareholder votes: The results of a shareholder vote must now be reported on SEC Form 8-K, Current Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, generally within four days after the end of the meeting in which the vote was held. This Form 8-K reporting will replace the current reporting on the annual Form 10-K and quarterly Form 10-Q, which corporations often file months after the meeting.
Chief Counsel Memorandum (CCM) 200949040 28 reiterates well-established law regarding when, under an accrual method of accounting, a bonus accrual is fixed and can be taken into account for tax purposes. Under the facts, the employer established a bonus plan for nonexecutive employees by which it would award bonuses to the employees in year 1 and would pay the bonuses within the first 2½ months of the following year (i.e., year 2). However, if the award recipient was not employed on the payment date in year 2, the bonus would instead be paid to charity in year 2. The IRS concluded that because the employees were required to be employed in year 2 to receive the bonuses, the bonuses were not a fixed liability in year 1 and could not be taken into account that year. Rather, the liability became fixed when the bonuses were actually paid to the individuals who remained employed on the payment date in year 2. Moreover, since the employer did not actually make any contributions to charity in year 2 (because the bonus awards were all paid to the employees, since they remained employed on the payment date), the employer had no entitlement to accrue a liability for a charitable deduction in year 1.
Where, as here, employees cannot receive bonuses unless they are employed on the date of payment, the liability for that bonus compensation is subject to a contingency. Therefore, the liability does not become fixed until the contingency is satisfied—that is, when the employee is still employed on the date of payment and receives the bonus compensation.
Further, the IRS pointed out that the all-events test cannot be satisfied before the economic performance occurs. Because the employer’s bonus plan required the employees to continue their service to the company until the date the bonuses were paid, the economic performance did not occur and the liability was not fixed until the date the bonuses were actually paid.
Whether a stock option qualifies as performance-based compensation under Sec. 162(m) is determined at the time of grant, and options with an exercise price of less than the FMV of the stock at the time of grant (i.e., discounted options) do not qualify. In AM 2009-006, 30 the IRS made clear that discounted options that are later repriced, or for which the employee repays the discount, still fail to meet these requirements. As such, none of the compensation attributable to such grants (i.e., the spread on exercise) is performance-based compensation under Sec. 162(m).
As discussed in the memorandum, in 2006 many corporations were found to have issued discounted options as a result of a discrepancy between the purported grant date and the actual grant date. In some instances the options were deliberately backdated with the benefit of hindsight in order to increase the spread on exercise. However, in other instances contemporaneous records to establish the grant date were simply not available.
In September 2006, the chief accountant of the SEC issued a letter to the AICPA advising how the grant date should be determined for financial accounting purposes. 31 It noted that generally the measurement date is the first date on which the individual recipient, the number of shares, and the option price are first known, unless the company operated as if the terms of its awards were not final until its completion of all required granting actions (in that case the completion of all granting actions would be the applicable date). The affected corporations applied the SEC’s measurement date standard in amending their financial statements.
For tax purposes, the IRS’s Large and Mid-Size Business (LMSB) examination process likewise adjusted the taxpayer corporations’ option grant dates consistent with the measurement date articulated by the SEC. AM 2009-006 observed that, under the circumstances, it was reasonable for the LMSB to use the same grant dates for purposes of Sec. 162(m). It cautioned, however, that the measurement date for accounting purposes is generally not controlling for tax purposes and may be less stringent than what is required.
Since the Sec. 162(m) regulations do not provide a standard for determining the grant date, the memorandum advised that it is appropriate for corporate taxpayers to look at the standards under Secs. 409A and 421, which generally set the grant date as the date the corporation completes the corporate action constituting an offer of sale of a certain number of shares of stock to a designated individual at a fixed price per share. Committee meeting minutes or a unanimous written consent, prepared contemporaneously or prior to the intended grant date, provide a verifiable way of determining the grant date. The memorandum stressed that taxpayers are required to maintain adequate books and records in order to prove entitlement to deductions against income.
Although the corporate taxpayers amended their financial statements and tax records to reflect the measurement date as the date of grant, their efforts to similarly reprice the options as of the measurement date did not result in those options constituting performance-based compensation under Sec. 162(m). Because the options had been granted at less than FMV on their date of grant (i.e., on the measurement date), they failed to be qualified performance-based compensation under Sec. 162(m). This would be the case even if the executive reimbursed the employer for the discount or the option was repriced based on the stock’s FMV on that date.
The memorandum explained that none of the options in question had been canceled but instead were subject to a voluntary letter agreement to increase the price of the shares. As noted in the memorandum, if the options had been canceled they could have been reissued at an exercise price not less than the FMV of the shares on the date of reissuance and met the requirements for performance-based compensation under Sec. 162(m).
An employer’s salary advance program required recipient employees to earn out the advances through future services or otherwise make payment in full at termination of employment. In lieu of payment, under the program the employees could offset their outstanding salary advances against their deferred compensation benefit at termination of employment. In addressing the program, the IRS chief counsel cited potential problems with Sec. 409A.
Therefore, amounts that currently or in the future may be offset against nonqualified deferred compensation are treated as payments of deferred compensation and may violate the anti-acceleration rule under Sec. 409A(a)(3).
Failure to comply with Sec. 409A results in the benefit under the deferred compensation plan being included in the recipient’s taxable income retroactive to the year of the deferral, with interest imposed on the past-due taxes at the standard IRS underpayment rate plus 1% and the application of a 20% penalty to the amounts that are included in income. The advice memorandum advised the employer to discontinue the salary advance program or modify the terms of the NQDC plan so that it complies with Sec. 409A.
Alternative amortization schedules: Either a 2 + 7 year or a 15-year alternative amortization schedule can be elected to amortize the shortfall amortization base for an eligible plan year. 36 With the 2 + 7 year schedule, only the interest on the shortfall amortization base is paid during the first two years. An alternative schedule can be elected for up to two eligible plan years; however, if two years are elected, the same alternative schedule must be elected for both years.
Eligible plan years: An eligible plan year is any plan year beginning in 2008 through 2011 for which the due date for the minimum required contribution is after June 25, 2010. 37 Many plans will not be able to use the relief for 2008 plan years because the minimum required contribution due date for 2008 has already passed.
Increased payments: The installment payments under an alternative schedule are increased by the excess employee compensation and the extraordinary dividends and redemptions for the plan year. 38 In the case of a 2 + 7 year amortization, this cashflow restriction applies for the three years beginning with the election year. With the 15-year amortization, the restriction applies for five years beginning with the election year. In any case, the restriction period will begin no earlier than the first plan year beginning after 2009.
On July 30, 2010, the IRS issued Notice 2010-55 42 to provide initial guidance on the election of alternative amortization schedules as currently prescribed under the Pension Relief Act. The notice reiterates the statutory conditions under which plan sponsors can make the election. Among other bright-line requirements, the notice underscores that sponsors can make an election for a plan year only if the due date for the minimum required contribution occurs after June 25, 2010, the date the legislation was enacted. For example, a sponsor may not elect an alternative amortization schedule for a plan year beginning October 1, 2008, and ending September 30, 2009, because the due date for contributions for that year was June 15, 2010. Further, an electing sponsor is required to give notice of such an election to participants, beneficiaries, and the PBGC.
Notice 2010-55 does not answer many of the key questions relating to the relief, including how to make an election to take advantage of the alternative shortfall amortization schedules. But it does respond to one question that apparently has come up regarding whether filing a Form 5500, Annual Return/Report of Employee Benefit Plan, for a plan year will preclude the plan sponsor from electing relief for that year. Notice 2010-55 clarifies that for plan years ending before the guidance is issued, the sponsor will be permitted to elect an alternative amortization schedule regardless of whether the Form 5500 (and Schedule SB, Single-Employer Defined Benefit Plan Actuarial Information) has been filed for the year. Notice 2010-55 instructs plan sponsors to file the Form 5500 (and Schedule SB) in accordance with the applicable deadlines and states that future guidance will address the reporting requirements for electing plan sponsors whose Form 5500 (and Schedule SB) has already been filed.
The notice requirements associated with making an election.
The IRS also issued Notice 2010-56 43 providing similar guidance for multiemployer plans that have filed, or will file, Form 5500 (and Schedule MB, Multiemployer Defined Benefit Plan and Certain Money Purchase Plan Actuarial Information) before guidance is issued.
The IRS released final regulations under Secs. 430 and 436 on determining the value of assets and liabilities for funding purposes and on applying the benefit restrictions to underfunded plans, respectively. 44 The regulations apply to single-employer pension plans for plan years beginning on or after January 1, 2010, although plans are permitted to rely on them for earlier years.
In general, the regulations provide a number of rules for determining target normal cost and the funding target attainment percentage. In addition, special rules apply to the recognition of benefit restrictions, the restoration of missed benefit accruals, post–valuation date amendments, terminated employees, and unpredictable contingent events. In recognition of the fact that many employers will take advantage of these changes, the regulations provide for automatic approval of many of the changes in funding. In addition, automatic approval is provided for a valuation date change and a change in the asset valuation method for the 2008, 2009, or 2010 plan year and for the first plan year to which Sec. 430 applies to determine the plan’s minimum required contributions. Special elections are also available to adjust the prefunding balance and the funding standard carryover.
Divest all other employer securities and reinvest in other investment options after three years of service.
At least three other investment options must be offered under the plan (each of which must be diversified and have materially different risk and return characteristics), and restrictions cannot generally be imposed on the investment in employer securities that are not imposed on the investment in other assets. Defined contribution plans that hold publicly traded employer securities and certain plans holding employer securities that are not publicly traded are subject to the requirements, although ESOPs that hold no Sec. 401(k) or (m) contributions (i.e., hold no deferrals, after-tax contributions, or matching contributions) are excepted if they are separate from other defined contribution plans of the employer under Sec. 414(l). This exception applies because the Sec. 401(a)(28) rules already apply to ESOPs, and an ESOP by definition is designed to invest primarily in qualifying employer securities.
Broader exemption for investment funds. Certain investment funds that hold employer securities as part of a larger fund (e.g., an investment company registered under the Investment Company Act of 1940, a common or collective trust fund maintained by a bank or trust company, or a pooled investment fund of an insurance company) are considered not to hold employer securities if the investment is independent of the employer and the employer securities do not exceed 10% of the fund. 48 The group of investment funds eligible for this exception was expanded to include exchange traded funds that satisfy Sec. 851(a). In the case of multiemployer plans, the group was further expanded to include funds managed by an investment manager within the meaning of ERISA.
Frozen fund exception clarified. Restrictions cannot be imposed on investment in employer securities that are not imposed on investment in other funds. An exception applies for frozen funds. The regulations make clear that an employer securities fund would be considered frozen even though dividends on the employer securities are reinvested in additional employer securities. 50 The regulations also make clear that the frozen fund exception is available only if the plan does not permit additional contributions or other investments to be invested in employer securities (i.e., the plan cannot have another “unfrozen” employer securities fund).
Anti-cutback relief. Some ESOPs have been satisfying the diversification requirement of Sec. 401(a)(28) by distributing a portion of the participant’s account within 90 days after the election period but are now subject to new Sec. 401(a)(35), which is not satisfied by such a distribution option. The preamble to the final regulations explains that eliminating the distribution option would not violate the anti-cutback provisions of Sec. 411(d)(6). It also gives notice that anticipated guidance under Sec. 411(d)(6) will permit the elimination of the distribution option during the current extended remedial amendment period that expires on the last day of the first plan year that begins on or after January 1, 2010.
The final regulations are effective and applicable for plan years beginning on or after January 1, 2011. Until then, plans are permitted to rely on Notice 2006-107, 55 the proposed regulations, or the final regulations in complying with Sec. 401(a)(35).
1 The Patient Protection and Affordable Care Act, P.L. No. 111-149, and the Health Care and Education Reconciliation Act of 2010, P.L. No. 111-152, were signed into law by President Barack Obama on March 23 and 30, 2010, respectively. In this article, these two acts are collectively referred to as the PPACA.
3 The statutory language used for the aggregation rules is verbatim text of the Troubled Asset Relief Program (TARP) restrictions (established under the Emergency Economic Stabilization Act of 2008, P.L. No. 110-343). Both the Joint Committee on Taxation report and IRS guidance confirm that brother-sister controlled groups and combined groups are disregarded in applying the aggregation rules for purposes of the TARP restrictions (Joint Committee on Taxation, Technical Explanation of Title III (Tax Provisions) of Division A of H.R. 1424 (JCX-79-08) at 7 (October 1, 2008); Notice 2008-94, 2008-44 I.R.B. 1070, Q&A-1(b); Sec. 162(m)(6)(C)(ii)).
4 Notice 2010-6, 2010-3 I.R.B. 275.
5 Notice 2008-113, 2008-51 I.R.B. 1305.
6 Notice 2008-115, 2008-52 I.R.B. 1367.
21 Regs. Secs. 1.6039-1(a) and 2(a).
22 Regs. Secs. 1.6039-1(b) and 2(b).
24 Regs. Secs. 1.6039-1(a) and (b).
27 A summary of the new requirements and a link to the 129-page final rule are available online.
29 Sec. 461(h) and Regs. Sec. 1.461-1(a)(2)(i).
31 Letter from Conrad Hewitt, Chief Accountant, SEC, to Lawrence Salva and Sam Ranzilla (September 19, 2006).
32 Chief Counsel Advice (CCA) 200935029 (8/28/09).
35 Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act, P.L. 111-192.
36 Sec. 430(c)(2), as amended by Pension Relief Act §201.
37 Sec. 430(c)(2)(D)(v), as amended by Pension Relief Act §201.
38 Sec. 430(c)(7), as amended by Pension Relief Act §201.
39 Sec. 430(c)(7)(F)(i), as amended by Pension Relief Act §201.
40 Sec. 430(c)(2)(D)(vi), as amended by Pension Relief Act §201.
41 Sec. 436(j)(3)(A), as amended by Pension Relief Act §203.
42 Notice 2010-55, 2010-33 I.R.B. 253.
43 Notice 2010-56, 2010-33 I.R.B. 254.
45 Pension Protection Act of 2006, P.L. 109-280.
47 REG-136701-07. For more on the proposed regulations, see Walker, LaGarde, and Haberman, “Current Developments in Employee Benefits and Pensions (Part II),” 39 The Tax Adviser 816 (December 2008).
55 Notice 2006-107, 2006-2 C.B. 1114.
Deloitte Tax LLP in Washington, DC. For more information about this article, contact Ms. Walker at debwalker@deloitte.com.

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